While markets seem rather subdued
The one thing that we can conclude
By reading the news
Is problems still ooze
From countries both stupid and shrewd
Once again a roundup of the overnight news highlights the weakening growth in China (HSBC PMI 47.7, exp 48.2) contrasted to the surprisingly stronger data from Europe (Eurozone PMI 50.1, exp 49.1). While there are ongoing financing problems in Spain, it seems the FX market remains quite comfortable with the single currency for now. The funny thing about the stronger EZ numbers is that I think the market will make the following assumption: Bernanke mentioned weaker EZ growth as a downside risk hence reducing the chance of a quick taper => equities rallied; but now, EZ growth is picking up and a quicker taper is back on the table ergo selling equities seems a better bet. As I type, SPU’s are modestly higher, and European equity markets have rallied about 1%, but as the US walks in and the day progresses, I suspect that the equity markets may find themselves selling off somewhat today.
FX markets, however, continue to lag the action. The China story remains the current fixation, with both the JPY and AUD falling after the PMI data was released. And though the euro is modestly higher this morning after the PMI data there, in truth the movement across the other major currencies, besides AUD and JPY, has been tiny, about 10bps. So FX players remain sidelined, as I forecast, and are awaiting what they perceive as important data, like next week’s employment report. Problems around the world have not moderated at all, but they have not accelerated either, so at the margin, things are just not that interesting. Given this environment it is difficult to forecast substantial short-term movement in the FX markets. However, a quick roundup of the longer term problems that still exist shows that the financial crisis that began 5 years ago remains with us today:
- Spain is drawing down its National Pension assets, thus removing one of the only buyers of Spanish bonds from the market.
- There are no buyers for Greek government assets.
- The Portuguese government remains on shaky footing with no ability to choose between flouting their promises to the Troika or imposing austerity at home.
- The Italian Grand Coalition has passed no new legislation addressing the massive structural problems internally.
- The Germans remain unwilling to finance the bill for greater Eurozone integration until at least after the election in September.
- Bank regulators around the world are proposing higher capital and leverage ratios for large banks because the risks to the financial system remain significant; and finally
- US politicians are proposing easier standards for banks to issue mortgages because higher rates have reduced both supply and demand for home mortgages. (It strikes me that this and the demand for more capital are in direct competition for the same funds. I wonder how this will turn out!)
None of this would lead me to believe that the world is different today than it was six months ago, and most of the problems extant then remain in place. So, what does this mean for FX?
EUR – I still like it lower, as the Fed taper comes back on the table and the ECB remains firmly entrenched on an easing path. While I have been impressed with the resilience of the single currency, the fundamentals still point lower in my mind.
JPY – A weaker yen is still on the cards. Doubling the money supply and rising inflation will serve to do the job. I continue to like 110 by year end.
GBP – This is likely the only currency that will hold its own as the growth story seems to be more stable than in the rest of Europe, and I believe that Carney will be responsive to that data as time progresses.
AUD – There is nothing to encourage anything but a further decline. Slower Chinese growth and more rate cuts will undermine any ideas over ‘safety’. 0.80-0.85 by the end of the year.
LATAM – These currencies will continue to suffer as the year progresses. Neither Mexico nor Brazil is showing signs of positive economic performance and in Brazil the inflation situation is becoming uncomfortable. BRL = 2.30-2.35 at year end. MXN = 13.50-13.75 by then.
Other EMG – we have already seen 1/3 of the hot money that went into these markets during 2012 and Q1 2013 flow out in the past 2 months. More will leave and these currencies will suffer accordingly. While I expect that most EMG central banks will look to smooth the declines, these currencies are going to weaken further vs. the dollar.
This morning’s US data brings New Home Sales (exp 484K) but I don’t think it will matter to the FX folks. Today is likely to be another day of limited movement overall.