WISE MONEY

The money markets have been surprising muted in the last week despite market moving data. Chinese exports in November rose by a staggering 34% from a year earlier and this pushed up their trade surplus to $22.89 billion.

Normally this would have led to a surge of risk in the markets as investors respond to the healthy data- the main beneficiaries of this would be the Euro and the Aussie Dollar and selling of US Dollar.

However investors have taken a wait and see approach- this could be due to concerns still awash in Europe but more probably it is related to fears that China’s CPI and PPI due out on Sunday is expected to be much higher than anticipated and thus it will lead to a rate rise.

Although China is leading the drive to recovery there is always the concern that their economy may overheat and it is precisely these concerns that are holding back the move to risk.

Yesterday the MPC decided to hold rates and leave stimulus measures untouched- we will need to wait two weeks for the BoE minutes to see the thinking behind the decision.

Also the minutes will highlight the sentiment in the MPC- will the hawk/dove divide widen?

The Pound is slightly up this morning against the USD and EUR- interestingly there was an article in the Telegraph trumpeting the pound for 2011.

According to Barcap they see the pound being the star of 2011 and GBP/USD hitting $1.82 and GBP/EUR 1.28.

Wise Money cant remember the last time the pound was talked up!

The reasoning behind the strength will correlate with gains in the FTSE and the deliverance of the cuts to the deficit boosting the pound…mmm tell that to the revolting students.

There is no change to sentiment this morning as the euro remains in retreat as Eurozone bond yield spreads remain the driver for US Dollar buying. This is sufficient to keep Eurodollar testing 2 – 3 month lows on a daily basis.

The sovereign spreads continued to widen yesterday despite the widely heralded financial rescue announced for Ireland and its banking sector.

The package did little to dissuade fears of contagion of the Greek/Irish problems into other peripheral nations.

Official reaction towards the future of the Euro and Eurozone has remained positive with ECB and EU spokespersons being joined by the Chinese government news agency, Xinhua in encouraging the future of both.

The Chinese stated that ‘Contrary to the widespread claim that the Eurozone is doomed to break up, the single currency will not fail’.

It did add however that the currency was facing its toughest challenge since instigation.

Other than the above interest, things in markets remain subdued with just minor de-risking taking place ahead of the year end.

Now is the time of course that analysts are penciling in their outlook for currencies for next year.

Against the current back drop and with adverse conditions in the UK, Eurozone and Japan expected to persist for a while yet, most predictions are for the Dollar to be stronger overall during 2011.

This will only strengthen traders’ resolve to test lower levers in Eurodollar and Cable and push USD/Yen higher during the remaining few trading days in 2010.

It seems the Irish are wisely refusing to admit they require access to ECB bail out funding. However, the main point is, that as a country, there is no urgent need for any funding but as a region overall, it is vital that the whole Eurozone sovereign debt issue is sorted quickly – before contagion spreads to Iberia and beyond.

Therefore, the funding for the Emerald Isle appear ever more likely with the chance that it will be aimed at face saving for the Government, further capitalisation of the banking sector instead of an economic rescue package for the country.

We will have to wait to see if this course of action will actually show enough to dispel market worries of wider Eurozone problems remains in question with history suggesting that rumours will then shift to other countries as per the reaction with other peripheral nations less well positioned to handle with the stress that Ireland has had to bear.

Asian markets have taken advantage of recent Euro weakness to take short term profits, selling the greenback up to 1.3655 and 1.6080 but there is noise from China suggesting interest rates are to be raised “very soon” quickly upturned the move.

Shanghai equities dropped sharply as a result and the Dollar recovered some lost ground. The scene looks set for further gains today with both fundamentals and technicals siding with the Dollar.

Today, the pound will likely be pushed around in the slipstream of Euro/Dollar activity though the CPI and RPI data from the UK at 9.30 has initially provided a Sterling rally.

