From the Brown Brothers Harriman Currency Strategy Team
Highlights
US dollar is softer across the board so far today vs. the majors, as markets regain a semblance of calm after Bernanke’s comments yesterday. Markets await Friday’s stress test results, and no further leaks have been heard yet today. The euro has recouped some of its losses in the European morning, as the 1.27 area held for now. The yen was mostly softer, suggesting risk aversion has eased, while the Swiss franc is mostly firmer. EM FX was firmer, with Eastern European currencies leading the way after yesterday’s losses. Hungary is the top performer there, helped by successful sale of HUF50 bln in 12-month bills, albeit at higher rates. Biggest gainers on the day so far vs. USD are HUF, NOK, CZK, AUD, and PLN, while the only losers vs. USD so far today is TWD. Markets again pare back CNY appreciation views to the lowest since June 9, SARB expected to keep rates steady at 6.5% (see below).
Asian markets were mixed, and MSCI Asia was basically flat today. China, HK, India, and Singapore markets rose, while Japan, Korea, and Taiwan underperformed and were down on the day. European markets are higher so far today, helped by strong European data (see below) with Euro Stoxx 50 up almost 2% so far. Futures markets are currently pointing to an up open for US equity markets today.
US bond market is likely to hang on recent gains today if US data today continues to come in weak. Japan bond market was higher as 10-year yields fell 3 bp, while European bond markets are mixed as 10-year yields in UK, France, and Germany are flat, down 1 bp, and flat, respectively. Greek 10-year yields are down 3 bp, Portugal up 6 bp, Ireland up 2, Italy up 1 bp, and Spain up 4 bp.
Currency Markets
Markets are recovering from Bernanke’s stated concerns about the “unusually uncertain” economic outlook. Slew of European data today was mostly stronger than expected. Euro zone July PMI came in at 56.7 vs. 55.5 expected and 56.0 in June, May euro zone new industrial orders rose 3.8% m/m vs. expected drop of 0.1% and revised 0.6% gain (was 0.9%) in May, and UK retail sales rose 0.7% m/m in June vs. expected 0.5% and revised 0.8% gain (was 0.6%) in May. Today, US data expected to show continued weakness, with data weighted towards a housing sector that has been weaker than expected in recent months. Indeed, there is not much on the data side to disperse the gloom surrounding the US economic outlook until July jobs report due out August 6. It’s too early to get a read on market expectations for this important number, but it’s really the next potential flashpoint for the US outlook.
As the yen gains from all the heightened concerns, Japan officials are not happy. Vice Finance Minister Ikeda said excessive yen gains were not desirable, which comes a day after Trade Minister Naoshima warned that the strong yen posed a threat to Japan’s recovery. Earlier today, USD/JPY tested the year’s low just above 86 before bouncing higher, but further gains seem likely if global concerns heat up again as we expect. After the 86 area, next target is the Nov 09 low around 85. Japan’s fiscal hands are tied right now given plans to cap government spending at JPY71 trln annually, and so we expect further pressure will be brought to bear on the BOJ to take additional measures to try and help offset the headwinds from a stronger yen. This might include increasing its JGB purchases, which currently stand at JPY1.8 trln per month. At this point, however, we downplay the risk of BOJ intervention to weaken the yen. The BOJ has not intervened in the foreign exchange market for several years, and that alone suggests that the bar is set very high. The strong yen is not desirable for country that is struggling to escape deflation, but the market has been very orderly and intervention is not a tool that can be deployed simply because an official does not like the price action. Today, the yen is softer but the market bias seems for a stronger yen right now.
Brazil central bank hiked rates by 50 bp to 10.75% vs. market expectations of 75 bp. Total hikes this year of 200 bp still haven’t slowed the economy discernibly, but as we highlighted earlier this week, the slightly improved inflation data appears to have given the central bank a bit of leeway to slow the tightening cycle (previous two hikes were 75 bp each). Latest weekly central bank survey showed market expecting a year-end rate of 12%, but this could shift down slightly after the 50 bp hike. Some analysts appear to be overreacting to the decision, saying that the end of the tightening cycle was near. Bank noted “the reduction of risks to the inflationary outlook that has taken shape since the last Copom meeting, as a result of the recent evolution of domestic and external factors.” To us, that is still a far cry from signaling an end to the cycle. There are three meetings left (Sep 1, Oct 20, and Dec 8). We note that in the past, the central bank has shown a willingness to act near election time, with a 300 bp hike seen in Oct 2002 (when markets were scared of a Lula win) and a 50 bp cut in Oct 2006. Meanwhile, it’s a different story for South Africa, as the SARB could cut rates when it meets today. Most are looking for steady rates at 6.5%, but 8 of the 26 analysts polled by Bloomberg expect a 50 bp cut to 6%. June CPI report is due out next week and expected to show the y/y rate easing to 4.5% from 4.6% in May, and SARB officials have said that price pressures are expected to ease further in Q3. Note that the recovery remains spotty, with the PMI dropping below 50 in June for the first time in 8 months. The rand has been in the middle of the EM pack so far in Q3, up 1.7% vs. USD, but we think high yields are the only thing going for it right now. If rates come down, then the rand will lose more of its appeal, in our view.
PBOC set the yuan reference rate at 6.7859, the lowest this month. Interestingly, PBOC said that it will seek to start publishing a trade-weighted value for the yuan in order to help move market focus away from the USD/CNY exchange rate towards a basket approach. Clearly, with all the focus in the US regarding the yuan’s value vs. the dollar, it is a way for China to try and deflect some criticism about the exchange rate. That is, if the USD/CNY rate is not moving that much, PBOC could perhaps justify it by showing that the yuan had gained a greater degree vs. the nominal trade-weighted basket. 12-month NDFs are now pricing in only 1.0% appreciation, the lowest since June 9, which was before the depegging of the yuan. As we noted yesterday, we think that the current sell off in the CNY NDFs will offer investors a chance to establish long CNY positions. 12-month forwards appear too cheap and we believe market is underestimating appreciation potential. Even if growth moderates to a more sustainable 10% in China, we don’t think that will prevent modest appreciation of 3-5% over the next 12 months. President Hu pledged measures to boost consumption in H2, and noted that policy-makers are focusing on raising the effectiveness of government-induced investment.
Upcoming Economic Releases
Canada retail sales for May due out 8:30 EST/12:30 GMT and are expected to rise 0.4% m/m after dropping 2.0% m/m previously. US weekly jobless due out 8:30 EST/12:30 GMT and are expected to rise to 445k from 429k previously. SARB announces policy decision at 9:00 EST/13:00 GMT and is expected to keep rates steady at 6.5%. At 10:00 EST/14:00 GMT, US June existing home sales due out and are expected to fall 9.9% m/m after dropping 2.2% m/m previously, US June leading index is expected to fall 0.3% m/m after rising 0.4% m/m previously, and US May house price index is expected to fall 0.3% m/m after rising 0.8% m/m previously. At 9:30 EST/13:30 GMT Fed’s Bernanke testifies before House Banking Panel and Fed’s Dudley speaks.