Risk Appetite Recovers

From the BBH Currency Strategy Team.


The US dollar is mostly weaker vs. the majors as risk appetite creeps back in the wake of yesterday’s impressive recovery in equities after the very weak US data. EUR/USD still had trouble moving above 1.27. The yen and Swiss franc are largely weaker today as well. Market sentiment remains jittery, however, and so we expect further swings in market sentiment as we move into September. EM currencies are largely firmer. Biggest gainers vs. USD so far today are HUF, PLN, SEK, GBP, and KRW, while the only loser is IDR. US data out today (weekly claims) could see another hit to sentiment. While normally a minor data release, weekly claims are being watched closely due to ongoing weakness in the labor market and another 500k number would not be taken well. For next Friday, market is looking for +46k private sector payrolls in August vs. +71k in July, which would continue the weakening trend in the US economy. Market is still looking for around 2.5% growth in Q3, but if August data remains as weak as July, then we will likely start to see forecasts dropping down to the 1.5% area.

Asian equities were higher, with the MSCI Asia-Pacific Index posting a 0.5% gain today. Philippines and Malaysia outperformed on the day, while Hong Kong, Korea, and Taiwan underperformed on the day and ended lower. Nikkei 225 posted a 0.7% rise, but remains below 9000. European bourses are trading higher so far today. US shares are looking for direction, as futures trading points to flat opens for the major US indices.

Core euro zone bond markets are slightly softer due to the easing today in risk aversion. Peripheral spreads to Germany have narrowed slightly today but remain very elevated. The Ireland-German spread is flat at the record high +344 bp. Portugal, Greece, and Spain 10-year spreads are narrower 1-2 bp. US Treasuries remain firm on the flight to quality trade, with 10- and 30-year yields down 2 bp on the day. Ireland and Hungary debt auctions went OK despite negative developments this week in both countries.

Currency Markets

The euro saw another bounce vs. the dollar during the Asian session but was again unable to significantly breach the 1.27 area. Stronger than expected German GfK confidence may have helped, along with the return of some calm in the peripheral bond markets. The overall GfK index rose to 4.1 vs. expected 4.0 and a revised 4.0 (was 3.9) previously. The meeting later today of major global central bankers at the Jackson Hole symposium in the US has dampened some of the jittery selling of risk assets and currencies, amid hopes that policy-makers will reaffirm commitment to policies that support the global economic recovery (more below). We remain of the belief that given divergence being seen this week between the euro (firmer) and peripheral spreads (wider), something has to give. And we would put more likelihood that the euro will play catch-up and weaken rather than on the chances that stresses in the peripheral countries eases and spreads narrow. Regular readers will know that we remain negative on the periphery due to likely downgrades and recession in the coming quarters, and this week’s Ireland downgrade is a simple reminder not to get too bullish on Europe right now.

The yen remains softer today after Japan officials this week intensified their jawboning about possible intervention measures. However, today’s trading is due more to risk appetite returning than to actual intervention fears. As we’ve said before, any intervention would likely be unilateral and thus likely to be ineffective. The Jackson Hole Symposium brings together senior central banking officials from around the world, but those looking for any concrete cooperation are likely to be disappointed. Given that officials in Europe have had trouble coordinating policy this year (see Germany’s handling of the naked short ban), how can markets expect an even greater degree of international cooperation? No, for now it’s clear that G3 policy-makers (US, Japan, euro zone) are at this point acting to maximize their own utility (unless we were to see another big leg down in the global economy). For now, it’s steady as she goes. In our view, the strong yen is simply not the threat to global growth that it might once have been (see 1995, when G7 issued statement calling for orderly reversal of the weak dollar/strong yen), and so it’s unclear why the US or Europe would be dragged into intervening. And as the SNB can tell the BOJ, unilateral FX intervention is highly unlikely to do much except slow the move, not reverse it.

EM currencies are recovering a bit today after having taken it on the chin earlier this week. However, we continue to feel that EM cannot see a sustainable rally when concerns about global growth remain in play and risk appetite is weak. Risk off trading mentality looks likely to persist into the fall and in this volatile environment where swings in market sentiment are frequent and sharp, we continue to highlight cross-EM plays that favor countries with strong fundamentals over weak. Defensive plays would suggest favoring Asia and Latin America over EMEA. The Philippine peso got a boost after the economy unexpectedly accelerated in the second quarter, growing at the quickest pace in three years. GDP climbed 7.9% in Q2 from the same period a year ago, up from a revised 7.8% in the first quarter, and significantly better than the 6.3% pace of growth expected by economists. The central bank, however, left rates at 4%, a record low. In contrast to the relatively sanguine attitude of the Philippine central bank towards inflation, the Bank of Korea warned against the possibility of inflation risks, and suggested further rate increases were on the way. Governor Kim Choong Soo said ‘vigilance against the possibility of the awakening of inflation expectations’ is necessary and that the quarter point rise in the benchmark rate last month ‘may not be sufficient.’ The central bank this month held rates at 2.25%. While inflation was at 2.6% in July, Kim forecast it would rise to more than 3% in the final quarter of this year to a peak of 3.4% next year. Australian business investment unexpectedly declined in the second quarter, on concerns about global growth and the proposed imposition of a 40% tax on mining profits announced by the ruling Labor Party in May. Capital spending dropped 4% from the first quarter, when it shrank 1%. Economists had expected a 2.3% gain. The softening of investment flows may continue in the uncertain aftermath of the national elections last weekend. Elsewhere in Asia, Singapore industrial production dropped back in July to the slowest pace in eight months. From a year ago, output climbed 9.9%, more than the 9.3% expected but down from 29.5% growth in June as drug companies cut production.

Upcoming Economic Releases

At 8:00 EST/12:00 GMT, Brazil reports unemployment rate for July, which are expected to remain steady at 7.0%. At 8:30 EST/12:30 GMT, US reports weekly jobless claims, and initial claims are expected to fall to 490k from 500k last week. At 10:00 EST/14:00 GMT, Brazil reports budget data for July. At 10:00 EST/14:00 GMT also, US reports Q2 mortgage delinquencies and foreclosures. No US speakers of note.

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