Europe’s Thin Ice

The ice throughout Europe’s still thin
Can Angela Merkel yet win?
And what of Rajoy?
He’s no altar boy
While Silvio’s soon a has-been

The FX markets are remarkably dull this morning, with perhaps the most exciting movement that of the New Zealand Dollar which has fallen almost 1% on a story about China banning milk powder imports from Fonterra, the big dairy producer there. Otherwise, in the G10 space, things are little changed. Friday’s payroll data were mixed with the NFP number disappointing at +161K but the Unemployment Rate falling to 7.4%. However, given the buildup in expectations from the strong ADP number as well as the relatively stronger US data we had been seeing, it was no surprise to see the dollar fall in the wake of the number. Just not that far.

With regard to the major currencies, the weekend merely brought a rehash of the ongoing problems in Europe. In order of importance (at least in my opinion) these are: the upcoming German election; the fallout from the upholding of Berlusconi’s tax fraud conviction by the Italian Supreme Court; the ongoing inquiry into Spanish PM Rajoy and the PP’s slush fund; and Greece’s continuing struggle to reform itself to both satisfy its paymasters at the Troika and its long suffering population. The thing is that for now, market players are quite sanguine over the prospects of any of these becoming an issue. After all, it is the beginning of August and many, if not most, of the important players in Europe are on summer holiday. However, I feel it would be a mistake to dismiss these issues. After all, the flip-side to traders and politicians being on holiday is that markets are far less liquid during this time of year. And any news from one of these stories, or any other major surprise, can have a disproportionate impact on prices. So while it is hard to point to a cause for a large move in the near term, especially since we won’t be seeing important data for at least several weeks, it is not hard to see how a surprising piece of information could lead to an outsized move. And this, my friends, is why companies hedge their FX risks!

A brief look at Emerging markets shows that Chinese non-manufacturing PMI data was released marginally better than expected at 54.1 over the weekend. The pundits in China were quick to point out that the slowing growth story there is ending and China remains on track for 7.5% growth in 2013. Now on the one hand, I would say that a modest positive blip in a survey outcome is hardly the start of a trend and so further weakness may yet appear. On the other hand, we are talking about China, and quite frankly, they can print any number they choose as the official growth statistic. Who is going to call them out on it? Again, my concern remains that growth there is slowing a bit more rapidly than the government would like and my money is still on GDP much nearer 7% if not below when it is all tallied up at year end. I will say this, a stronger China number would normally lead to a positive performance by the AUD, but as we look this morning, the Aussie has traded to fresh 3 year lows and shows no signs of stopping. It seems to me the market is still betting on a further slowdown in China.

As you can see from the table below, there is very little data this week, with this morning’s non-mfg ISM likely the most interesting data point. However, I doubt any of this results in much movement.

Today ISM Non-Mfg 53.1
Tuesday Trade Balance -$43.0B
Thursday Initial Claims 336K
Continuing Claims 2945K

My best advice is make sure the current low volatility environment allows you to keep appropriate hedges in place while they’re cheap. Because when we get the next move, the price of hedging will surely increase.

Good luck