IB FX View

Your move, comrade

Wednesday June 10, 2009

It’s tempting to lead today’s commentary with an observation about how the dollar fell apart following comments from the first deputy chairmen of the Russian central bank concerning a flight out of U.S. government debt. However, that claim is hard to prove with the euro now trading down on the day at $1.4036. Perhaps it would be easier to prove that Bundesbank president Axel Weber has once again been drinking battery acid as he reportedly discusses raising interest rates early in the cycle at a time when the Eurozone is in contraction, inflation is worryingly low and it’s increasingly hard to determine whether rising unemployment trumps the state of the German banking system. The dollar index has shed earlier losses with today’s news.

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The comments from Bank Rossii need to be put in perspective as we try to remove the apparent nail in the dollar’s coffin, ham-fistedly driven home earlier today. The Russians do have around $400 billion held in international reserves according to their May balance sheet. About 30% of those reserves are dollar denominated in U.S. treasuries, which means we’re talking about perhaps $135 billion. Yet the sum under the spotlight today is a mere $10 billion, which is the amount mentioned in a late May speech by Finance Minister, Alexei Kudrin who said that $10 billion worth of Russia’s foreign reserves would be devoted to purchasing IMF bonds. So we’ve shrunk from $400 billion to just 7.4% of $135 billion to yield a $10 billion dollar debacle. Did anyone ever mention that the daily forex market turnover is $3.4 trillion?

For sure it makes no sense to discount the need or likelihood of a viable alternative to the dollar’s reserve status over time. But one also needs to keep the chatter in perspective and look at the deeper situation. The early story was one of dollar-panic and rising yields. Perhaps in preparation for today’s $19 billion 10-year government note auction has more to do with why yields are rising than the $10 billion Russian purchase of IMF bonds.

Speaking of rising yields, the MBA reiterated the elasticity of mortgage demand to rapidly rising financing costs earlier today. U.S. mortgage applications last week fell to the lowest reading since February with a gauge of new purchases rising 1.1% while the refinancing gauge shed 12%. And with average 30-year fixed rates at the highest since November at 5.57% one can understand the reticence to buy a home especially with prices still in decline. Today’s rise in bond yields is confined to the long end and not the short term interest rate complex (STIRs) where investors seem to have swallowed the quirky U.S. employment report last week, which many feel argued for higher fed funds rates.

There was very little to read about in the U.S. trade deficit this morning. The level of April exports from America was at the lowest reading in three years as the overall trade deficit widened marginally to $29.2 billion according to the Commerce Department. Demand for American made goods and services fell at a sharper rate than demand for imports from overseas. Looking ahead the ongoing inventory correction is likely to prevent a rapid boost to the role of trade in the overall growth report.

The Canadian dollar, or loonie, shed earlier crude oil related gains as Statistics Canada flawed investors with a trade deficit of C$179 million rather than the expected C$1 billion surplus. This report comes as something of a mystery in light of record advances for commodity prices during May and we’re keeping a beady eye out for explanation under the headline, “where did all the loonies go?” The Canadian dollar this morning buys 90.04 U.S. cents after closing at 90.53 on Tuesday.

Meanwhile a consumer survey conducted during the first week of June released by Westpac Banking Corporation and the Melbourne Institute came in at 100.1 today. This report marks the first triple-digit reading since January 2008. The Aussie continues to ride the crest of that wave and today buys 80.35 U.S. cents.

The British pound is just rounding off an excursion to $1.6474 in Wednesday’s session having dropped more than a cent since. Earlier in the day equity prices rose sharply following the first expansion of industrial production in over a year. Forecasters continued to see contraction but were surprised with a 0.3% advance. The euro continues to lose ground to the pound and today buys 85.68 pennies.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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