From the BBH Currency Strategy Team.
Highlights
The US dollar is mostly firmer today after yesterday’s surge. After yesterday’s gains were briefly and marginally extended in early Asian trading, a consolidative/corrective attempt was made that was extended into early European activity, when the euro reached just above $1.2930 and sterling made two attempts runs above $1.57. However, a poor news stream out of the euro zone, which included an unexpected decline in June industrial output (-0.1% vs consensus forecast of +0.6%) encouraged new selling. And a sloppy gilt auction helped send sterling back to its lows. Japan’s verbal intervention and indications that it checked rates has helped steady the yen, but may have deflected the speculative attention toward the Swiss franc, which is the exception today, posting across the board gains today.
Global growth concerns and the nearly 3% drop in the S&P 500 yesterday took a toll on Asian equities, with the MSCI Asia-Pacific Index dropping 1.3%. Having fallen every day this week, it has lost a little more than 4% in this downdraft. It is set to snap a five week advancing streak. The Nikkei lost almost 0.9% and briefly touched the 20% decline threshold since its multi-month high set in early April. Technology shares tumbled in the wake of Cisco’s poor guidance and the growth worries hit the commodity producers. European bourses open firmer but have struggled to maintain the early upside momentum. Telecoms are the clear leader today, with consumer goods and utilities also helping, but technology and commodities here too are weak. Of note, Irish financials, which have been a source a renewed concern in the markets, are off more than 3% today, underperforming the market considerably. The tech sector has also been hit hard (-6%+).
Bond markets are quieter today after yesterday’s sharp advance. JGBs remain firm in the wake of the yen’s strength and equity market weakness. European bond activity is subdued. Irish bonds have steadied, though Portuguese bonds remains under a little pressure. The shorter end of the curves in Europe are outperforming with 2-year yields mostly 2-3 bp lower, with some notable exceptions. The Irish 2-year is off 8 bp to 2.81%, while Portuguese and Greek yields are a bit higher. Of note the US-German 2-year spread, which finished last week 24 bp in Germany’s favor has steadily fallen to about 15 bp now, which is a three-week low, as is the euro against the dollar.
Currency Markets
The news stream from Europe has soured and this has overshadowed the FOMC decision to recycle the Agency and MBS maturing issues into the Treasury market. This still seems very benign in the sense that it is simply maintaining the size of its current balance sheet. The decline in inflation suggests under some Taylor-rule-like application that the US ought to have an easier monetary policy than say was the case at the start of the year. Maintaining the existing size of the balance sheet is to prevent is shrinkage, but to be sure the Fed is not crediting banks with new reserves or in any other way “printing” fresh money. The change of the Fed’s balance sheet is in terms of composition. It will have a bit more Treasuries and a bit less Agency bonds and MBS. In addition, that the US economic recovery has nearly slowed considerably—after yesterday’s US trade figures, it is becoming clearer that the economy may have grown half of the 2.4% initial estimate—had already largely taken on board. The new news is from Europe and it has not been good. In our SpecialFX thematic piece tomorrow, we will argue that while European officials addressed the liquidity dimension of the crisis, the solvency issue requires strong growth and that has been called into question.
ECB President Trichet noted last week that Q2 growth was stronger than expected and that Q3 was off to a good start. This may be a premature judgment and based with the Q3 assessment based almost exclusively on survey data. Today’s news confirms that the euro zone industrial recovery faltered in late Q2. The consensus had expected a 0.6% rise in June industrial output and instead a 0.1% decline was reported. That May’s advance was revised up slightly (1.1% from 0.9%) does not change the underlying picture. This is not meant to exaggerate the small decline after a large increase, but rather to highlight the negative news stream. Tomorrow Q2 GDP for the euro zone will be reported. The consensus calls for a 0.7% increase after a 0.2% expansion in Q1. The risk seems to be on the downside after today’s industrial production data. Greece, whose economy is 2-3% of the euro zone economy, reported today that Q2 GDP contracted 1.5% after a 0.8% decline in Q1 that was revised from -1.0%. The consensus had been for a 1.1% decline. Elsewhere, Irish banking woes continue to be discussed and flagged in the media and today there is also reports playing up that some local governments in Spain continue to be frozen out of the capital markets. There is also a report in the local German press warning of the costs of bailing out the German banking sector. The euro has sold off 5 cents this week and this is inflicting serious technical damage. There is near-term scope toward $1.2750. A convincing break there would signal scope for another 1% decline. The 5 day moving average is likely to cross back below the 20-day moving average either tomorrow or Monday and this often has been a useful indicator of the underlying trend. They last crossed to the upside on June 16th. On the upside, the $1.2950-$1.3000 area will likely cap gains.
Moody’s warned that the political instability in Japan could exert downward pressure on Japan’s AA2 rating, but the market seemed to pay it little mind. Instead the focus was on what seemed to be steppe dup verbal intervention, which included press reports suggesting that the Prime Minster referred to yen gains as “rough”. The BOJ also expressed concern about yen strength and an official survey is being undertaken to assess the impact of the yen’s rise. Nevertheless the comments by Finance Minister Noda were a bit like the proverbial wet noodle and seemed to ease the threat of imminent action, even though the BOJ confirmed it checked prices today (as part of its “market vigilance”) and helped cap the dollar’s recovery near JPY85.80. Taking together Japan’s official claims that it will take appropriate action and the fact they have done nothing underscores that the bar to intervention is high. An unnamed EU official was quoted on the wires indicating that it would not look at such intervention kindly. If Japan were to intervene, it would, no doubt, prefer a multilateral exercise, as that would increase the chances of success. However, Japan look out on the limb by itself. Meanwhile, the euro has broken below JPY110 for the first time since early July. The multi-year low was set in late June near JPY107.30.
Upcoming Economic Releases
The US reports July import and export prices, but the weekly initial jobless claims at 8:30 EST/12:30 GMT are more important. If they don’t pullback from the 480k area, the market will be disappointed. The Fed’s Duke speaks at 10:00 EST/14:00 GMT at the Chicago Fed on the Community Reinvestment Act, but is the first Fed official speaking since the FOMC meeting. Chile’s central bank meets and is expected to lift its overnight rate 50 bp to 2.0%.