Ministers With the Clay Feet

In Brussels they’ll once again meet
Those ministers with the clay feet
The question at hand
The German demand
That banks fix their own balance sheet

It has been a mixed day in the FX markets as traders await further US data, but more importantly, await any further news from the Fed as to the possible timing of the next actions. Central banks have been the focus of most traders lately, between the Fed and all the talk of the ‘taper’, the PBoC and its efforts to deflate the real estate bubble without causing an economic crash, the BOE and its pending change in leadership as Mark Carney starts on Monday, and finally, the ECB, where Signor Draghi continues to assure the world that they have plenty of tools at their disposal, but seems unwilling to use very many of them. That’s quite a list and it didn’t even include the BOJ, which we all know is on a mission to double the money supply in Japan over the next two years.

Starting in Europe, more comments from Draghi indicating that the ECB will remain accommodative for now and urging individual nations to address the fiscal problems that bedevil the Eurozone were sufficient to undermine any support for the euro. It is now approaching 1.30 and I continue to believe is heading steadily toward 1.25 over the next several months. The very clear difference in tone between the Fed and the ECB will continue to weigh on the euro going forward. Perhaps just as importantly, the EU FinMins will be back in Brussels trying to iron out the banking resolution process for the future. Remember, late last week they could not agree on the measures to address bank failures and when the new banking regulator should be called in to support a particular bank. I see no reason that positions would have changed in the past 5 days, and so as I wrote Monday, the outcome is likely to be no real resolution, but some announcement that things are solved. Politically, they cannot afford to fail again, but economically, neither side will give in. As I also wrote Monday, this remains an underlying reason the euro will continue its decline.

The pound is also a bit softer this morning, following the euro and seemingly anticipating the onset of the Carney era. Remember, the entire world is expecting great things from Carney, who is on record as calling for ‘flexibility’ in inflation targets (read higher inflation) and has been willing to push the envelope with regard to innovative monetary policy measures aimed at easing policy. Certainly, if the BOE votes for more QE, one of the possibilities at next week’s meeting, the pound will suffer further.

Down Under, the political situation is heating up as PM Gillard lost the Labour Party leadership election and the Labour Party will now be lead by Kevin Rudd in the September elections to come. But the Aussie’s weakness over the past months has not been political, it has been the result of position unwinding. Aussie had been one of the favored destinations for investors seeking a combination of yield and safety with a modicum of liquidity thrown in. It is apparent that much of that positioning has been reduced. Add to that the tepid economic growth and the apparent weakening in China, and Aussie suddenly doesn’t look so attractive. Remember, the 10 year average price of AUDUSD is 0.8575, with recent time spent above 1.00 as the historic outlier. Aussie has further to decline.

And let’s talk about China now, where the PBoC continues to moderate the liquidity problems that have arisen in the banking system. While they are working hard to prevent a melt-down, and certainly do not want to see any bank failures, it has become clear that the Xi Administration is keen to make major adjustments in the Chinese economy. The effort to diversify away from an export led economy to one that is more reliant on domestic consumption has been fraught with periodic problems, like this liquidity situation. This is the conundrum in which the Chinese find themselves. It is easy to add liquidity and reduce the short term lending rates, but in so doing, they would continue to encourage the property speculation they are trying to defeat. So they are trying to find a middle ground, and the short term gyrations are the result. This highlights just how difficult it is for a country to make monetary policy adjustments and have markets behave as desired. And this is in China, where the government has much greater control over everything. Remember that when thinking about the Fed and its ability to control its message, policy and market responses, or rather its inability to do so.

Finally, a quick word on India, where the Rupee traded to a new historic low vs. the USD at 60.765, falling a full 1.75% on the day. The problem has been a steady outflow from the Indian stock markets by international investors combined with the domestic problems of slowing growth and rising inflation. The RBI has not yet focused on either growth or inflation, trying to manage both simultaneously. This has reduced international confidence in the currency, and quite frankly, I expect it will continue to slide. There is nothing that says it cannot reach 65 at some point on this move, regardless of the RBI’s modest intervention efforts.

Good luck