Draghi’s Legerdemain

In Italy, Portugal, Spain
Small business is feeling the strain
The ECB moans
They still can’t get loans
Despite Draghi’s legerdemain

It has been a relatively quiet Memorial Day weekend in the FX markets, with last week’s activities mostly being consolidated.  There seems to be a sense of calm overtaking the markets and I can’t tell if it is simply the start of summer, with less interest exhibited by players, or if it is a genuine sense of relief that things may be getting better.  My gut tells me it has more to do with summer than with the progress that has been made recently by governments around the world.

Looking at Europe first, there was another weak piece of data with French Consumer Confidence falling to 79, exp 85, although the euro had only a modest reaction to that news.  In fact, ultimately it is slightly higher on the day.  The newspapers have all been focused on the change in tone amongst the EU leadership as there seems to be less discussion of further austerity and more discussion of how to encourage growth.  The problem is all the ideas to encourage growth revolve around the government doing something, rather than simply allowing businesses to perform their best.  More mandates and regulations are not going to increase the GDP of Europe.  There has been much written on the inability of small and medium sized businesses in Southern Europe to get credit to expand, with Germany going so far as initiating a program to have its own development bank, KfW, make favorable loans directly to SPANISH companies!  FinMins throughout Europe decry a broken transmission system, but I think it is simply banks evaluating the credit risk of these companies and charging accordingly.  After all, the banks remain in the cross-hairs of the ECB as well, with capital requirements constantly increasing.  However, it is difficult to imagine the Eurozone growing strongly without those smaller companies growing.  Will this help the situation?  Perhaps at the margin, but ultimately, the peripheral nations remain vastly uncompetitive by virtue of years of bloated costs and benefits, and until that is corrected, which will be a long painful process, Europe will suffer.  As will the euro, which will have difficulty rallying from current levels.

In Japan, 10 year JGB yields reached above 0.90% again overnight as an auction of new bonds was not that well received.  There is a certain irony in the idea that the BOJ is seeking to increase inflation significantly but simultaneously reduce yields on JGB’s.  Those two actions are diametrically opposed, and ultimately, given the massive expansion in money supply that is on the cards, JGB yields will rise.  Last night we heard from a BOJ member, Miyao, who reiterated that the massive expansion was still on track despite last week’s comments from Economy Minister Amari, and that seemed to be sufficient to help USDJPY to rally about 1%.   The yen still has much further to fall, but it feels like we are going to spend much of the summer range trading.  As USDJPY has rallied so much in the past 9 months, a period of consolidation seems inevitable.  While I continue to look for 110 or beyond by year’s end, it is very likely that the next several month’s will see a 100.50/103.50 range.  In fact, that would be healthy for the move, and prepare the market for the next leg higher in the dollar.

Overall, the dollar has been mixed this morning, with market players looking at specific stories rather than broad themes.  If I am correct about the summer doldrums arriving, then this should be the pattern more frequently than not.  It is my view that currency markets will not be the prime drivers of the financial system this summer, rather they will be the tail of what happens.  So keep an eye on equities and commodities as well as US Treasuries.  Especially if Treasury yields begin to rally, then we could see some FX fireworks, but if the Fed is successful at containing those rate rises, the summer should be dull in the FX world.

Good Luck