Dollar, Yen, and Swiss Franc Firmer In Thin Holiday Trading

Highlights

US dollar was mostly firmer vs. the majors as the risk off trading environment carried over from last week, albeit in thin holiday trading.  Yen and Swiss franc were largely firmer, while EM FX was mixed.  Biggest gainers on the day vs. USD were PLN, RON, MYR, KRW, and TWD, while biggest losers vs. USD were SEK, BRL, GBP, CLP, and CAD.  ECB, BOE, and RBA meetings this week offer some event risk, though no policy changes are expected (see below).  Turkey CPI was lower than expected, and should allow the central bank to remain on hold for now.  Peru central bank intervened aggressively to prevent PEN strength.  Bank Indonesia kept rates steady at 6.5%, as expected.  South African government workers may strike over a pay dispute.  Hungary YTD budget gap exceeded the full year target after only 6 months, and should help keep downward pressure on the forint.  Brazil analysts boosted year-end policy rate expectations to 12.125% from 12% last week and 11.75% last month, and likely to head even higher in the coming weeks due to strong data.

US equity markets were closed.  European markets were lower, with Euro Stoxx 50 down 0.6%.  Nikkei futures point to a down Japan open, and the strong yen should hurt Japan exporters.

US bond market was closed.  European bond markets were mostly higher, as 10-year yields in UK, France, and Germany were down 3 bp, 6 bp, and 4 bp, respectively.  Greek 10-year yields fell 3 bp, Portugal fell 6 bp, Italy fell 1 bp, and Spain rose 9 bp. 

Currency Markets

The Bank of England and the European Central Bank are both holding their regular policy meetings on Thursday and while a no-change interest rate outcome is most likely from both central banks this month, the central banks are facing different policy dilemma at this stage of the cycle.  At the Bank of England, interest rate hikes have already been discussed at the June MPC meeting.  Andrew Sentence voted for an immediate monetary policy tightening last month and policy remarks since the meeting suggest that his bias to raise interest rates could well be maintained this month.  While acknowledging a tighter fiscal stance, Sentence notes that the recent budget unveiled a fiscal tightening broadly in line with expectations and with most of the tightening coming in the outer years.  He also believes that the UK economy has turned the corner and focusing on nominal demand, the current 6% growth rate is above the historic trend in place before the crisis.  In an inflation targeting monetary policy framework context and considering that UK CPI has been reported above the 2% inflation target for six consecutive months, Sentence’s case cannot be ignored.  It would appear that at this point, his view is a minority view on the MPC  as seven of the other MPC members on board at the time of the June meeting favored to keep policy on hold and to assess the extend to which the budget would affect the near to medium term growth profile, hence inflation prospects.  Since then, question marks over the global recovery have intensified.  Martin Weale (formerly a Director of the National Institute for Economic and Social Research) has just been appointed as a new external MPC member (to replace Kate Barker).  The latter voted for an unchanged monetary policy outcome at his last meeting on the shadow MPC and he will probably be in the wait and see camp for now.  Note that the shadow MPC voted 7-2 in favor of a no-change monetary policy outcome this month (versus 5-4 last month), capturing growing concern over the international scene.  The time for rate rises may not have come yet in the UK, but in the wake of recent domestic economic news (in particular on the inflation front), comments from BoE members and latest MPC meeting minutes, we note that i) the MPC will start raising interest rates before it contemplates withdrawing any of the QE (£200bn so far) in place, ii) the first rate rise will be seen earlier than initially anticipated and possibly before year-end and iii) the case for a rate rise is stronger in the UK than in the euro zone and the BoE will most likely start raising rates before the ECB. 

At the European Central Bank, rate hike discussions will remain off the agenda for the foreseeable future.  In fact, some would even argue that there is still a case for delivering further QE (the ECB is reluctantly buying sovereign bonds at an average pace of a €1.5 billion a day), in the euro zone economy. We believe that the ECB remains reluctant to do so and is unlikely to play the QE card at this point, but ECB chief Trichet will most likely confirm that the monetary authorities will stick to the approach of making sure that ample liquidity will stay available should the need arise.  A need for assistance from monetary policy could also emerge later this month as Spain rolls over Eur25bn of its debt.  The bottom line is that the ECB will not release further monetary stimulus unless market conditions deteriorate further.  From an economic perspective, there is no sense of urgency when it comes to normalizing the monetary policy environment.  Inflation is very well contained (see CPI yearly rate running at just 1.6% y/y in June) and monthly economic indicators have pointed at a still very sluggish recovery and a geographically uneven economic climate.  The various austerity measures undertaken in the periphery countries will only exacerbate those geographical discrepancies.  All this is in line with our view that the ECB is no where near normalizing interest rates and a rate rise seems unlikely this year.  If anything, it is QE talks that could resurface at some point, even if that would not be the ECB’s favored scenario.  The respective ECB/BoE monetary policy outlook is consistent with our bearish near to medium term outlook for EURGBP.  The cross has recovered from last week’s low, but we are of the view that this provides good selling opportunities.  Medium-term investors should look to enter fresh short positions in the 0.8280/0.83 region, with near-term support at 0.807 (June low) and the psychologically important 0.8000 support likely to be tested.  Our updated quarterly currency forecast show EURGBP at a low 0.75 by the end of Q211.

CFTC data shows that for the week ended June 29, speculative bets on a stronger US dollar were overall lower.  Net short euro positions rose to -73,670 from -70,974, Swiss franc net shorts increased to -12,848 from -10,265 previously, while sterling net shorts fell to -34,771 from -46,346 previously.  AUD net long positions rose to 12,854 from 11,806 previously, CAD net longs fell to 15,894 from 26,353 previously, and NZD net longs rose to 2,486 from 822 contracts previously.  MXN net longs increased to 42,496 from 35,639 previously.  Yen net longs rose sharply to 27,427 from 3,630 contracts previously, the biggest net long since early March.  With the yen firmer since the start of last week, net yen longs should increase further in the next weekly report.     

Upcoming Economic Releases

Asia: Philippines CPI; Australia trade, RBA meeting; Japan leading index Europe/EMEA: Swiss CPI Americas: US non-manufacturing PMI; Canada building permits.  No US speakers of note.