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Obama's New Strategy on China is USD Negative

Fri, Jan 23 2009, 01:31 GMT
by Kathy Lien

GFT

Obama’s New Strategy on China is USD Negative

The US dollar and the Japanese Yen, the two lowest yielding G10 currencies continue to be the two best performing.  It is important to remember that the dollar and the Yen are not rallying because investors have grown more optimistic about those currencies but because they are more pessimistic about the outlook for the US and global economy. We have seen an unusual amount of currency related comments made by central banks and government officials around the world because of the sharp rally in the dollar and the Japanese Yen.  As these currencies continue to rise, the risk of a reversal grows.  Tim Geithner has been confirmed as the new US Treasury Secretary but rather than cheer his confirmation, analysts are worried about some of the comments he made at his confirmation hearing.  

Obama’s New Strategy on China is USD Negative

According to Geithner, the Obama Adminstration will be saying goodbye to the buddy versus bully approach to China.  He believes that Obama will "aggressively try to change Yuan policy" and that China will no longer get a free pass in trade violations. Geithner even went one step further by saying that Obama believes that China is "manipulating" its currency.  Many people fear that this is rookie rookie mistake.  China does not readily succumb to political pressure.  That is why former Treasury Secretary Paulson allowed China to appreciate the Yuan on their own terms. To a large degree this strategy has worked because over the past 3 years, the Yuan has risen more than 15 percent.  This is a bad time to ask for Yuan strength because growth in China has slowed materially.  To force China to appreciate its currency means less demand for US Treasuries and US dollars and unfortunately that is not something the US can afford right now when the government needs to spend its way out of recession.  Furthermore, turning up the heat on China could lead to an economic war.   Geithner also reiterated that the US has a strong dollar policy which interestingly enough runs completely counter to his calls for a stronger Chinese Yuan.  Like his predecessors, Geithner is doing nothing more than paying lip service to the strong dollar policy because in reality he is advocating a weaker dollar against one of the country’s largest trading partners.  In addition everything that the US government has done so far to address the economic crisis leads to a weaker dollar.  So there is no real meat to Geithner’s comments on the greenback; the Yuan on the other hand is completely different story.  

Dollar Strength Poses Major Risks

The stronger the US dollar becomes, the more pressure it puts on major central banks like the Bank of Japan, the Bank of England and possibly even the Federal Reserve to take action.  In a normal economic environment where growth is steady or improving, central banks may not be compelled to intervene in the currency market but if the Yen continues to fall and Japanese corporations start exerting pressure on the BoJ, we could see the first physical intervention in more than 4 years.  The UK is already receiving pressure from its French neighbors who want them to stop the pound from falling. As for the US, a strong dollar hurts more than it helps and that could lead to some pointed comments from Bernanke who could criticize the deflationary impact of a strong currency.  Switzerland has already warned about currency intervention and if the BoJ, BoE, ECB or Fed talk currencies as well, we could see a significant reaction in the US dollar.   Jobless claims and housing starts highlight the seismic challenges facing the US economy.  Jobless claims hit the highest levels since 1982 while housing starts and building permits hit a record low.

GBP/USD: HEADED FOR RECESSION

After yesterday’s dramatic intraday recovery in the British pound, the currency is having a tough time extending its gains.  Underscoring the weak conditions in the UK were more disappointments in economic data.  The CBI industrial trends survey which measures factory orders fell to the lowest level since 1992 while home repossessions in the third quarter rose 92 percent from the year prior.  Technically, the UK economy is not currently in recession but as of tomorrow, the recession should be official.  In the third quarter growth contracted by 0.6 percent and in the fourth quarter, GDP is expected to fall by another 1.2 percent.  The trade deficit increased in the last 3 months of the year while consumer spending slowed and unfortunately the Bank of England expects the weakness to continue.  With the economy headed for its first recession in 17 years, more interest rate cuts are expected.  In addition to the GDP report, retail sales are due for release which should fall as well.  With the market so bearish British pounds, disappointing economic data could lead to another round of selling.  

