Beginning to Heal

In Europe they’re starting to feel
That growth is beginning to heal
So euros are strong
And pounds are along
For the ride. Its all somewhat surreal

First the big news – yesterday was my first day at RBC. As time progresses you can be sure I will be reaching out to sit down and discuss things, but for now, as I am all alone on the desk in NY, the occasional phone call and my morning note will remain my MO.

Data out of the Eurozone this morning showed export performance improving while inflation remained under control. This combination has encouraged the FX community to bid up all G10 currencies relative to the dollar, with the euro and Aussie leading the way. The GDP data earlier this week was the first sign that things were getting better, although a closer look shows that stronger growth in Germany and, surprisingly, France offset still very weak situations in Italy, Spain and the Netherlands. So is the situation uniformly better in Europe? Clearly not yet. But at least it seems that they may have found the bottom in the economy. And that, when combined with the mostly mixed data that we have been seeing in the US, (yesterday’s IP, Capacity Utilization and Empire Mfg were all softer while Initial Claims fell to their lowest level in 5 years and Retail Sales were strong) has been enough to adjust attitudes. Hence the dollar’s current weakness. This morning we add the Housing picture to the markets with Housing Starts (exp 900K) and Building Permits (945K) at 8:30 followed by Michigan Confidence (85.2) at 10:00. As I wrote earlier in the week, the data would give us the opportunity to evaluate the ongoing recovery here, and so far it remains tepid at best.

But the question remains, is tepid good enough for the Fed to still consider the taper? Everything that I read, including St Louis Fed President Bullard’s comments last night, lead me to believe that the Fed has become quite concerned over the possible downsides of exploding its balance sheet from a bit less than $1 trillion prior to the 2008 crisis to almost $4 trillion now. And remember, even the taper won’t stop that growth, merely slow it down slightly. While they certainly take comfort in the continuing low inflation readings, I am certain that the FOMC is aware of the potential for inflation given the amount of reserves that are in the system. While they have not really been a problem to date, recent data shows that they may be starting to migrate from the excess category to the utilization category. And that is where inflation will start to show itself. At any rate, the betting is still for the taper to begin next month and I believe the market has a $20 billion reduction penciled in. So any difference from that will be the mover when the Fed finally speaks again.

In the emerging space, INR has traded to yet another record low, breeching 62 for the first time, although it has since rallied back a bit. This show is not over folks, and I continue to look for at least 65 and perhaps an eventual move toward 70 as it evolves. The RBI is losing reserves, down 7% so far this year, which means their ability to manage the currency will be impaired further. They are running out of things to do short of significant changes in fiscal policy. Alas, given the current political situation that is nigh on impossible. Brazil, too, is finding themselves on the wrong side of the market right now, and my view of 2.50 remains intact. Last night the central bank announced they would be rolling over their currency swaps on some $5 billion and they continue to intervene to try to smooth the market. While inflation printed slightly below the top of their range at 6.27%, it remains a grave concern. This is especially so in light of the fact that growth has shown no spark. It appears that Brazil is redefining the term stagflation, and that is going to weigh on the Real for a while yet.

The flip side of that is China, where the Renmimbi has been remarkably stable over the past months, stuck between 6.11 and 6.15 for months now. This has prompted discussion that the PBoC may widen the trading band again, perhaps to 2% or 3% from its current 1%. This is all part of the Chinese effort to achieve a convertible currency so that the CNY gains in global prominence. However, that goal remains a distant one as there is no indication they are going to suddenly remove exchange controls and it remains a question as to whether or not the Chinese banks could even withstand the pressures of a fully convertible currency. You know that the government will want the local banks to dominate the currency trading, but they won’t have the ability to do so in their current state.

For today, I think we see modest further USD weakness against the rest of the G10. However, if Treasuries accelerate their recent decline, that might change some views, further hampering the equity market and likely forcing some traders out of short USD positions.

Good luck and good weekend