BBH CurrencyView
- Dollar pares recent gains as EZ struggles to control crisis; Global stocks boosted by Asian data reports
- North American session likely to be dominated by Bernanke; further easing unlikely but still possible
- Chinese economic narrative continues at policy makers pace; macro measures remain key in Brazil
The dollar is paring back some of its recent gains as markets shrug off Moody’s downgrade of Ireland’s credit rating in lieu of the positive data reported by Japan and China. With important events ahead for Italy (bond auction tomorrow and austerity vote on Friday) uncertainties hanging over the EZ are likely to limit the euro’s upside (up nearly 0.6%), though the euro has consolidated from recent lows as Italian and Spanish spreads ease back. Sterling couldn’t catch a break after upside momentum was capped following the soft UK employment report. June’s claimant count jumped 24.5k (which was the biggest rise since May 2009) while employment growth has topped out based on the claimant number, providing more fodder for the doves at the MPC. Meanwhile, the dollar bloc extended Asian market gains as risk appetite remained firm throughout the European session following China’s strong output growth, which resulted in less demand for safe-havens. Asian stocks rose for the first time in three days with the MSCI Asia Pacific advancing over 1%. Likewise, European shares also snapped a three-day loss streak as the EZ struggles to get the crisis under control, with Italian banking stocks outperforming their peers. Irish 10-year yields remain under pressure, 31bps.
In the North American session this morning all eyes are likely to be focused on Bernanke’s semiannual Humprehey-Hawkins testimony. While it is unlikely in our view that Bernanke is going to signal a green-light on further easing, we suspect that if the topic arises he could signal that the Fed has both the capacity and willingness to do more to support the economy to achieve its dual mandate of growth and price stability. Indeed, yesterday’s Fed minutes have been interpreted by some as suggesting additional quantitative easing. This is a result of direct discussions over further easing in yesterday’s minutes as policy markers concluded that growth was likely to be slower than had been projected in April given persistent weakness in housing, ongoing balance sheet restructuring, sluggish income/consumption growth, fiscal contraction, and uncertainty over future tax and regulatory policies. Moreover, policy makers also suggested that the recovery was subject to downside risks, which despite the liberal interpretation of the FOMC minutes suggest to us that a minority at the Fed may support further easing if the economy does not turn out as expected. This policy contrast with most other central banks remains clear, suggesting the Fed is as far away from a hike as ever. As a result, the dollar is likely to get a boost from periods of risk aversion yet those rallies are likely to remain temporary and short-lived. Still, with fiscal consolidation ahead for the US the path of least resistance is the continuation of easy monetary policy. Meanwhile, the downward re-pricing of EZ rate expectations in the last few days correlates with the euro’s fall but is starkly at odds with the recent messages from the ECB. All told, although euro uncertainty is likely here to stay for the time being (which is likely to keep markets choppy) Bernanke is likely to remind us today that the Fed and the outlook for rates may provide headwinds to a sustained dollar rally.
The Chinese economic narrative continues to unravel as we had expected, and we suspect as policymakers would want it.GDP number overnight showed that the economy is decelerating but still growing at a strong pace. Inflation is still elevated but the underlying trend seems to be improving once we strip out headline inflation and especially pork prices. Even though it is too early for an official change in language, we think that policy in China will gradually shift away from focusing in inflation to a more balanced approach. The two new competing objections rising in policy priority are to improve the tightness in the interbank market and to ensure that growth will continue to decelerate in a controlled pace (i.e. not fall too quickly). In this context, we expect at least one more interest rate increase and further FX appreciation – though possibly at a slightly slower pace than earlier in the year. In Brazil, Reuters is reporting that policymakers may impose limits on currency futures and other derivatives, possibly in the form of taxes. The move follows measures announced last Friday to limit positions in the spot market. This does not come as a big surprise. The last measure seemed to have caused more political risk than currency risk. We still think that the risk-reward for being short USD/BRL is not favourable for the very short-term, but this period of uncertainly can create a good better entry points for more medium-term long BRL positions should we see a larger move of USD/BRL above the 1.60 level.