IB FX View

Japanese support for dollar assets trumps Chinese data

Friday June 12, 2009

The dollar is making weekly gains ahead of the Italian G8 summit at the weekend as some investors perhaps rein in short dollar positions for fear of warnings over dollar weakness should the world’s richest nations deliver a communiqu The reaction came after a strong 30-year U.S. government bond auction, which struck a chord with overseas central banks and helped remove fears over rising global yields driven by an escalating budget deficit. Comments from a Japanese official over faith in American policies also diverted eyes away from strong Chinese data. The euro is lower at $1.3970 while the Japanese yen is weaker against the dollar at 98.18 but has reversed course against an earlier move on the basis of increasing prospects for risk appetite across Asia.


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The driving news this Friday is the story concerning commentary from Japan’s Finance Minister, Kaoru Yosano whose conclusion that his nation’s confidence in U.S. government debt is “unshakeable” has boosted appetite for the dollar.

On Thursday U.S. yields continued a March higher sending the benchmark 10-year treasury yield to 4% for the first time since November, as bond dealers prepared for an $11 billion 30-year auction. The auction results say half of the purchases come from what’s called indirect bidding, which is comprised of buying on behalf of other central banks. The recent dollar scare story doing the rounds that so-called BRIC nations are set to start buying IMF bonds instead of U.S. government debt has a different and less fretful bias in light of these recent events.

On Thursday former Fed chairman, Paul Volcker reiterated the official strong-dollar stance of the U.S. administration. But the manner in which he concluded his comments left us feeling that the only way to achieve a strong dollar was by pursuing the right policies. Various administration and central bank comments from the U.S. recently have left us feeling that each department is trying to pursue the right policy in a conservative and responsible manner. Mr. Volcker’s comments taken in that manner could be interpreted as stating that there is no deliberate intention to pursue any policy that would debase the currency. Maintaining a strong dollar thus continues to require conservative and prudent policies.

Mr. Yosano noted that the dollar’s position as the world’s reserve currency isn’t under threat and supports Mr. Volcker’s line of reasoning as well as his country’s decision to stand by U.S. assets. He said, “we have complete trust in the fact that the U.S. views its strong-dollar policy as fundamental.”

The Yosano interview trumps overnight government statistics from China showing a surge in lending, output and sales. Traditionally such expansion would feed the commodity rally and increase investors’ appetite for Aussie and Canadian dollars. That’s not happening today with both trading down against the greenback in light of a rejection of seven-month highs for the price of crude oil this morning. Today’s story is sending investors back into U.S. dollars and fixed income fuelling lower yields and more confidence in the dollar.

Chinese bank lending doubled in the year through May to a $97 billion Chinese yuan equivalent after the central bank lifted lending restrictions at the time it announced its fiscal stimulus plan. Industrial output has surged as a result and grew 8.9%, while retail sales were also 15.2% higher than last May. The news rounds off a positive week for China’s economy after fixed asset investment grew by one third through May. However, the silver lining brings a cloud in this case.

Economists observing China’s reflation as the government encourages borrowing to fuel spending, arguably to prevent falling consumer prices, are raising red flags at the potential for a surge in nonperforming loans going forward. In addition the surge in money supply values is fuelling concern over an outburst of inflation. It’s important to note the distinction here between loans and boosting a central bank’s balance sheet. The Fed is not printing money, rather it’s borrowing it. In China, the banking system is raising those little red flags as it lends hand over fist to anyone filling out a loan application.

The Aussie dollar is weaker against the dollar today buying 81.07 U.S. cents, while the Aussie buys less yen at 79.69 this morning. The Canadian dollar is also weaker buying 89.35 U.S. cents after Mark Carney at the BoC indeed reiterated his views that a 13%-three-month rally in the unit stood in the way of sustained economic recovery.

Sterling has regained some earlier losses against the dollar and buys $1.6455 after Bank of England Markets Director, Paul Fisher noted the likely speed bumps along any recovery road if banks can’t spur lending. It seems that this threat is becoming a realistic theme in Britain. The Bank also noted that the decline in home values has likely left 1-in-10 homeowners with a mortgage greater than the value of their house.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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