- Why EUR/USD Refuses to Fall
- USD: Will FX Volatility Increase on FOMC?
- GBP: No Fresh Insight from BoE King
- AUD: Unfazed by Weak Chinese Data
- CAD: Pushes Higher Despite Softer Housing Numbers
- NZD: Lifted by Stronger Manufacturing Activity
- JPY: Japan Back in Recession
Why EUR/USD Refuses to Fall
The euro rebounded slightly against the U.S. dollar despite Mario Monti's decision to step down as Italy's Prime Minister, the rise in European bond yields and the decline in Germany's trade and current account surpluses. While it can be argued that Germany's trade numbers beat expectations, the surprise was small and there was still deterioration from the previous month. Industrial production in France also fell sharply in the month of October, raising concerns that Europe's 2 largest economies could detract rather than contribute to growth in the beginning of 2013. The resilience of the euro in the face of all these factors is impressive and goes to show how important the balance sheet of central banks can be to a currency. On Wednesday, the Federal Reserve is expected to increase their balance sheet further. While the ECB is also committed to easy monetary policy, their balance sheet has not changed much because no one has asked the central bank to active its Outright Monetary Transactions program. In fact the ECB's balance sheet has actually benefitted from the stability in the region, the reopening of funding markets and the return of deposits, explaining why the EUR/USD refuses to fall ahead of the FOMC meeting.
Whether today's gains can be sustained in the long term is a completely different question and depends on whether European bond yields continue to rise. We are worried that Spanish 10 year yields are now closer to 6% than 5% but they still remain below emergency levels. The 30bp increase in Italian bond yields is distressing but as long as it remains below 5.5-6%, no alarm bells will be sound. The resignation of technocratic Prime Minister Mario Monti is a loss for Italy but he could still choose to run in February's elections even though he said he is not "even thinking about this possibility at this stage." As the third largest country in the Eurozone, the election in Italy creates new stress for the region that could weigh on the EUR/USD in the New Year. For now however, the market is focused on shorter term factors like the FOMC announcement. The German ZEW survey is due for release tomorrow and based on the rally in the DAX and the approval of aid disbursement for Greece, we expect investor confidence to improve but it will be interesting to see if sentiment has been dented by the warnings of weaker growth from the German government.
USD: Will FX Volatility Increase on FOMC?
The U.S. dollar traded lower against all of the major currencies despite the lack of U.S. data on the greenback. We believe the weakness in the greenback reflects the market's expectations for easier monetary policy from the Fed. Intraday volatility in FX increased last week on the back of stronger than expected U.S. labor market numbers and ECB comments. The year is winding down quickly but there could be one more push in volatility before everything settles down. Between this year's final FOMC announcement on Wednesday, the EU Leaders Summit Thursday and Friday and the December 16th general election in Japan, there is no shortage of event risks that could increase the volatility in the forex market. For currency pairs such as EUR/USD, we have already seen larger intraday moves even though it remains stuck in a broad 1.2680-1.3125 range. On the other hand, currency pairs such as AUD/USD and to some degree USD/JPY as well have seen limited intraday volatility over the past week. Of these 3 key events, the FOMC announcement will receive the most attention for 3 reasons - #1 the Fed is expected to change monetary policy and #2 the Fed will be releasing its economic forecasts and #3 Bernanke will hold a press conference. Timing is the main reason why this month's FOMC meeting has received so much attention. Operation Twist comes to an end on December 31st and unless the Fed wants to let a significant amount of stimulus instantly evaporate they will announce fresh measures to keep the party going. With the Fiscal Cliff still in the background and the talks going no where, the Fed will want to keep every ounce of their existing stimulus in place in case Congress cannot agree to a reasonable plan by the end of the year. By making major changes to monetary policy at these special quarterly meetings, Bernanke also has the opportunity to provide further details with the hope of minimizing volatility in the market. Operation Twist was announced in September 2011 with the initial details outlined in the FOMC statement. While they may like to do so, extending the Twist is not an option because the Fed is running out of short term Treasuries to sell. Instead, it is widely believed that the Fed will replace OT with an open-ended commitment to buy $45B in Treasuries every month, bringing their total monthly purchases to $85B ($40B is currently spent per month on Mortgage Backed Securities). By not conducting sales on the short end of the curve, the Fed will end up leaving monetary policy slightly more accommodative. Yet the FOMC announcement isn't until Wednesday and tomorrow we have the U.S. trade balance scheduled for release along with wholesale inventories and the IBD/TIPP Economic Optimism Index.
