Turnaround Tuesday Falls Flat

BBH CurrencyView

• Global stocks continue to show heavy losses in Asia and Europe, oil & copper down; G10 mostly mixed
• Euro group meeting injects more uncertainty about Greece; EUR/USD “death cross” on daily chart
• RBA strikes dovish tone, AUD/USD down nearly 1%; China warns over proposed US currency bill

Safe havens remain in vogue as global stocks continue to show hefty losses driven by concerns about global growth and the uncertainties about the ongoing euro zone debt crisis. The EuroStoxx 600 index is just off its lows but still over a net 2.5% lower, having reversed about half the recovery gains seen in late September, and back within 4% of the 26-month low seen on September 23. The MSCI Asia-Pacific index dropped 2.3% and S&P 500 index futures point to a 0.6% decline at the open after the heavy 2.85% loss in the cash index yesterday. Adding in some part to the demand for bunds (2-year down 6bps) was the fact that Spanish jobless claims soared in September, with the jobless number increasing by 95k and the second month in a row of higher unemployment. Oil down 1.8%.

The Euro group meeting came and went without providing any clarity about how to reduce the tensions in the euro zone debt market. In fact, it is more likely that meeting injected more uncertainty by delaying the final decision for the Greece aid tranche for at least another month and hinting at a greater investor role for Greece by considering to increase the size of their haircuts. The Euro group also concluded by cancelling the special meeting planned on October 13 as officials still wait for the troika report on Greece, which won’t be ready for another couple of weeks. So the final decision on Greece won’t come until later that month, although officials stressed that Greece will have enough cash to cope, as all sides are eager to prevent default. Ministers at least managed to come to an agreement on Finnish demand for collateral for further aid, but the further delay of Greek aid and the fact that there was no agreement on an extension or leveraging of the EFSF will add to concerns that the measures are insufficient to cope with the crisis. Indeed, as policy makers continue to dither funding market remain under duress with EUR-USD basis swaps (basis point premium to swap euros for dollars in the interbank) market just 4bps shy of the recent high in early September, along with the continued rise in the European libor-OIS spread, which has increased to nearly 82bps. All this appears to place more weight on the shoulders of the ECB which in our view is likely to announce further accommodative measures at this week’s meeting to deal with the spillover in the funding markets from the concerns over the sovereign debt crisis. Against this backdrop we expect the EUR/USD to remain vulnerable to more negative news and in turn expect it to remain under pressure in the coming days. Momentum traders are also likely to add to this selling pressure following the “death cross” of the 50 and 200dma, which is likely to see the EUR/USD test 1.3047.

Elsewhere in the G10 the RBA, as expected left rates unchanged at 4.75% at its October meeting. The surprise came from the introduction of new dovish language, despite the better than expected trade and building approvals data announced ahead of the meeting. In short, the RBA maintains the view that it is still too early for the Bank to cut rates given the effects from the market selloff have yet to flow through into the real data just yet. However, the key to the statement was the Bank’s willingness to ease rates driven the by the recent downward revisions to the ABS’s underlying inflation measures. These revisions were quite substantial and in turn have likely gone some ways to mitigating the banks fears that inflationary pressures are likely to get out of hand. In fact, the OIS market is now pricing in a move as early as next month but we suspect at this juncture that an interest rate cut is unlikely. Rather, we suspect that the Bank is more likely in wait and see mode to determine how the ongoing European sovereign debt crisis impacts global growth over the next month (along with October’s inflation report) and thus we would expect the RBA to cut before 2012 if the situation deteriorates further. China warned Washington over a proposed currency bill, which is aimed at forcing Beijing to let the yuan rise. The PBoC and the ministries of commerce and foreign affairs accused the U.S. of politicizing the global currency issue. The PBoC said it deeply regrets U.S currency bill and warned that the passage of the bill may seriously affect progress of China’s currency reform, which could lead to trade war. The PBoC justified its position, claiming that the real exchange rate has risen greatly against USD if inflation is taken into account. This is confirmed by the BIS’s Chinese REER which has by nearly 17% since 2005. The China foreign ministry said it "adamantly opposes" US senate bill on CNY, claiming it violates WTO rules and "seriously upsets" China-US trade relations. It repeated that CNY exchange rate not to blame for China-US trade imbalances.