Dollar Edges Higher; Geithner Warns Against Devaluation

The dollar continued to edge higher through the Asian session, even making ground against the yen. EUR/USD slipped back towards $1.39, erasing the gains from the North American session, ahead of Germany’s ZEW report out later this morning. USD/JPY crept up to JPY81.50. Tensions about currencies continue to grip the political and financial world — US Treasury Secretary Geithner criticized devaluation as a policy tool, said China’s yuan policy was unfair to trading partners and said the dollar would remain the global reserve currency. RBA minutes gave Australian rate hawks some encouragement, though the AUD slipped back. There is a bunch of ECB and Fed speakers out today, while the Bank of Canada rate decision comes later. EM currencies were led lower by South Korea’s won, down 1%, with losses also for PHP, SGD, ZAR and MYR.

Asian stocks were mixed. Apples’ estimate-beating Q4 results were overshadowed by its disappointing profit forecasts, while Citigroup profits buoyed financial stocks. The MSCI Asia Pacific index slipped 0.2%. Losers in the region included benchmarks in Korea and Taiwan. Japan’s Nikkei added 0.4% and indexes eked out gains in Australia, India and Singapore. Futures on European indices were a little mixed, but US markets are being called lower for the moment.

Treasuries were little changed overnight, while Japanese debt lost a little ground. The benchmark 10-year Treasury held on to the gains made yesterday, with the yield at 2.5% ahead of US housing data later today. The 30-year bond yield fell 1 basis point to 3.95%. Japan’s 10-year JGB yield added 2 bps to 0.88%. An auction of 5-year debt today drew a bid-to-cover ratio of 3.43, up from 2.79 last month. The government sells 1.1 trillion yen of debt ($13.4bln) on Oct 21.

Currency Markets
Tensions continue to grip politicians and central bankers regarding currencies ahead of the G-20 meeting of finance ministers and central bankers this weekend.Brazil’s action yesterday reinforced the suspicion that more EM countries will in coming months resort to capital controls to help ease appreciation pressures.  Meanwhile overnight, US Treasury Secretary Tim Geithner said ‘no country around the world can devalue its way to prosperity,’ China’s yuan policy was unfair to trading partners, and that the dollar would remain the world’s reserve currency.  In addition to Brazil’s decision yesterday to boost the IOF tax on fixed income foreign investments to 6% from 4%, an official from India’s finance ministry let it be known today where its line in the sand could be drawn. A source from the ministry said that the government is comfortable with a range of INR43-45 in USD/INR — the pair has dropped from INR47.095 on Aug 31 to trade around the INR44.46 level today. Chile President Pinera said yesterday that he is concerned by peso appreciation as some industries are “really suffering,” while Czech central banker Rezabek said that the strong koruna was “not good” until the economic outlook has stabilized.  Last Friday, South Africa central banker said that the strong rand exerted downside risks to the economic outlook and that the bank could cut interest rates again in response.  

The move from Brazil was no massive surprise, but it remains a pretty strong statement since it comes just two weeks after it was hiked to 4% from 2%.  In addition, Brazil increased the tax on margin deposits on futures markets to 6% from 0.38% previously.  We continue to believe that the authorities will continue to tinker with its toolbox to find the right combination of policies to curb excessive BRL appreciation.  Brazil’s central bank starts its two day meeting later today, and the market is looking for rates to be kept steady at 10.75%.  Though rates are expected to remain steady through 2010, the market is looking for tightening to resume next year and rates to end 2011 at 11.75%.  September IPCA rose 4.7% from 4.5% in August.  More worrisome, wholesale IGP-M inflation for September rose 7.8% y/y vs. 7.0% y/y in August and was the highest since Feb 09.  Real economic data have softened but remain strong enough to worry about ongoing price pressures, and recent inflation data bear this out.  With Brazil continuing to suck in foreign money with rates at 10.75%, a restart of the tightening cycle next year would presumably keep those flows intact.  Most recent polls show Rousseff holding a slim lead over Serra for the October 31 second round vote.  We remain hesitant to make any currency calls with regards to the election, as we believe markets are fine with either Rousseff or Serra.  However, we believe that Serra offers less risk over the medium-term.

A key part of all this gnashing of teeth about currencies is of course the dollar’s weakness, and anticipation of QEII in the US remains among the most potent forces in the capital markets. There are more Fed speakers out today to listen to: Lockhart, Evans and Dudley, while housing data will also be watched closely.  The case the Fed has built for the public is based on inflation being too low and clearly officials are concerned about the contraction in bank credit too. Yet there are beginning to be signs that these forces may be ebbing, perhaps in part because of the Fed’s signalling effect.   Although it may have been lost in the shuffle, a more balanced view would note that the trimmed mean CPI calculation of the Dallas Fed has risen for three consecutive months.  Bank credit appears to have stopped contracted.  Money supply, measured by M2 has accelerated recently.  The St. Louis Fed’s money multiplier has has edged up. Retail sales in the US has picked up after a soft patch earlier in the summer.  The Aug-Sept increase was 1.3% vs 0.2% in the June-July period. The National Retail Federation forecasts the strongest holiday sales in the US in four years. This is not to deny the worrisome challenges the US faces.  However, the risk of a double dip in the economy appears to have ebbed in recent months and some of the financial variables also seem to have improved on the margins of late. With QEII so heavily discounted, largely as a result of the Fed’s own guidance, it is as if the Fed has a free pass:  If they execute QEII, and the preliminary signs noted here deepen and broaden, they will take (be given credit) for the recovery.  If they execute QEII and conditions worsen, they can argue they did what they could.  The biggest risk is doing nothing and conditions get worse.

Upcoming Economic Releases
Asia-Pacific: Hong Kong unemployment. Europe/EMEA: Eurozone current account, construction output, German ZEW survey, UK CBI trends, Poland industrial output, Netherlands consumer spending. Americas: US Housing starts, building permits, Bank of Canada rate. Events: ECB’s Trichet, Costa in Frankfurt, ECB’s Weber in Munich. Fed’s Dudley, Lockhart, Evans.

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