IB FX Brief

Conflicting forces create a currency melee

Thursday February 18, 2010

The U.S. dollar changed course sharply during mid-morning trade in New York after reaching a nine-month high against the euro this morning. Recent gains for the dollar have come on the heels of rising risk aversion. The smoother handling of Greek sovereign debt disarmed euro currency bears of their claws and allowed a broader asset class rally that undermined the dollar. However, the global recovery continues to take new twists and turns influencing the world of currencies any way you choose to see fit. It’s no longer the fear of weathering a deep recession that’s gripping investors. Hindsight indicates the exit several quarters ago. The question now is whether the newborn recovery has the will to stand on its own two legs as its parents consider packing up unwanted items cluttering the nursery. There is a curious sensation that global economies are slowly being weaned off emergency measures, which has created a new dynamic in currency trading.


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U.S. Dollar – The dollar took a prolonged boost from midweek minutes released from the Federal Reserve taken when the FOMC began to discuss raising the discount rate and reducing its 28-day lending facility to banks to overnight loans instead. The committee deemed such a move as “soon to be appropriate.” Until now the Fed’s quantitative strategy has centered on purchasing mortgage, corporate and government bonds in an effort to revive the clogged arteries of the financial system. Although its strategy is working it comes at the cost to the Fed of a severely swollen balance sheet. The January minutes revealed the desire by some FOMC members to sell some of those assets partly due to the hazardous problem that concentration on the housing market could leave the Fed under political pressure to channel funds to other problematic parts of the economy.

The discussion comes on top of Kansas City chief Hoenig’s appeal at the time of the statement in January to adopt flexibility towards abandoning almost-zero interest rate monetary conditions. The broader balance sheet discussions at the Fed raised dealers’ perceptions that the there is a groundswell of support for casting off the chains of monetary and quantitative stimulus measures faster than the market felt. Immediately this forced dollar yields higher and elevated the view that the dollar would benefit from an economic upswing faster than other nations.

The risk from here is that investors lose sight of the reality that the economy is growing only at a tepid pace. Initial jobless claims earlier today showed an unexpected 473,000 reading while continuing claims were also revised higher from last week. If anything, last week’s initial claims might have been felt the impact of lower signings due to adverse weather conditions.

In other data, inflationary pressures at the factory gate increased at a faster rate than was expected. Monthly January producer prices increased at almost twice the forecast pace coming in at 1.4% to give a year-over-year increase of 4.6%. Excluding volatile food and energy the data showed a 1% annual increase. Overall in conjunction with weaker labor market data, the stronger inflation data is a bad mix for the dollar.

Canadian dollar – The Canadian consumer price index also revealed underlying strength in prices today. After a monthly decline of 0.3% in December, January data reversed by the same magnitude to deliver an annual 1.9% rise in consumer prices. The Bank of Canada’s core CPI measure therefore came in at 2% and one-third higher than in December. This is a significant development for the Canadian dollar, which rallied on the data as high as 95.89 U.S. cents.

Many quarters ago the BoC Governor promised to leave interest rates at near-zero until the end of the second quarter of 2010 with the caveat that inflation remained stressed. Official predictions for the path of inflation have CPI at the central bank’s 2% target by the third quarter of this year. The premature return to the target rate at the very least serves as a reminder that June really isn’t that far away.

Economic recovery in Canada is partially due to improved conditions in its biggest market south of the border. Demand for its natural resources in the form of gold, crude oil and a variety of base metals has also fuelled demand for the Canadian dollar. But during 2009 investors wanting to diversify their holdings away from U.S. dollars and perhaps the euro, chose Canada is its favored destination. Data released today reveals that investors feasted on more than C$109 billion worth of Canadian assets led by fixed income. The number is more than twice the previous record allocation, which is why today I raise the notion that currency direction is a little more complicated than simply favoring the American dollar because it might be first to the exit in terms of emergency stimulus measures.

British pound – The pound slid on a second day of bad data on Thursday and headed towards $1.5555. Following unexpected weakness in labor data, the pound was held hostage to the largest January budget deficit since public record-keeping began in 1993. The £4.3 billion shortfall is significant since January is that time of the year when corporations pay taxes due to the government, indicating weakness in company revenues. The prediction was for a government revenue surplus after spending of £2.6 billion, which is why the market got into such a tizzy earlier today. The pound leapt aboard the euro’s recovery train after the U.S. data and rebounded to its current $1.5640. On a more positive note for sterling the broad monetary measure, known as M4, expanded at a healthy monthly pace of 0.6% to give an annualized pace of growth of 5.6%.

Euro – The euro continues to wander aimlessly around the global map. In a sense the collection of European ministers has done well in pulling the rug from beneath the feet of the unruly forex market, which earlier smelt blood. But the market tugged back midweek leaving the euro looking vulnerable once more. Having based at $1.3540 earlier the euro went on to hit $1.3654, justifying its wandering description above.

The euro wins over the pound today and purchases marginally more of the British unit at 87.04 cents. Against the yen the euro is at a roughly unchanged ¥124.14.

Aussie dollar – The Aussie continues to toy with the 90 U.S. cent mark and has reversed earlier in the day losses against the dollar to 90.03 cents. The Aussie declined to around 89.40 overnight taking its tone from weakness in the euro and an announcement from the IMF that it would “shortly” commence selling some of its holdings of gold bullion. Gold is Australia’s third largest export product.

The fall in the Aussie was also tempered by comforting words from the Deputy Governor at the RBA. Philip Lowe noted that China’s ambitions to build out its infrastructure would demand “extraordinarily high levels of investment” and had “decades to run.” This reminded investors of the likely longevity of the relationship between Australia and China, which in turn will benefit its local dollar. 

Japanese yen –The Bank of Japan failed to tow the line thrown out to sea by Finance Minister Kan who asked for further measures from the BoJ aimed at assaulting the threat of deepening deflation. The Bank instead maintained both its benchmark interest rate policy and the pace at which it buys financial assets. The yen reached a four-week low against the dollar yesterday at ¥91.39, which inspired exporters to buy. This morning the dollar blasted above here despite that mid-morning weakness noted above and reached ¥91.50.    


Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       


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