IMF to the Rescue?

BBH CurrencyView

• Market sentiment is improving amid hopes that G20 policy makers willing to take action to stem crisis
• Markets keen to focus on Italian vote of confidence and US economic data in North American session
• China’s inflation slowed in Sept. from August; Singapore’s MAS continues a policy of SGD appreciation

The dollar is paring back some of its recent gains in part as European stocks and growth sensitive currencies rise amid signs that G20 policy makers are working on a solution for the euro zone debt crisis. In fact, the dollar ran into ran into selling pressure in Asia after USD/SGD fell sharply following the MAS decision to ease policy less aggressively than the market had expected. China’s easier CPI release raised discussion that the PBoC could have room to ease into year-end, though we suspect given the elevated level of inflation it is more likely to ease bank RRR rather than a interest rate cut. This backdrop helped the market overcome news of ratings downgrades of Spain and a slew of European banks, and general ongoing concerns about the banking sector, with the EuroStoxx 600 up 0.8%, although bank shares are flat. Peripheral spreads are under pressure ahead of Italy’s second vote of no confidence in a month this morning, while the final EZ HICP was confirmed at 3.0% y/y.

Ahead of the weekend risk appetite appears to be gaining momentum again, despite another downgrade of Spain sovereign debt rating and Fitch’s downgrade of several UK banks, along with adding a slew of European banks to credit watch. In fact, reports from the G20 meeting that the IMF is considering a plan to make short-term credit lines available to fundamentally sound countries, along with discussions about developing nations raising their funding contributions to the IMF, which in theory may be used to increase global lending capacity to Europe. These are important steps to help shore up some of Europe’s banking ails but in our view for now these are just discussions, which are unlikely to be officially announced or more importantly acted on until the official summit on 11/3. That means, while the headline news is likely to be supportive of risk appetite in general we doubt this is likely to be enough for the EUR/USD to make a convincing break of the recent highs, given the lack of consensus between various groups and the outstanding political risks that loom. After all, the Italian government faces a confidence vote today due to the failure to secure a majority on a procedural vote earlier this week. We expect the government is likely to pass the vote successfully and thus maintain a slim majority. However, given the recent tensions in the peripheral bond market, with Italy’s generic 2- and 10-year increasing by 24 and 36bps over the past few weeks we would expect a no confidence vote would likely limit any positive developments from the G20 meeting. Otherwise, with economic data light outside of the US markets are keen to focus on advanced US retail sales, with the market expecting a strong headline print from last month. In fact, the market expects a headline print of 0.7% (up from 0.0%), though the distribution of forecasters are skewed below the average, suggesting an upside surprise would quite supportive of sentiment. In turn, firm US data readings would likely be supportive for currencies with links to the US, such as CAD and MXN.

In the EM space China CPI slowed to a 6.1% y/y rate in September from the 6.2% y/y clip in August, as inflation growth further slowed from the recent peak rate of 6.5% y/y in July. PPI growth moderated to a 6.5% y/y rate in September from 7.3% in August and a peak 7.5% in July. The further slowing in the pace of inflation growth was largely expected, and should allow for a pause in tightening from the central bank amid ongoing uncertainty over the global outlook. Of course, inflation growth rates remain elevated despite slowing from what appear to be cycle-peak rates in July. To us, that rules out chances for any kind of easing from the PBOC in the immediate future. Elsewhere, Singapore GDP rose 5.9% in Q3 compared to the same quarter in 2010, a pick-up from the 1.0% rate in Q2. GDP rose 1.3% on a q/q, saar basis after the 6.3% plunge in Q2, keeping the economy out of a recession. Subsequently, the MAS decided to maintain a policy of modest, gradual appreciation of the SGD, leading to the SGD to outperform the rest of the Asian currencies in the overnight session. The move comes amid a softening in global demand and deterioration in the growth prospects of Singapore’s major trading partners. In fact, the Bank reduced the slope of the Singapore dollar policy band with no changes to the width of the band due to the expected drop inflation in 2012 from current levels today. This is the third consecutive tightening move, aimed at ensuring price stability in the medium term, while keeping growth on a sustainable path. As such, we expect the SGD NEER to rally to at least the center and probably the upper half of the new bands, with a range of 1.25-1.30 expected for the next couple of weeks, though the risks may be to the downside.