The figures came in at +0.2%, +3.1% respectively which is the highest y/y rate since June. Post the figures cable rallied as high as 1.6088, however these gains have not been given back and currently sit at 1.5986.

Dominique Strauss-Kahn the IMF’s Managing Director said co-operation between countries had weakened since the financial crisis started in 2008.The Fed’s policies have led to a wave of money-seeking opportunities in the emerging economies. That tends to push their currencies up, undermining their competitiveness.

There is also the risk of bubbles in financial and property markets. And capital inflows can go into reverse – as they did in the Asian crisis in the 1990s.

So the third element in the currency “war” is the resistance of emerging economies, and some developed ones too.

Brazil and Thailand have used tax measures to slow the inflows. Japan, South Korea and others have intervened in the currency markets, buying foreign currency in an attempt to interrupt the rise of their own.

There is a view that they will just have to live with it. The upward pressure on the currencies of many emerging economies reflects the fact they are more growing strongly than the US.

It is difficult for them to manage, but the underlying reason is that they are doing relatively well.

The currency war is closely linked with another theme that has been troubling many economists for several years, that of global economic imbalances.

In international terms, it is trade that is unbalanced. Actually, the thing that is most often the focus is the “current account balance”, which means trade in goods and services plus some financial items, including remittances that migrant workers send home.

Usually, though, trade is responsible for most of the current account imbalance.

Some countries have large trade surpluses, notably China, Germany, Saudi Arabia and Russia. The biggest deficit country is the United States.

Some countries at the eye of the European storm have hefty deficits too – the PIGS aka Portugal, Ireland, Greece and Spain.

Britain also has a deficit, although as a share of national income, it is not all that large.

The other side of international imbalances is high savings at home with a surplus country such as China, and relatively low savings in a deficit country such as the US.

Household savings have risen in the US, the UK and other deficit countries, because consumers are borrowing less in the wake of the financial crisis.

But international imbalances also reflect how much governments borrow and in many deficit countries that has risen, partly offsetting the increase in private savings.

Why does all this matter? Those countries where saving has risen desperately want to export more. They want to sell more abroad to make up for consumers at home drawing cutting back their consumption.

That is true of the US, Britain and many others. They could do that more easily if consumers in China and the other surplus countries were willing to buy more imported goods.

A rise in China’s currency would not be a cure all, but it would probably help in the short term. Although it would also create greater inflation.

It has been called a “currency war”, by the International Monetary Fund’s managing director and the Brazilian finance minister among others.
IMF chief Dominique Strauss-Kahn warned that there were signs that countries were trying to use their currencies “as a weapon”.

For his part, Brazil’s Guido Mantega said competitive devaluations by advanced countries amounted to a new trade war.

“We’re in the midst of an international currency war,” he told a meeting of industrial leaders in September. “This threatens us because it takes away our competitiveness.”

There are three key elements, two of them fairly new, but the first is a long standing one.

It is China’s policy of managing its currency and limiting its movement against the US dollar.

It has been though several phases and during the financial crisis, China went back to keeping the yuan from rising.
Clerk counting 100-yuan notes China is trying to hold the yuan’s value down

Since just before the Toronto G20 summit in June, it has eased the controls and allowed the currency to move up against the dollar, but by less than 2.5% (as of now). And because the dollar has fallen, the yuan has dropped against many other currencies as well.

The reason for the Chinese reluctance to allow the yuan to rise much is a fear of job losses among export industries that would be made less competitive.

The rise against the dollar has not been enough to satisfy the US, where there is a long standing complaint that China manipulates its currency to gain an unfair advantage. The cry is: “It costs American jobs.”

Many in the US complain about China, but they are not innocent either.

The dollar has fallen sharply in recent months, because interest rates are low, so investors have been seeking higher returns in emerging economies.

They need to buy the currency of the country concerned to make those investments. That tends to push its value up, while the dollar, which they are selling, tends to fall.

