WISE MONEY

The Bank of England minutes, released today showed that the MPC has not come any closer to raising rates. The vote as expected showed the split remaining at 6-3, with Spencer Dale & Martin Weale voting for a 25 basis point rise and Andrew Sentance for a 50 point rise.

Data this month has shown the economic recovery stalling somewhat, and the surprise drop inflation (although probably temporary) should be enough to postpone any rise in interest rates.

The Pound is being pushed around by the Euro-Dollar pair, which has rebounded from the lows yesterday after strong earnings from IBM, Intel and Yahoo boosted risk appetite in the Asian session.

One would have expected the S&P downgrading of the US outlook to negative from stable to push up US rates.

But there was almost no reaction.

Whether this reflects S&P’s standing in the market post crisis, or the fact that the Fed is the only buyer of Treasuries currently is difficult to assess.

But the Dollar has reacted negatively, and may come under further pressure this afternoon if existing home sales data fails to impress.

The US Dollar is struggling to stay above it’s November 2009 low around 74.17, with little sign of a change in fortune. A shock rise in weekly jobless claims to 412k (380k expected) did nothing to help the Greenback’s efforts as higher commodity prices, and in particular energy prices played negatively.

Undoubtedly, many US Dollar pairs have entertained an increase in sensitivity to oil price movements over recent weeks, with the USD falling on the wrong side when oil prices move higher.

The commodity currencies e.g. Canadian Dolar are the key beneficiaries but EUR/USD is also strongly linked with the price of oil.

Various Fed comments this week including supportive comments on the USD’s role as a reserve currency have had little effect to boost the view on the dollar despite the generally hawkish slant.

The capability of the single European currency to survive a flood of dire news from the eurozone periphery continues to surprise.

Above all, peripheral bond yields carry on rising especially Greek yields as expectations of debt restructuring develop.

Remarks from Germany’s finance minister have added to such expectations.

Reports that the Bank of Spain accepted the recapitalisation of 13 banks and that Spanish banks lent only EUR 44 billion last month, the lowest since Jan 2008, may have provided some relief.

The euro was given a further boost following Trichet’s press conference yesterday and although the decision and conference both panned out exactly as expected, confirmation of at least one more rise in Euro rates enabled traders to justify renewed buying. The ECB President conveyed that there had not been a decision that makes this the first in a series of rises, but added that the Central Bank will act as needed and that interest rates across the maturity spectrum remain exceptionally low.

The phrases used in the statement suggest the ECB will sanction a further rise, all things staying the same, following the June meeting.

During the next couple of months however, there is the potential for the playing field to alter considerably.

Portugal’s decision to finally admit that the weight of debt on its books is too heavy a burden to bear allows the process of bail-out to proceed, but the assertions of Finance Ministers that this is now it, that there will be no contagion into other Eurozone states and that Spain’s funding capabilities are not being threatened sounds very much a déjà-vu situation.

Ministers will undoubtedly fight hard to avert any pressure being bought to bear on either Spain or Italy, but if the market senses any weakness at all, then it knows that it is able to shatter the defences.

For now though, all the talk is of Portugal; how much to bail-out, who will negotiate it and when an agreement can be reached.

All we do know is that the terms and conditions demanded by the EU will be more severe than those austerity measures rejected by the Portuguese parliament a couple of weeks ago, a decision that put Portugal into its current tail-spin.

At present though, investors are willing to give the Euro the benefit of the doubt.

The Dollar cause has not been helped by the continued failure of US politicians to reach agreement on extending the country’s debt ceiling, thus increasing the possibility of a Government shutdown.

Added to this, yields on Dollar bonds dipped yesterday afternoon following the news of yet another earthquake in Japan, which also sent equities lower.

The MPC did indeed leave rates and QE levels unchanged and it looks as though we will need to await release of the minutes from the meeting on 20th April and possible even until the release of the 1st Quarter GDP estimate on 27th April to get a better idea of what will happen at the May meeting.

Economic data has been so mixed recently that the likelihood on any sort of consensus looks remote. Official rates will therefore remain as are which in turn, will diminish Sterling’s appeal on the current differential trading scenario.
The Dollar and the Yen remain under the cosh this morning whilst the Euro and Aussie Dollar have made further gains.

Recent US Dollar movements seemed to be reflecting hopes that the Federal Reserve would curtail its asset purchase scheme before the official deadline in June.But just released minutes of last months FOMC meeting seem to have put to bed any notion that QEII will be curtailed, with most members seeing no reason to end quantitative easing early.

The Dollar immediately weakened against Sterling and the Euro on the announcement, with a larger divergence in views between members more apparent than in last months minutes even though the overall tone of the minutes was more upbeat on the economic recovery.

There was also mention of the size of the balance sheet and the Fed’s credibility.

We expect this to become a major issue once QEII does eventually end along with the Fed’s plan for selling all of its holdings back into the market.

Sterling gained two cents against the Dollar after strong service sector data yesterday.

After the snow induced contraction in the 4th quarter, the first three months of this year have shown strong levels of growth, with March reading 57.1 against last months 52.6.

