The British Economy’s Grooving

From Europe the news is improving
The British economy’s grooving
And there’s no mistaking
That Germany’s making
An effort to keep things there moving

It’s been something of a mixed bag in the FX markets overnight as the dollar has fallen against its G10 peers but rallied vs. many emerging currencies. This morning’s data from Germany and the UK has shown continued improvement in those nations although across the rest of the Eurozone things are less robust. Starting with the euro, it has edged higher on the back of strong German Factory orders (+3.8% in June), which set the tone for euro strength, albeit not an overwhelming amount. UK IP was stronger than expected (+1.1%) and House Prices there rose more than expected (+0.9%), with both pieces of data adding to the picture that the UK is climbing to a level of sustainable growth. The pound has mirrored the euro, rallying a small amount, and both currencies have maintained a positive tone over the past several sessions. Meanwhile, Italy continues to be mired in recession, with the GDP having fallen 2.0% in the past 12 months. While that was better than the -2.2% expected, it still highlights just how big are the problems that remain.

The bigger movers in the G10 space have been AUD and NZD. Aussie seems to have been the beneficiary of the adage: sell the rumor, buy the news. The RBA cut rates 25bps last night, which was almost universally expected, but in the accompanying statement they indicated that there was little reason to expect further cuts in the near term. The market had been short AUD overall prior to the announcement so the rally is not that surprising. Meanwhile in New Zealand, the fears over the milk powder issues I mentioned yesterday seem to be abating as the government there has made a strong effort to downplay any long term impacts on the economy.

And what of the yen? It has been edging higher over the past several sessions as the market awaits the outcome of the debate on raising the consumption tax there in October. If you recall, the plan was to raise the national sales tax to 8% in October and 10% in October, 2014, but PM Abe and his crew are concerned that raising taxes in a still weak economic environment may derail the recovery. Of course with a debt/GDP ratio approaching 250%, the government needs to show that they are looking at the revenue side of the equation in addition to the spending side. The IMF has added pressure on the Japanese to implement the tax hike with a statement overnight (of course, the IMF’s only known solution to all problems is raising taxes), and there continues to be concern over the idea that the BOJ is monetizing Japanese debt. So what can one expect? The long term situation in Japan has not changed meaning the yen has much further to decline. The catalyst for the next leg is still most likely to be the revamped ‘third arrow’ of policy from the government. However, given how tenuous the situation remains with regards to the massive debt position, it is quite feasible that something else triggers the next sell-off there. I see no reason for USDJPY to trade below its recent lows of 97.65, but markets are perverse and if positioning is more heavily short yen than I think, that move could be larger. In the end, the yen will eventually weaken further, but for now it has legs for modest strength.

In the EMG universe, INR is noteworthy for having traded to yet another historic low, this time at 61.806 before bouncing on intervention stories. Traders and investors continue to be concerned over the massive C/A deficit and are fleeing the local stock markets. This currency has further to fall as the RBI will not have the firepower to do much more than smooth the decline. I am still looking for 65.00 before the end of the year. And in Brazil, we are once again seeing the dollar above 2.30. The central bank there is doing all it can to prevent a freefall, with rate hikes trying to fight increasing inflation and slow the currencies decline. But the market is not yet a believer in the preferred outcome and sellers of BRL continue to materialize everywhere. Remember last year when the central bank was fighting a ‘too strong’ BRL? They created all kinds of rules to prevent inward investment and a rising currency. I’ll bet they would be pretty happy with that issue right now! USDBRL is on its way to 2.50, with the central bank there simply slowing the trajectory. Mark my words.

This morning in the US we see the Merchandise Trade Balance (exp -$43.0B) but unless it is a big miss, I doubt it will matter much to the market. As I wrote yesterday, there seems to be very little that has people willing to get involved here. Without comments from a Fed personality, I expect we close the day within 0.2% of where currencies are right now.

Good luck