Away From the G10

Away from the G10 we’ve seen
That traders are really quite keen
To sell the Rupee
And while on that spree
The Rand and Real they demean

Mixed is the best description of the FX markets this morning as we are seeing the dollar weak against the euro and pound, rallying slightly against the yen and much stronger vs. a number of EMG currencies, notably BRL, INR, ZAR and MXN.

Starting with the G3, the euro seems to be benefitting from the realization that the ECB’s balance sheet has actually been shrinking over the past 3 months, and is now actually $400 billion smaller than the Fed’s. And that trend shows no signs of slowing. European banks continue to repay the LTRO loans, (some $57 billion since May) reducing the ECB balance sheet. At the same time, the Fed continues to buy $85 billion in Treasuries and Mortgage-backs each month, inflating theirs further. With no actual QE by the ECB, its balance sheet has no prospects for growth. So even though the taper is going to reduce the rate at which the Fed acquires assets, they are going to continue acquiring them for a while yet under virtually any circumstance. I believe this has been an important and little known fact that has helped underpin the euro’s relative strength of late. Every time I look at the big picture in Europe, I can see no good reason for the euro to maintain its current levels, but this information may be why the single currency has been so resilient. It is also why the taper is so important for the dollar’s value, as when the Fed stops ballooning its balance sheet, the dollar should find more significant support. As to the pound, it has been dragged higher by the euro, but there has been very little in the way of information as a driver. Meanwhile, the yen is softer this morning, down 0.50%, after the release of a much larger than expected Trade Deficit last night. The decision to shutter its entire nuclear fleet continues to have a major impact on the Japanese economy in two ways. First, there are concerns over the ability to generate sufficient power to insure that air conditioners stay on and factories continue to run at peak efficiency, and second, the Trade deficit continues to widen as the high cost of importing fuel impacts that directly. But given the general lack of volatility of late, and the fact that the summer vacation schedule continues to detract from market liquidity, right now these currencies don’t seem so interesting.

So let’s look at the EMG space instead, where we see USDBRL having traded to its highest level since March 2009 just below 2.40. If you recall, it was several months ago that I called for a move to 2.50, and now the market has really started to roll. While the central bank continues to try to minimize volatility, it does not have sufficient reserves, nor apparently credibility, to do the job properly. Weekend comments highlighted internal dissent between the government and the central bank and that is only likely to help the weakness continue. The thing about currencies like BRL is that once they get rolling, they have an opportunity to really overshoot any semblance of reality. So while I think 2.50 is almost a certainty now, I think there is a very real chance that it could trade to 2.75 or even beyond. And it can do this far more rapidly than you might think, so beware. India, too, is having serious problems as the central bank there is also running out of tools to help it manage the weak currency. As I have written consistently, slowing growth and rising inflation are a very difficult mixture for a central bank to manage effectively. At some point, they have to decide which issue they will attack first, to the detriment of the other. So if they go after inflation, growth will slow further, while if they attack inflation, then a recession is quite possible (likely). It should be no surprise that the INR is falling further, down another 2.25% overnight to yet another new low and now above 63.00. It was several weeks ago that I called for 65.00, but 70.00 now feels very realistic. Remember, the thing about EMG currencies is once they get started on a move of this nature, it is very difficult to slow them down without significant policy changes. As to the ZAR, it has moved back above 10 for the first time in a month as continued unrest by unions combines with further rate rises in the US Treasury market giving investors two reasons to exit the currency. In MXN, the big figure is 13.00, but here too it has been more than a month since we have traded at these levels. The story here is more focused on the US side of the equation, with better growth and higher Treasury yields sufficient to dissuade investors from emerging markets in general and seeking the safety of dollars. The dollar is strong throughout the EMG space and as long as we continue to see Treasury yields rally, I think this situation will continue.

While there is no data today, we do learn about the housing market this week, as well as get the FOMC minutes from the last meeting. Here is a look at everything expected:

Wednesday Existing Home Sales 5.15M
FOMC Minutes
Thursday Initial Claims 330K
Continuing Claims 2970K
Leading Economic Indicators 0.50%
Friday New Home Sales 487K

My guess is that the minutes will be the most interesting information unless the housing data miss forecasts dramatically. Of course, if the equity market weakness of last week continues more dramatically, then we could see a bit more volatility than we have been in the G10 currencies, but right now it does not feel like there is much to get excited about.

Good luck