And the effect is aggravated by the Federal Reserve’s other policy, known as quantitative easing. The Fed buys financial assets and the money it pays with has to be invested somewhere.

The weak dollar has an advantage for the US – it’s that competitiveness issue again. It should help American exporters.

The US has a large trade deficit, so more exports could help fix that. Many argue that the Fed’s policies are actually intended to weaken the dollar and help the US economy recover by exporting more.

The Fed’s policies have led to a wave of money-seeking opportunities in the emerging economies. That tends to push their currencies up, undermining their competitiveness.

There is also the risk of bubbles in financial and property markets. And capital inflows can go into reverse – as they did in the Asian crisis in the 1990s.

As Wise Money expected the Bank of England’s release yesterday of the MPC minutes revealled that there was a three way split amongst it’s members.
Adam Posen showed that he argued for, and also voted for, an increase of £50 billion in the amount of QE in the system.

This kind of addition would equal a 25% increase in the holding of gilts by the BoE – a sizeable sum.

Naturally, the vote for no change outweighed Posen’s submission and also Andrew Sentence’s regular demand for a withdrawal of liquidity on perceived inflationary pressures.

Sterling didn’t react too well to the outcome – nothing serious but just looked a little vulnerable.

The Budget cut provided little additional information – lots of numbers and political jargon but nothing unexpected for the money markets to react to.

The more prevalent remarks came from the Institute of Fiscal Studies within a report released overnight.

In it they questioned whether the Government’s UK growth projections were overly optimistic and that there was a possibility that the £ 80 billion – odd of cuts might not prove to be enough.

Sterling reacted badly to this forecast, and fell to a 6-month low against the Euro.

Overseas investors are going to need verification that the behaviour taken would produce results before they get their assurance in the currency back. This will leave Sterling prone to continued downside pressure in the short term.

For global currencies, and ahead of this weekend’s G20 meeting in South Korea, two events have provide this morning’s interest. An interview with the US Treasury Secretary, Tim Geithner, reported in today’s Wall St Journal proved interesting reading.

He emphasised that the US had not embarked upon a policy of devaluing the US Dollar and that the strong dollar was still vital for global stability and recovery and that the major currencies values were roughly in line.

He did however divide countries into 3 groups and pointedly entitled the first, which included China, as those whose currencies were “undervalued by any measure”.

He berated the emerging market countries for not allowing market forces to set currency values (especially China) and stated that they all had a role to play.

He added that, “If China knew that if it moved more rapidly, other emerging markets would move with them, it would be easier for them to move.” This could all make G20 a bit lively with the US seemingly trying to create a them and us situation with the us being the ‘good guys’ and the them being cast as the villains.

Sterling may have a volatile day as the Pound gets pushed around by the release of the MPC minutes from the last meeting and the long awaited public spending review, which will be presented by Chancellor George Osborne at lunch time. Right on cue, the former has just been released, showing a MPC member (surprise surprise it was Adam Posen) was the only pushing for further stimulus measures (extra QE) and sending Sterling down 30 pips in quick time.

We finally have 3 different views on the committee, 7 voted for no change and Andrew Sentence again voted for a rate rise. We’ve also just seen worse than forecast public finance and public sector net borrowing data no doubt adding to the negative Sterling sentiment.

The Public Spending Review will detail where the axe will fall, right across government departments.

If there are no surprises and the cuts are in line with the plans announced in the Budget, then most of details should already be priced into the market.

However, we are not ruling out a bolt from the blue by Mr Osborne, as this is why the market will be very choppy right for the majority of today.

The surprise interest rate increase by the Chinese helped the safe haven Dollar to gain slightly across the board.

The move can be seen as part of the Chinese government efforts in unwinding the stimulus measures put in place during the financial crisis and also can be seen in the context of the on going ‘currency wars’ as a olive branch to the US.

Eventually the rate rise should see further appreciation of the Yuan against the Dollar.

