IB FX View

Pound weakens as unemployment rises

Wednesday June 17, 2009

The stand out loser in today’s currency trading is the British pound, which has lost almost two cents to $1.6267 and weakened to 85.29 pennies against the euro. The Japanese yen meanwhile continues to outpace the U.S. dollar rising to 95.89 as expectations over any change to the Fed’s rate policy are factored in, which favors the Japanese unit. Weakness in U.S. consumer prices is holding back the dollar from building on yesterday’s gains.


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Two events have eroded the appeal of the pound sterling today. First, a rise in the number of jobless of 39,300 carrying the core measure to a total of 1.54 million masks a broader loss of 232,000 jobs making for a bigger total of 2.26 million people out of work. On the latter measure the trade and industry group, the CBI expects the number of unemployed to easily breach the three million mark in the first quarter of 2010.

Second, minutes from the June 4 Bank of England MPC meeting left investors in no doubt that the Bank means business with its chilling rhetoric about the fragile state of economic recovery. Rising equity markets might be an isolated barometer of investor sentiment. We feel such fervor is at odds with reality, and apparently so do the Bank’s members. Today the message from the minutes showed that it’s way too early to slow down or alter the pace of asset purchases in the economy. We’re unclear why this is having such a negative effect on the pound today given that it’s hardly unknown that the recovery is fragile. The Bank continually warns us about that.

While headline consumer prices are proving sticky at 2.2% year over year, an article dissecting the data pointed out that thanks to far lower comparable energy prices today against those of one year ago when crude oil reached $147.12 per barrel, British consumers are seeing a relative boost to incomes of around 10% compared to a year ago. The other major factor comes courtesy of lower interest rates, which have the effect of sharply reducing monthly mortgage payments.

The U.S. Labor Department delivered the weakest 12 month reading for consumer prices since 1950 today. Monthly consumer prices rose at a 0.1% pace and on the measure that includes volatile food and energy components, prices actually declines over the year at a 1.3% pace. Ex-food and energy the annual price increase registered a 1.8% gain. While oil and gasoline prices were sharply higher one year ago and impacting the reading positively this month, it’s important to realize that recent gains in gasoline prices are effectively reducing workers disposable income.

Research by economists last week at Morgan Stanley points out that by making the assumption of a $2.75 peak in gas prices, consumers will pay $50 billion more this year for gasoline at the pump. That’s almost identical to the tax handout from the Obama administration this year. Retailers struggling to maintain sales in the face of rising unemployment will find it very difficult to raise prices to consumers. Yesterday the Federal Reserve pointed to the lowest rate of industrial capacity utilization since record-keeping began in 1967, further indicating that the current degree of slack across the economy. Such a position makes it rather hard to argue for rising prices in such bad economic weather.

The dollar continues to look strong relative to the euro on a fundamental perspective after earlier in the week ongoing warnings over both the state of health at German banks and more losses to come. While the dollar is broadly stronger today, its performance against a stronger euro mirrors that of yesterday in which early euro optimism is sold into and evaporates throughout the trading day. It won’t surprise us to see the dollar take out yesterday’s lows against the euro, while in the bigger picture we’re more confident about seeing $1.35 than $1.40 from here.

Gains for Asian equities overnight helped investors muster their recently tarnished appetite for the Australian dollar. Meanwhile, New Zealand central bank governor, Alan Bollard chided investors for buying his local dollar in expectation of buying into a domestic recovery. Recently, Mr. Bollard has lashed out against the strength of the New Zealand dollar as he indicates that such currency strength suffocates any sign of recovery especially for the domestic exporters. The Aussie today buys 78.63, while the Canadian dollar is lower on the back of recent declines in the price of gold, although the precious metal is higher today. But the weakness of energy and equity markets is sapping investor appetite for the Canadian unit, down to buying 87.38 U.S. cents today.

What’s unusual today about the plight of the greenback is its strength despite a heavily cited Bloomberg news article describing how the Fed might use next week’s FOMC statement to bash interest rate expectations out of the ballpark. On the one hand we are seeing Japanese yen strength as a direct result of this argument, but the dollar’s late morning momentum in the face of a reduction in expectations of higher yields soon, is remarkable. As bonds and Eurodollar interest rate futures were heavily sold last week, expectations for a November FOMC meeting hike surged close to 70%. Now the odds are back under 50% but the Bloomberg article predicts that the Fed will want to communicate a vehement message that the committee members are no where near the point of tightening monetary policy. Quite right too. We feel that they will make comments to the extent that during the period between meetings, money market participants over reacted to certain news and began to force spreads and implied forward rates to places they should not go under current economic circumstances. Government bond yields are lower again today following the consumer price report and bolstered by the sense that might prevail if the Bloomberg nugget turns out to contain gold.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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