BBH CurrencyView
- Dollar mixed vs. majors ahead of ECB decision; signal for 25 bp hike in July widely expected
- Negotiations on second Greece aid program continue; talks could drag on for weeks
- NZD outperforms on hawkish RBNZ statement, AUD underperforms on weak jobs data
The USD is mixed into the London morning but flat against the EUR ahead of the ECB press conference. AUD underperforming on the day following weak jobs data while NZD outperformed on a more hawkish outlook for the RBNZ following its decision to keep rates on hold. Greek 2-year yields continue to move higher, rising 117bps on the day after rising 120bps yesterday. The renewed negative sentiment is rooted on confusion and lack of clarity about how to solve the rift between EU policymakers made evident by German Finance Minister Schaeuble’s letter published yesterday. Oil, however, has given up earlier gains to trade flat on the day, but WTI futures remain firmly above the $100/barrel level as questions about supply are sure to continue to haunt markets. European equity indices are slightly positive and US futures are pointing to a higher open. In Asia, however, Chinese equity indices fell almost 2% on the day,underperforming regional and global bourses. Declines were driven by rumors that next week’s batch of data (new loans, CPI and PPI) will come in higher than expected and thus fueling expectations for further PBOC tightening. Consistently, 1-month shibor rates have risen 70bps since the start of the week. A report by the CBRC yesterday about stricter lending requirements for banks is also weighing on China sentiment. CNY 12-mo NDFs pricing in only 1.3% appreciation, lowest since September. We see ongoing PBOC tightening via policy rate hikes, reserve requirement hikes, and CNY gains. Actual y/y CNY gains at 5.5%, highest since January 2009. BOE kept policy steady as expected today, but the vote breakdown will not be known until later. Minutes to this meeting will be released June 22.
The ECB is widely expected at its meeting today to signal a rate hike at its July meeting. Therefore, there would appear to be some near-term risk of disappointment if Trichet does not use the catchphrase that the market has come to expect. However, euro corrections have remained short and shallow in recent weeks, and so any softness after the decision will likely be viewed as a buying opportunity. Our base case remains that, after prolonged negotiations, the troika will announce a second aid package for Greece that will allow for a muddle through solution now in the hopes of delaying a hard restructuring until 2013, when ESM is in place and euro zone banks are stronger. Schauble’s leaked letter yesterday caused some convulsions in global markets, but we assumed that he was engaging in some brinksmanship to help limit domestic political fallout from an unpopular bailout. CDU parliamentary manager Altmaier said the ruling CDU/CSU/FDP bloc “will formulate a resolution together.” However, FDP lower house leader Bruderle stated that “There has to be a participation of private creditors.” With talks with the troika are dragging on, there will be scope for negative headline risk regarding Greece over the coming weeks. There are clearly differences between the troika and Greece regarding program targets and goals, and there are also clearly differences amongst the troika on how to handle private sector involvement. These are not easy issues to solve, and so markets should not be expecting a quick solution. However, our base case for a muddle through solution for Greece coupled with continued ECB tightening will likely provide fuel for the euro to continue rallying. Bernanke comments and Fed Beige Book this week confirms market expectations of no Fed tightening until 2012 at the earliest. Even in the absence of QE3, this dovish stance will prevent the dollar from gaining much traction for now. Under this base case scenario, we would expect EM currencies to continue firming against the dollar as well.
Brazil hiked rates 25 bp to 12.25%, as widely expected. But more importantly, it left the key forward looking part of the statement unchanged. We thought there was a slight risk that they would soften the language “the implementation of adjustment in monetary conditions for a sufficiently long period continues to be the most adequate strategy…” Keeping this section unchanged signals continuity in the tightening cycle and puts the market assumption of only one more 25bps hike into question. This is likely to be taken positively by markets beyond FX as it will help drain the inflation risk premium caused by authorities’ use of macroprudential policy and the uncertainly about its effects. We still have no strong views on USD/BRL at these levels and expect the broad range of 1.55-1.65 to hold for now. However, we have long felt that market expectations for a 12.5% year-end SELIC rate was subject to upside risks given our more bullish assessment of the economy. Any break of 1.55 towards 1.50 would likely bring on more FX measures.