BBH CurrencyView
- US leaders agree on budget deal, but House vote poses event risk ahead of August 2 deadline
- Euro zone periphery benefits from improved market sentiment, but remains vulnerable
- Equities and EM FX firm today on US news and stronger than expected China July PMI
News of a deal regarding the US debt ceiling and mostly strong data out of G10 and EM countries is underpinning a broad risk-on market sentiment. Global stocks and energy prices are higher while the dollar, yen, Swiss franc and precious metal futures are lower. EUR/USD made a decisive break above the 1.44 holding above the 50- and 100-day MAs. In contrast, JPY and CHF are giving back some of their recent gains falling 0.6% and 0.25%, respectively. Gold is down 0.5% and silver down 1.5%. German 10-year yields are up for the first time in 6 sessions, rising 4 bp. In the euro zone periphery, 10-year yields are falling about 10 bp in Italy and Spain. Equity markets closed sharply higher in Asia, as the Nikkei was up 1.3% and the Kospi rose 1.8% on the back of strong trade and CPI data in Korea. European bourses are up close to 1% with only Spain in the red, driven by the underperformance of financial sector stocks in the IBEX. S&P futures are pointing to a 1.5% higher open and energy futures are up over 1%.
US congressional leaders have struck a deal to raise the debt ceiling. However, many potential pitfalls remain in place. Leaders from both parties are trying to push through votes today on the package, with event risk coming from the more problematic House vote. Remember, the agreement has only been reached with party leaders, who now have to sell the deal to the party rank and file. The Tea Party wing has proven hard to control for Boehner, and so a truly bipartisan vote will be needed to pass it in the House. On the other hand, many of the more progressive democrats are unhappy with the compromises made (especially no tax increases), and so it falls on the more centrist Democrats to support the compromise bill. Looking ahead, the reported $2.4 trln in cuts proposed over the next ten years falls short of the $4 trln set by some ratings agencies as the threshold needed to avert a US ratings default. As such, the compromise plan has not yet removed downgrade risk. We suspect the agencies are looking at the details of the deal and so would expect a flurry of comments from them in the coming days. While it appears that a US downgrade has been priced in by the markets, the likely market reaction to such a move remains unknown. We believe many major currency pairs will near-term remain in recent trading ranges until the agencies have weighed in.
Euro zone periphery is benefiting from improved market sentiment, but remains at risk. After last week’s move on Spain by Moody’s, we noted that downgrade risk remains very high for the periphery and is rising for core countries such as France and Belgium. With Spain and Italy in the agencies’ crosshairs, the euro zone debt crisis is poised to move back to the front burner. Indeed, the fact that EUR/CHF made a new all-time low today of 112.72 suggests that the potential resolution to the US debt ceiling will simply turn the market’s focus back to the euro zone periphery, rather than allow the periphery to escape market scrutiny altogether. Elsewhere, the UK also remains at risk, as the weaker than expected July PMI reading of 49.1 suggests that fiscal tightening will slow the UK economy and perversely negatively impact the budget outlook ahead. We see the UK as an AA credit, and believe that a significant deterioration in the UK growth profile will lead to renewed ratings pressure by the agencies. Sterling is underperforming today in the majors, and the UK slowdown theme is likely to persist and keep such underperformance in play in the coming weeks.
Official China July manufacturing PMI was stronger than expected at 50.7 vs. 50.9 in June. Markets were concerned about potential contraction in China manufacturing sector after July HSBC index was reported on July 21 at 48.9 versus 50.1 in June, the first sub-50 reading in a year and the lowest in 28 months. The HSBC PMI reading was not the official government one, but rather a private sector alternative, and was revised upward today to 49.3 from 48.9 preliminary and 50.1 in June. However other recent data have been more encouraging, including Q2 GDP, IP, and retail sales, all of which support the soft landing thesis. We continue to favor this soft landing scenario, and hope that today’s PMI data could help boost positive market sentiment in the wake of the potential US budget deal. Indeed, EM currencies are up sharply so far today from both the US and China news, with many at or near new highs for the year. USD/IDR made a new multi-year low around 8461, with others such as USD/KRW likely to follow. Expect more FX intervention ahead in EM as local currencies make new highs. Brazil must be unhappy that USD/BRL is right back at 1.55.