GBP: No Fresh Insight from BoE King
Despite the lack of U.K. economic data, the British pound traded higher against the U.S. dollar and Euro. Bank of England Governor King spoke in NY today and unfortunately provided very little clarity on the current and future performance of the U.K. economy. He said a "durable global recovery is proving elusive" and uncertainty in the euro-area "has dampened U.K. investment." The economy itself has "experienced zig zag pattern of output" but the "squeeze on U.K. take home pay should diminish which will hopefully lend some support to the economy. King said the BoE is confident that the government's Funding for Lending scheme will feed through to lending and increase the momentum in the housing market. Since there was both optimism and pessimism in King's comments, there was very little reaction in the GBP/USD. Meanwhile this is an extremely light week for U.K. releases with the only significant report being Wednesday's employment numbers. Between now and then we expect sterling to trade mostly on risk appetite. The RICS house price balance is due for release this evening and thanks to the central bank's FLS program, house prices are expected to have fallen at a slower pace in the month of November.
AUD: Unfazed by Weak Chinese Data
Like the euro, the resilience of the commodity currencies has been remarkable considering the weakness of last night's Chinese trade numbers. China is Australia's number one trade partner and generally speaking weak Chinese data should be bearish for the Aussie. While the AUD/USD did sell-off initially, the move was mild and the currency pair ended the day unchanged. Don't be mistaken by this performance because the deterioration in Chinese trade activity is significant. The country's trade surplus shrank from $32.05B to $19.63B in the month of November with exports rising a mere 2.9% against a 9.0% forecast. Imports were also weak and in fact saw zero growth last month compared to forecast for 2% growth. Economists had been looking for Chinese trade activity to drop but not by this much. Part of the weakness was attributed to the completion of iPhone shipments but we can't see that as the only reason why Chinese trade activity deteriorated. Growth in other parts of the world is slowing and China is feeling the pain. If export growth remains anemic this month, the new leadership may be prompted to increase stimulus in the New Year. The upside surprises in China's retail sales and industrial production numbers may have provided some support to the AUD but expectations for easier monetary policy from the Federal Reserve this week could be the main reason why most of the major currencies are holding steady against the greenback despite weaker data. Once again, the New Zealand dollar was the best performing commodity currency thanks to the larger than anticipated increase in manufacturing activity in the third quarter. The Canadian dollar also shrugged weaker housing starts to extend its gains against the greenback. Trade numbers are due for release tomorrow and with the big deterioration in the IVEY PMI index, we expect the country's deficit to increase - whether that hurts the CAD or not is a completely different story. The hawkishness of the Bank of Canada has allowed investors to look beyond all of the weaker economic reports.
JPY: Japan Back in Recession
Japan is officially back in recession. According to the latest GDP report, the economy shrank by 0.9% in the third quarter. There was no revision to the Q3 GDP numbers, but second quarter growth was revised down from flat to -0.1% and 2 consecutive quarters of negative GDP growth defines a recession. Yet the Japanese Yen did not weaken on the news for 2 main reasons - the current account balance returned to surplus in September and some economists believe that this decline in growth marks the bottom for Japan's economy. Throughout the past month, we have heard warnings from local economists that Japan's economy has fallen into recession. The trade balance has been in deficit for most of the year and last month's report showed Japan incurring its first current account deficit in more than decade. The rapid deterioration in Japan's economy was not reflected completely in the GDP numbers and many analysts, us included expected the recession to be caused by negative growth in the fourth quarter. However with the downward revision to Q2 growth, Japan is already in recession and could start rising out of it with current account activity beginning to improve in the fourth quarter. We remain skeptical because while the country's current account balance returned to a surplus in October, the details of the report show a decline in exports and imports, which mean external and internal demand weakened. Nonetheless, the Eco Watchers survey increased slightly in November, providing some support to the Yen.