There once was a banker named Ben
When asked he said, never again
Would he take a role
That’s taken its toll
On quite a long list of good men
Now markets are somewhat concerned
The next chairman might not have learned
The lessons that showed
Why growth really slowed
Soon they’ll wish that Ben had returned
It seems to be official now, Chairman Bernanke will not be returning to the Fed when his term ends on January 31, 2014. President Obama made it clear in an interview that Ben was ready to move on. So what does this mean for markets in general and FX markets in particular? I think we are likely to see an uptick in the level of nervousness across the board in markets. Despite the controversy he courted, market response to Bernanke’s unprecedented monetary policies has been pretty impressive overall. Concerns over newly inflating asset bubbles are growing, but for most people, who simply hold equities in their portfolios, the rally that has taken place over the past 4 years has been a welcome relief from so much of the overall economic anxiety that has accompanied life since the onset of the Financial Crisis in September, 2008. During that same period, the dollar has been anything but stable, rallying sharply in 2010, falling sharply through 2011 and edging back higher since then. I think the biggest uncertainty for market players is that whether or not they agreed with Bernanke’s policies, they grew to understand his behavior and were able to trade accordingly. But with a prospective new Chairman coming on board, aside from all the speculation about who it will be, there will be the matter of learning a new communication style as well as determining if the new Chairman’s policy ideas are seen as positive for markets. This is another factor that will, at the margin, increase volatility for the rest of the year.
As to the FX markets overnight, the dollar has had a better session than yesterday, rallying against most currencies, notably the JPY and AUD in the developed space, and the ZAR and INR in the emerging space.
The session started with worse than expected Japanese IP data, a rise of only 0.9% in April, and the initiation of weakness in the yen. Moving on to Europe, EU auto sales fell to their lowest level in 20 years! Both these items were sufficient to help boost the dollar in the G10 space. The euro was able to shake off its early weakness after a combination of better than expected German ZEW figures (38.5 vs. 38.1 expected) and comments from Signor Draghi, repeating that they ECB will do “whatever it takes” to keep the euro in one piece, and that other nonstandard measures, whether negative deposit rates or further liquidity injections are all possible. The euro reacted positively to these things and is the only currency in the developed space higher this morning.
Meanwhile, UK inflation data was released at a higher than expected 2.7% in May, up from 2.4% in April and higher than the 2.6% forecasts. Inflation in the UK remains stubbornly above the 2.0% target and seems to be a hindrance to the BOE in its efforts to support the UK economy further. Remember, Mark Carney will be taking over as the new BOE governor on July 1, and all eyes will be on him to see if there will be more stimulus coming regardless of the inflation situation. At any rate, the pound is softer this morning, down from recent highs at 1.57, and I continue to believe it is a better sale than buy at these levels.
Perhaps more importantly, data on Chinese home prices continues to show they are rising sharply and are creating concerns that the PBoC will not be able to support the broad economy while inflation is so prevalent. It was the latter story that helped undermine so many of the Asian currencies, including the AUD. If China is embarking on a period of slowing growth and rising prices, then all those nations that rely on exports to China as a key part of their growth strategies, a.k.a. the rest of Asia, are going to find themselves in significant difficulty and their currencies are going to suffer for that as well. Remember, one of the reasons that Asian currencies had performed so well over the past several years was the idea that most of these nations were growing rapidly, albeit in the shadow of China, but that they had learned their lessons from the Asian crisis in 1997-98 and fixed their fiscal issues. This resulted in a combination of strong underlying fundamentals and rapid growth, drawing in lots of investment. While their fiscal situations remain in good stead, the potential slowdown in growth is going to have very negative repercussions. We continue to see investment funds flow out of the area and I see no reason for that to abate in the near future. This large scale exiting of financial investments will certainly weigh on these currencies. India seems in particular difficulty, with inflation still above target and growth below target. Last night’s 1.5% decline was precipitated by a widening of the trade deficit, which has simply been adding to their problems. We also saw significant weakness in ZAR (soft commodity prices combined with ongoing local labor strife) BRL (weaker Chinese growth restricting its exports) and HUF(declining bond yields discouraging investors).
Yesterday’s Empire Mfg number was much better than expected, and today we see Housing Data (Housing Starts exp 950K, Building Permits exp 975K) as well as CPI (exp 0.2% headline and core). This is the area of the US economy that has performed best of late, and more strong numbers should translate into both higher yields and a stronger dollar. I like the dollar from here, especially against the pound in the short term, but receivables hedgers need to be on their toes.