The currency blog

…. even in the face of overwhelming arguments against it. Concerns over sovereign default following the recent negative actions from the 3 largest ratings agencies had caused bond prices in the nations concerned to collapse and their yield spreads over the perceived stronger risks to widen. This occurred for Dubai, Greece, Spain and Portugal on Wednesday and was followed by a massive sell off in UK Gilts yesterday (after investors re-assessed just what Alistair Darling had said, or not said, in his pre-budget report).

Since then however, there has been an element of retracement in European markets (partially following a comment from German Chancellor, Angela Merkel, that Europe has a responsibility to support Greece) and likely to be a bounce in Gilt prices this morning after a senior Moody’s analyst, at an Asian event, was quoted as saying that there were no plans to revise either the US or the UK triple-A rating status, adding that the ratings agency had looked very closely at both countries’ policy responses to their respective fiscal woes.

Good news for bonds; not such good news for the Euro - probably. Merkel’s comment, although promising a vague commitment, suggests that evolving problems within the periphery of the Eurozone will inevitable impact on the core and hence affect the overall ECB monetary policy. As such, it is perfectly reasonably to assume that the overvalued Euro will begin to struggle against non-European crosses even if, for the present, it holds up against the US Dollar and Sterling. A further argument that suggests the Euro is due a correction comes from yesterday’s US Trade Figures. The trade balance was stronger than expected with merchandise exports growing in October for the 6th consecutive month. Since April, goods exports have surged by nearly 17% which equates to an annualised growth rate of over 36.5%.

Analysis shows that the European Union is one region which has exhibited such a trend and although the data is not seasonally adjusted, the US deficit with the EU has narrowed and appears to be doing so at a faster rate than we saw last year. This improvement in the US trade performance must be reflected in a stronger 4th quarter GDP figure and will be taken as strong evidence that the US Dollar is undervalued against the Euro. Does this imply an imminent drop in the current cross rate (1.4750) ? Well probably not. Despite pundits pencilling in 1.4000 is a short term target, any real move is unlikely to happen prior to there being undisputable evidence from the US that the Federal Reserve is set to tighten policy - and that looks a long way off. It leaves us with the prospect of tight ranges for Euro/Dollar during the first 2 quarters of 2010 - volatility, yes but a concerted Euro weakening, probably not.

Talking of policy adjustments, yesterday we had the Swiss National Bank and the BoE / MPC meetings’ results to digest. The SNB were first out of the blocks and although they left the official interest rate unchanged, they signalled their first step towards withdrawing QE by announcing that were to end their purchases of corporate bonds. Not a complete withdrawal however as they continued that they will “act decisively to prevent any excessive appreciation” of the Franc - implying that the 1.50 level against the Euro was still the ‘line in the sand’. The decision from the UK was predicted correctly by the majority of the market analysts who rightly pencilled in that rates would be left at their historic lows and that the asset purchase programme would be maintained at £ 200 billion, to be completed by the end of February. They did add that the size of the programme would be kept under review but it looks as though monetary policy will be a non-event until the February get together when the next BoE Quarterly Inflation Report is due for release. The major concern over the UK’s course of action is that funds still do not appear to be reaching the broader economy, and that if this situation remains, that the BoE / MPC / Treasury are lacking a back up plan. Sterling to remain vulnerable to both economic and political news, going forward.

Discuss on this on the Currency Exchange Forum