Dollar Firmer As Euro Zone, Global Growth Worries Still Intensify

BBH CurrencyView

• US dollar broadly firmer vs. majors as global growth concerns, euro zone tensions pick up
• Merkel’s CDU lost weekend election in her home state of Mecklenburg-Western Pomerania
• Risk assets under pressure, Swiss franc still outperforming; US holiday today

The US dollar is up broadly at the beginning of the week as Friday’s disappointing US jobs report and escalating fears over the euro zone crisis. European indices have come into aggressive selling pressure with the Euro Stoxx 50 benchmark down 4.6% this morning, as a disappointing US job report fuelled concerns about the magnitude of the global economic slowdown while growing EU political risks hit bank shares (-4.7%). Regulatory pressures remain an added headwind for financial systemic risk after the US Federal Housing Finance Agency (FHFA) filed lawsuits against 17th global institutions over the sales of MBSs in the buildup to the 2008 crisis. This pushed the shares of European lenders named in the lawsuit down 6-8% this morning. Crude oil fell 1.6% to $85bbl overnight. Gold rose within a faction of the August 23 record high ($1917oz), reaching $1908oz intraday, a gain of 1.2% on the day. The Bund benchmark future reached a new lifetime high of 137.89 amid growth signs that the ECB has scaled back operations in Italian and Spanish bond markets, where 10 year government bond risk premia are up 26 bp and 14 bp, respectively.

Euro zone sentiment remains poor. The political backdrop continues to deteriorate ahead of an expected German high court ruling this Wednesday on the legality of the euro zone bailouts. German Chancellor Merkel’s CDU lost a weekend election in her home state of Mecklenburg-Western Pomerania. Her coalition has lost numerous votes in recent months, showing that Merkel’s handling of the euro zone debt crisis is taking a big political toll. It also underscores the bailout fatigue being felt in the stronger euro zone countries.

There is a full slate of central bank meetings this week, including ECB, BOE, RBA, BOJ, BOC, and the Riksbank. No rate changes are expected from any of them, though we expect that the ECB will be the most closely watched one for any clues regarding future policy. Fed Beige book for the September 21 meeting will come out this week, and in light of the poor US jobs data, more analysts are looking for some sort of Fed action at that meeting. In the EM space, Malaysia, the Philippines, Indonesia, Korea, Poland, Russia, and Peru all meet as well. We believe EM central banks have moved into dovish wait-and-see mode for now, with the obvious exception of Brazil and Turkey (who have both cut). At some point, more EM banks are likely to cut if the global outlook worsens, but we think it is prudent that they remain on hold for now.

The yen remains confined within a tight 76.5-77.5 range against the dollar after new cabinet announced. Incoming Japanese PM Noda has announced the new cabinet which features members of the Democratic Party of Japan (DPJ) who have strong ties to the opposition Liberal Democratic Party. The appointments mark an attempt to quell the party tensions which characterized the tenure of former PM Kan. The finance minister position was given to Jun Azumi, a former journalist and parliamentary affairs chief, who remains an unknown quality in terms of his views on fiscal and monetary policy, and hence market expectations around his appointment have been low. Still, new budgets will be expected to call for tax hikes as a way of financing future public sector expansion, most likely focused on a consumption tax, which had proven politically controversial for former PM Kan.

Inflation readings for August in EM have largely come in on the high side, but policy-makers will be hard-pressed to tighten policy in response due to the negative global backdrop. Turkey CPI rose a bigger than expected 0.7% m/m and 6.7% y/y, and we suspect the weak lira was a major factor behind this. While we do not think markets will punish countries that remain in dovish wait-and-see mode, they have been punishing the two that have cut rates already this year, Turkey and Brazil. BRL and TRY are likely to continue underperforming this week. Elsewhere, Indonesia inflation came in higher than expected too, but policy-makers there have been pretty open to IDR strength and are not obsessing about the exchange rate. As a result, IDR is not going to be seen in the same negative light as BRL and TRY, as sentiment has been harmed for these two by active encouragement of weaker currencies. We have always thought this was a dangerous strategy, and it is coming home to roost for these countries.

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