A potential trade dispute between China and the US increased as US law makers voted overwhelming in favour of measures that would allow levies to be placed on US imports of Chinese goods. The bill would have to be ratified by the Senate and President before any action is taken, and this is unlikely to happen until after the mid-term election in early November, but the US is hoping the threat of action is enough to spur the Chinese into further appreciation of the Yuan.

But as the US knows, we are in a very different position from 1985 and the Plaza accord.

China is in the position of strength and direct threats of manipulation by the US will be as effective as a one legged man in an ass kicking contest in forcing the Chinese to deviate from their gradualist economic plans.

The Euro has been on a fantastic run recently, gaining against both the Dollar and Euro and momentum seems to trump data just now.

News of the full estimated costs for the Irish Government of the bailout of Anglo Irish estimated at £29 Billion and the last of the rating agencies stripping Spain of top credit rating have not been enough to halt frenzied buying of the single currency over the past week.

We now trade over 1.36 in EuroDollar and 1.1653 in GBPEUR after German unemployment figures again impressed coming in way above forecast.

Today marks the start of a busy week in the wise money markets. A large amount of important data releases are scheduled for release this week and several prominent central bankers are due to speak.

This is set against the backdrop of further intervention by Japanese authorities, aimed at curbing Yen strength and further grumblings by the US of China’s refusal to let the Yuan appreciate to fair levels against the Dollar.

The Greenback is yet to recover from last week’s FED meeting and continues to struggle across the board, this afternoon the Chicago Fed National Activity Index will probably show a further slowdown in economic activity so expect the Euro and Sterling to cling stubbornly onto the gains from last week until tomorrow.

Later in the week US GDP is announced, with forecasts of a slight increase from 1.6 to 1.8 per cent. The Fed & markets will be following the figures intently, as disappointing figures may mark the start of the “exceptional measures” the Fed mentioned in the last meeting.

UK GDP figures are released on Tuesday; again the number is very important to the future path of Sterling, with positive growth vital in the face of the steep government spending cuts just over the horizon.

The fear among some economists is the announced cuts reduce growth below the levels needed to service existing debt payments and we enter into a death spiral of further cuts and further reductions in growth, leading to further cuts.

The UK housing market also showed further signs of slowing, all Britain’s regions showed monthly price declines in the Hometrack Housing Survey.

Over the past 10 years, the deliberate undervaluation of the Yuan by Chinese authorities has always been the elephant in the room in foreign exchange forex markets. The Chinese economic juggernaut has been powered by exports of manufactured goods to the west made cheap by very low input costs.

Quite rightly, China has been labelled the workshop of the world, and 8% average growth over the past thirty years has turned the underdeveloped middle kingdom to an economic powerhouse & the second largest economy in the world, behind the US.

America has long known China would overtake them eventually as the largest economy in the world, but they feel the Yuan undervaluation is giving the Chinese an unfair advantage.

The cheap currency encourages Chinese exports and promotes outsourcing of jobs from the US to China, which in a time of sluggish economic growth and stubbornly high unemployment in the US, automatically makes it political hot potato.

Treasury Secretary Tim Geithner’s comments yesterday that the US would use “all the tools we have” to reverse the bloated trade deficit with China, including WTO rules on fair trade, should come as no surprise in content, only in strength, given the usual soft tone used in diplomatic circles.

His comments come on the back of direct Japanese intervention earlier in the week aimed a curbing the strength on the Yen, and raises the prospect of a triangular trade dispute between the three largest economies in the world.

Sterling was, quite frankly, all over the place yesterday. Disappointing retail sales figures pushed the pound quickly lower in early trading, but as seems to be the way just now, we shook the negative news off quickly and resumed the march towards 1.57 against the USD.

Improvements in risk sentiment has aided Sterling’s move, as has improving economic data in Europe and the successful Spanish bond auction yesterday. The Euro has been driven higher against the Dollar, lifting Sterling versus the USD as well and we now trade over 1.31 in EURUSD and 1.57 in GBPUSD.