IB FX View
Investors slow to figure out China’s motivation
Wednesday January 13, 2010
The dollar is once again in distress after a torrid Tuesday in which a visitor from another planet might have been excused for inaccurately predicting that Chinese growth had slowed remarkably. The move by the central bank to lift reserve requirements held by banks is aimed at curbing excessive lending in the face of a speedy recovery. The dollar is also fighting off challenges from European currencies today, despite their many warts and spots, while commodity linked dollars are a little slower to react but are nevertheless making a comeback.
Investors yesterday were swift to prejudge the rationale for Chinese action. The response smacked more of a rapid falloff in the pace of growth rather than a measure to calm a raging bull. When the dust has settled veteran investors will be sharp to recognize that the commodity bull market is likely intact and that this is likely a dollar negative factor. Indeed, it is the success of earlier policy actions that have created buoyant economic conditions that has forced the central bank’s hand. At this stage weaker Chinese growth should not yet be a cause of market anguish, nor is it yet assured.
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U.S. dollar – Philadelphia Fed chief Charles Plosser in typical hawkish form said that the Fed should act well in advance of a turn in the fortunes for the employment situation in terms of adjusting monetary policy. It’s not the first time this has been said and had Friday’s payroll data been anything other than weak, Mr. Plosser’s words would have already impacted bonds by more than they have. Still, the dollar has lost any sense of momentum from these earlier comments.
As investors get to grips with the Asian fallout some factors are becoming clear. The demand for commodities remains strong and that is likely to undermine the dollar. It’s also awkward to conclude that the sharp fall in Asian markets reflecting European and American declines is hardly a move towards risk aversion, at least in the fashion investors became accustomed to a year ago. This is more of blowing the froth off the markets. As such dollar demand as an alternative is not a meaningful factor, which is possibly why the dollar is on the rack this morning ahead of the Fed’s Beige Book later this afternoon. The purpose of this book is to survey the Fed’s 12 districts so that the collective FOMC can make an informed decision on monetary policy in light of regional conditions. We will undoubtedly see creeping improvement in economic conditions around the nation, nothing to shout home about, and without justification for a change in official policy. Investors will be reminded that a creeping pace of recovery won’t force the Fed to provide a fillip to yields in this half of the year for now, which is likely to see a continued unwind in appetite for dollars.
Japanese yen –The dramatic headlong rush into the Japanese yen as a result of the Chinese measure to stem lending caused a dramatic covering of short Japanese positions. Large speculative positions were taken off the table, which is why the yen rose so far and currencies such as the Australian dollar fell so hard. The near 4% yield differential, along with the fact that Australia’s economy is clearly hitched to the Chinese locomotive, is strong rationale for risking a short yen and long Aussie combination. So you can easily see why investors sensing any change in that picture were swift to close the window yesterday. The rush into the yen was more of a short-covering exercise and is largely over. At ¥91.17, while the dollar is still higher on the session, the yen is rallying off its lows.
Aussie dollar – After falling to 91.75 U.S. cents on Tuesday as investors said “See ya mate!” to the Aussie, it’s trying pretty hard to recoup those losses and stands at 92.57 cents this morning. The move higher is certainly not meteoric, which is what we’re seeing for core European currencies so far this morning. In effect the Aussie is being treated with kid gloves, but it certainly looks like it’s on the mend.
Canadian dollar – Crude oil is lower as distillate inventories show ample supply for a cold winter, while gold is now higher on the session. As investors shrug off notions of a Chinese led global downturn, the Canadian dollar suddenly finds its appeal once more. Today it’s higher at 96.70 from 96.18 U.S. cents at Tuesday’s close.
British pound – I spoke some days ago about the undervaluation of the pound and almost immediately the pound perked up as if others were thinking the same. However, it found it hard to blow off the winter blows and traded either side of $1.60 to the dollar. But this morning, and I’m not sure entirely what’s behind it, the pound has reached lift off as it soars towards $1.6300, which would be the first time in four weeks. I would hazard a guess that several shorts have been steamrollered out of the way on today’s move, which followed a relatively upbeat report for U.K. industrial production for November. Still, this is old data and I wouldn’t blame the rally solely on this single number.
In other news, policymaker at the Bank of England, Andrew Sentence, said in an interview that the Bank was close to being able to hold back on stimulus measures. Notably of late, while the euro was winning against the dollar, the pound was doing better against the euro and today it’s at a nine-day high to its European neighbor.
Euro – At its best since mid-December, it would appear that investors are back on board the euro train today. I have recently knocked the notion that worries over sovereign risk are overdone regarding the impact on the core of the ‘zone. While that view is today bolstered by the words of the Greek PM in a German newspaper interview, to me it appears that there is insufficient follow-through momentum from euro bears betting that the euro will come under further pressure. When momentum wanes you have to be ready for a snapback, which often comes a day or two ahead of when you first conceive the notion. It appears that Mr. Papandreou’s declaration that there are no more skeletons in the closet is one less reason to be a euro skeptic. He also said his nation now has a solid basis for cutting the national budget deficit.
Elsewhere the German economy shrank 5% in 2009 according to GDP data reported earlier today. While this was sharper than the predicted 4.8%, I think investors have an eye on better things ahead for 2010 rather than being bothered by 2009.
At $1.4564 the euro is higher on yesterday’s $1.4495 close. It’s also higher by over one yen at ¥133.15 while lower against sterling at 89.50.
Senior Market Analyst firstname.lastname@example.org
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