IB FX View
Time for a rethink

Monday May 11, 2009

The week begins with investors shunning the recent and more populist view surrounding the economic turning point. Instead they are taking a more plain-vanilla position that the inflection point is nothing more and nothing less, and that it does not necessarily signal a return to economic prosperity. The euro is a little on the defensive having reached a seven-week high against the dollar and today starts the week a little lower at $1.3619.


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ECB president, Jean Claude Trichet chaired a meeting of other central bank governors Monday and made some interesting observations. While being ‘encouraged’ by the current inflection in the rate of economic growth, he noted that it was ‘no time for complacency.’ Should growth actually return, Mr. Trichet noted that this might be a queue for central banks to retract some of their support for domestic economies. But in the meantime central banks will couch their economies with extraordinary measures for as long as necessary. He also pointed to a reduction in bond credit spreads and easier interbank cash rates as signs of improvement.

The euro notably rebounded in March hot on the heels of the Fed’s announcement of the purchase of $300 billion in treasuries. Its latest rebound came after the pace of U.S. job losses slowed, instilling recovery hopes. So one jump stemmed from measures put into place to mend the world’s largest economy, while the other was a sign of potential success. The euro’s real strength here is that it has got away with not becoming subject to quantitative easing, and investors are clutching at some very short roots attached to green shoots. Last week’s ECB announcement that it would buy €60 billion of high-grade corporate debt was well short of the scope of either British or U.S. quantitative measures.

So the focus this week, which will make or break the medium-term fortunes for the euro, will be the reality check on what the current data means and especially whether it confirms or refutes the turn in the economy. We note three early strands of evidence as key drivers. First, industrial production in both France and Italy contracted at a deeper pace than had been expected. This news is the exact opposite of what investors have been getting excited about in recent weeks, the entire world over. Second, in Britain investors are braced for more of the same in terms of manufacturing weakness. In addition the RICS is expected to deliver ongoing pessimism on house prices. Again this will fly in the face of a one-month and very much out-of-place rebound last month. Third, Australian business sentiment declined at the margin in a release today. At minus 14, the picture is still one of more pessimists than optimists and today’s slight down turn hardly builds on all of the recent data that has created so many glimmers of hope.

Both the Aussie and Canadian dollars are off compared to last week’s strength against the U.S. dollar. This follows a more sober assessment for crude oil and metals prices after the recent bullish streak, lifting rates to a seven-week high.

Equity markets have taken their queue from what Europe’s largest bank, HSBC had to offer in its latest results. The bank may have made an astounding amount of money but the problems remain. An adjustment of the reading of the fair value of its own debt allowed under accounting rules lifted earnings, while the bank appears to have shaken investors’ optimism as it had to lift provisions for its worsening U.S. mortgage business while stating that its credit card operations were also struggling. The icing on the cake from the release was that 2009 will remain a tough year. Hardly in keeping with a turn in growth rates.

Andrew Wilkinson
Senior Market Analyst ibanalyst@interactivebrokers.com

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