Firms increased hiring for the first time in nine months, one of the key drivers in the Pounds move yesterday.

As tends to be the way at the moment, one positive piece of news is immediately followed by a negative one.

Manufacturing and industrial production figures have just been released and they have failed to impress – month on month manufacturing figures showed no growth and industrial data showed a slight fall from January and the retail sector continues to struggle.

After a short rally at the beginning of the year the Greenback has come under increased downward pressure following widening interest rate differentials against many other currencies. The stand out difference in view between the hawkish ECB and the somewhat dovish US stance highlighted in the latest FOMC statement has provided a catalyst to differing outlooks from either side of the pond.

Uncle Sam seems on tract to complete the full $600 billion of QE by the middle of the year in contrast to the ECB looks to be planning the market for a reduction in its liquidity operations.

Although there could be more movement EUR over the short term as a result of the move in interest rate differentials as well as improved feeling in the direction of the eurozone periphery, the potential rise for EUR/USD is looking more and more restricted.

Even European officials are starting to display an air of caution, with the ECB’s Nowotny claiming that markets are too enthusiastic over a possible improvement of the European Financial Stability Facility (EFSF) bailout fund.

Without a doubt, it is very likely that the euphoria recedes quickly once it becomes apparent that enlarging the bailout fund is by no means a panacea to the region’s ailments.

In other news, Moody’s are musing over the current AAA sovereign rating of the United States.

Following the Congressional Budget Office’s latest assessment of the 2011 outlook within which they put this year’s deficit at $ 1.48 trillion, the sovereign rating has again come under scrutiny.

Moody’s said that the probability of assigning a negative outlook to the current AAA in the coming couple of years is rising and although the risk to the rating itself was small, it is rising and will continued to do so during the next few years.

The Swiss franc has reached its highest ever level against the US dollar.The dollar dropped to 94.5 Swiss centimes yesterday- an all-time low.

The US currency fell against most major currencies on Tuesday following weak housing and consumer confidence data.

The Swiss franc has risen against both the dollar and the euro ever since the 2008 financial crisis, thanks to its status as a safe haven within Europe.

Markets have perceived the country as being a safe place to park cash, free of the debt worries that afflict some countries in the eurozone and – to a lesser extent – the UK.

The Swiss government is running a modest budget deficit in comparison to its European peers, while the country as a whole enjoys a big trade surplus with the rest of the world.

The franc has played a similar role to the Japanese yen – another currency that has proved a safe haven in the past two years, much to the chagrin of its government.

Like the Japanese, the Swiss intervened to weaken their currency earlier this year, fearing that a rapid rise would make its exports uncompetitive.

But – just like the Japanese government – the Swiss National Bank eventually gave up the effort in the face of an inexorable inflow of private money into its home currency.

Yesterday China intimated that their interest rates will be kept on hold in spite of inflation rising by 5.1% annualised, and the lack of liquidity on the run up to Christmas has placed the dollar on a downward spiral rather than any economic fundamentals. Consequently the market is in a state of confusion this morning with speculators appearing more than ready to wind down their positions heading into the weekend whilst the data/economic releases calendar holds plenty of potential for some good movement.

We started the morning with both Cable and Euro/Dollar in neutral territory from a technical analysis point of view but with projections for year end still for a marginally stronger Dollar – if only on ‘traditional’ end of year demand.

As for the rest of the day we have three US data releases before the release of the outcome of this month’s FOMC meeting.

Retail sales are expected to dip from last month’s strong figure and no change is expected from the Fed to either the interest rate or the current level of stimulus measures.

The recent pick up in US yields will maintain some concerns over the decisions but most analysts expect no change in anything.

Elsewhere, Moody’s said that the recent US tax proposals increase the probability that over the next couple of years, the US AAA rating would be put on outlook negative given that the positive effects from higher growth would be outweighed by the negatives.

US treasury bonds have endured their worst 2 days since the financial crisis of 2008 while yields and spreads in the eurozone continue to ease. This all looks like a bit of a shake out in markets ahead of the end of year lull and the moves will undoubtedly peter out over the next week or so.

We are in the middle of monetary policy decisions from Central Banks around the globe and things do look very much as though they are now on hold until we at least get well into the 1st Qtr of next year.

This week so far we have seen New Zealand, Brazil and South Korea leave official rates on hold (3%, 10.75% and 2.5% respectively) following on from a similar decision from Australia last week.

Today we have the BoE/MPC deciding on any rate and/or policy change and the over-riding expectation is for no change in either levels of interest rate or of QE2.

The minutes will surely reveal a continuation of the split in members’ opinions of both the future paths of the UK economy and inflation with a corresponding difference in policy.

The Bank of England Governor, and his Bank colleagues are likely to be in the middle, holding the two ‘warring’ factions together – another split vote is more than probable. No immediate currency implications.

The Far East again demonstrated the gulf between the pace of Eastern and Western economic recovery with Japanese 3rd Qtr GDP revised higher to expand at annualised rate of 4.5% whilst the Australian October employment figure was reported as rising by 54,600 which was about double the number expected.

Both currencies saw a spike higher on the respective releases.

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.