Dollar Softer on Intervention Outlook

Highlights
The US dollar is mostly softer in quiet trading.   Yesterday’s momentum has largely faded, but the beleaguered greenback still cannot sustain even modest upticks.  In recent days, a number of Fed officials that have spoken of the need for additional monetary measures have continued to weigh on dollar sentiment through the interest rate channel, while diversification of intervention proceeds provides an additional drag.   The Australian dollar has fully recovered from yesterday’s RBA-disappointment drop to trade at new multi-year highs today, just shy of $0.98.  The dollar has straddled the JPY83.00 level and there has been talk of bid emanating from quasi-government pension institutions.

Intervention moves by the BOJ and speculation that other central banks will follow up suit buoyed a strong equity session.   Asian stocks climbed, sending the MSCI Asia Pacific index to a 2-year high on optimism central banks would undertake additional measures to stimulate economic growth after the BOJ move yesterday. Japan’s Nikkei gained 1.8%, with gains for benchmarks across the region.  Financials and basic materials outperformed most other sectors.  European stocks rose amid speculation that other central banks will pursue some form of unconventional policy.  The Stoxx Europe 600, for instance, increased by nearly 0.9% in the midday session, led by gains basic materials and industrials. 

Bonds climbed with yields trading at record lows in the US and Japan. Japanese 10-year bond yields dropped 8 basis points to a fresh seven-year low at 0.82%. Treasuries also gained ahead of the jobs figures coming out today and later this week. The 5-year note yield fell to as low as 1.1755%, a record. European debt opened higher, with 10-year bund yields down 2bps to 2.26%.  In Europe, the 10-year yield on some of the periphery countries dropped as German factory orders increased almost four times the pace economists forecast, led by demand for investment goods.  Greece’s yield dropped the most, inching down 15 bps, followed by Portugal and Ireland with a decrease of 5bps. 

Currency Markets

The price action stands in sharp contrast with yesterday’s key developments.  First, like they did earlier this year, the Reserve Bank of Australia surprised the market by apparently signaling the need to hike rates and then failed to deliver.  This led to a wash out of some of the late buyers of Australian dollars.  At one point the currency was off about 2%.  It has now not only fully recovery but it is made new two-year highs today, just shy of the $0.98 level.  Second, Brazil doubled the tax on foreign purchases of Brazilian bonds to 4%.  The Brazilian real strengthened yesterday top new two-year highs.   Third, South Korea announced it was audited banks foreign exchange transactions and although this initially weighed on the won, the won completely retraced those losses and now is at its best level against the dollar since May.  Fourth, the BOJ adopted zero-interest rate policy and indicated another JPY5 trillion expansion of its balance sheet, and bypassing traditional limit of JGB holdings to bank note issuance.  The yen initially weakened, but has also recovered to trade at its best level since the Sept 15 intervention.   

There may be two general explanations for this counter-intuitive price action.  First, the steps taken are too small given the size of the countervailing forces.  For example, will cutting Japan’s overnight rate to zero from 10 bp really break the back of deflation?  Is the JPY5 trillion (~$60 bln) in additional asset purchases manage to break the liquidity trap in Japan?  If Japan just eased policy on the margins and the market is pricing in a near certainty that the Fed is soon to ease policy, does it really matter that much that the RBA did not hike rates yesterday, especially given that it is still signaling the need for higher rates ?   The strength of the Brazilian real despite the increase in the fixed income transaction tax may reflect the elevated profit expectations of the latest investors.   Policy makers had signaled the risk of the tax for the last couple of weeks.  Second, these factors are not really the main drivers of the current moves in the foreign exchange market.  The key driver is increased likelihood of new easing of US monetary policy.  The number of Fed officials that have spoken this week clearly gives the impression that Bernanke has been able to put together a consensus for the shift in policy he suggested at Jackson Hole.  The kind of easing of monetary policy that is apparently being discussed seems worth more than a 25 bp federal funds rate cut.  NY Fed President Dudley suggested earlier this week that $500 bln of Treasury purchases is tantamount to 50-75 bp worth of easing, depending on the holding period.   The other driver, partly related to this, is the diversification of the intervention proceeds out of dollars.   Yesterday’s international developments do not really alter these drivers.  That said, there is talk in the markets today that the G20 by seek an agreement from Asia (not singling out China) to allow their currencies to appreciate.  In fact, all Asian currencies, but the Hong Kong dollar,  have appreciated this year, with the Thai baht’s 11.5% leading the way, followed by Malaysia’s ringit 10.8% gain. 

German factory orders for the month of August increased almost four times more-than-expected, led by demand for investment goods such as machinery.  August’s non-seasonally adjusted figure increased 20.3% with a sharp upward revision of 18.4% on the previous month’s data.  Meanwhile, the seasonally adjusted component jumped 3.4% from July.  The strength of the reports suggests that surging exports are supporting German’s strong recovery, which has expanded at the fastest pace in two decades in the second quarter.   According to the ministry, the demand in August was led by above-average big-ticket orders.  Although domestic demand appears to be gradually improving, German growth is being driven by external demand.  A breakdown of the report, for example, highlights the reliance on export demand with foreign orders jumping 6.6% m/m, but domestic down 0.5%.  Looking at individual sectors, then, capital goods were strong all around, but again there was a distinct divide in intermediates between week domestic orders and strong exports. Consumer goods fell markedly on both sides.

Upcoming Economic Releases

At 7:00 EST/11:00 GMT the US reports MBA Mortgage Applications for the week of October 1.  There is no consensus but the quarterly average is 1.7%, which is well above the prior figure.  At 8:15 EST/ 12:15 GMT the US reports the ADP survey for the month of September.  The consensus is for a 20k increase, after last month’s fall of 10k.  In Canada the Ivey PMI data for the month of September are released at 10:00 EST / 14:00 GMT.  The consensus is for a small downtick to 62.0 from 65.9 the previous month.  Events: Treasury Secretary Timothy Geithner speaks at the Brookings Institution at 9:00 EST / 13:00 GMT.  US Economics Recovery Chair Paul Volcker Speaks in Toronto at 16:00 EST / 20:00 GMT.