EUR/USD: DOWNGRADE FOR PORTUGAL

The euro was virtually unchanged against the dollar due to a lack of influential economic data. French consumer spending on goods contracted by a larger amount than anticipated, as a rise in unemployment contributed to the decline. Consumer spending which counts for 15% of the economy helped France dodge a recession in third quarter, but will not contribute to the same outcome as the economy is expected to contract by 1.1% in the fourth quarter. Portugal joined Greece and Spain in becoming the latest country to be downgraded in their credit rating by S&P. The following puts more pressure on ECB to lower their interest rates in the near future. Nevertheless, ECB President Jean-Claude Trichet stated that he will be reluctant to take the rates to zero as he does not expect inflation to stay at low levels for considerable amount of time. Industrial Orders within Euro-zone continued to depreciate reflecting a rapid contraction within manufacturing sector, which could spill into more problems for the region as a whole. The current devaluation of the Ruble by Russian Central Bank might play in some favor for the euro, as Russia will be net buyer of the currency. Tomorrow, Germany and Euro-zone is expected to release its PMI purchasing and services which all are expected to contract. With a decrease in the manufacturing sector and a rise in unemployment throughout Europe, the ECB will be expected to bring the interest rates down to 1.5% at the March meeting.  

USD/CAD: CANADIAN DOLLAR SHRUGS OFF SHARP DECLINE IN RETAIL SALES

The commodity pairs were mixed in today’s trading with the greenback appreciating against Australian and New Zealand Dollar, while losing ground against the Canadian Dollar. The Canadian Dollar shrugged off negative economic news today as retail sales fell the most in more than a decade while leading indicators contracted for the 4th consecutive month.  Even more surprisingly the Canadian Dollar appreciated as the government announced that it will post first budget deficit in more than a decade. The Canadian economy is expected to shrink 0.4% this fiscal year as demand for big ticket items has declined both, domestically and abroad. According to the Bank of Canada, lack of exports will shave off 2.6% points from GDP this year, before rebounding in 2010 as weaker currency and a rebound in U.S. demand will spur the economy by 3.8%, an optimistic view for most analysts. Tomorrow, Canada will release CPI which expected to contract, but deflationary fears were negated as a concern by Finance Minister Jim Flaherty.  The Australian government stated that they may establish a fund lending directly to companies, if foreign banks should fail to contribute $49.5 billion in loans. The funds will be available if foreign banks withdraw from the Australian markets while national banks can not cover the required loans. The following policy will counteract for a shortfall in credit that may push the economy into recession for the first time in nearly 20 years. New Zealand’s Performance PMI rebounded to 42.5, but the report still signals that the economy is shrinking. Australia is set to release its figures for Export/Import Price Index tomorrow, while New Zealand does not have any economic news on the agenda.  

USD/JPY: STRONGER US STANCE ON CHINA WOULD REDUCE INTERVENTION RISK

In the US dollar portion of our commentary, we talked about how pressure on China to revalue the Yuan is dollar negative.  However it is also Yen positive.  One of the main reasons why Japan has not intervened in the Yen since March 2004 is because they wanted to give China the floor to appreciate their currency.  China may have balked if Japan was weakening theirs at a time when China was asked to strengthen theirs.  If Geithner or Obama is successful in getting China to agree to a stronger Yuan, one of the more immediately consequences could be a stronger Yen.  The Japanese Yen has long been a proxy for Asia and as a competitor to China in global trade a stronger Yuan would reduce the need for a stronger Yen.  The report that could brand China as a currency manipulator does not come out until April, so we have a few more months before Obama will consider drastically changing the US’ strategy towards China.  Meanwhile, the Bank of Japan kept interest rates unchanged at 0.1 percent last night.  In an effort to add liquidity to the financial system, the BoJ announced that they are considering buying corporate bonds.  Economic data remains weak with the trade deficit widening and exports plunging.  This has forced the BoJ to reduce their growth forecasts.  They now expect growth to contract 1.8 percent in the fiscal year ending in March and by 2 percent next year.  

GBP/USD: Currency in Play for Next 24 Hours

The currency in play for the upcoming 24 hours will be GBP/USD. The UK is expected to release its figures for GDP and Retail Sales at 9:30GMT or 4:30AM EST, which should guide the movement of the pair drastically. After a rapid selloff to a 7 year low the pair has rebounded modestly, although still lingering within the Sell Zone established through the Bollinger Bands. Support is placed at 1.3620 which is the low reached yesterday, as well as a lowest level in 2001. As the pair seems oversold for the time being, the resistance is originating at 1.4250. Resistance represents first standard deviation of the Bollinger Bands; if it is broken the pair will negate the sell zone and could continue to appreciate. Further, resistance coincides with a base of down sloping triangle which was breached earlier in the week. With influential economic data coming from the U.K. resulting in an increase of volatility, either of the levels could be tested.

Published on  Fri, Jan 23 2009, 02:23 GMT