The currency blog

The greenback fell yesterday, losing some of the gains made earlier in the week as a short covering rally fizzled out and US treasury yields fell. Analysts consider dollar selling against the euro and other currencies by reserve managers was forcing the US currency down and that it would remain under selling pressure, especially if the Fed says it will continue to pump money into the market to improve liquidity. The issue for the US dollar seems to be whether the market believes the Fed will deliver significant quantitative easing over a definitive time period. In other news out of the US, the durable goods data showed an increase to 3.3% against expectations of 2%. Month on month new home sales also showed an increase in September at 6.6% against expectations of 4.2%. The market reaction to these figures was muted as markets await the QE2 announcement in November.
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The recent Dollar weakness has been driven by the markets expectation of a monster bout of QE over the next few months. Judging by current levels analysts have estimated that the market was expecting as much as $1trn in further asset purchases by the Federal Reserve. However, recent rumblings from the American central bank has begun to indicate (along with a recent newspaper article) that any further QE will be much smaller in scale, $100 bn or so (the number seems small fry now, how ridiculous) but will be implemented over a longer time frame. Mr Bernanke has already made the analogy between further QE and a golfer with a new putter on the final hole of miniature golf course. He is better to be conservative and strike the ball less firmly due to the unknown way the ball will react to the new putter. Yes, I think it’s a rubbish metaphor as well, but that does not change the fact that the market is very short Dollars at the moment and next weeks FOMC may see a spike in the value of the Greenback. Shorts may rush to cover positions if QE is indeed on a much smaller scale than expected. It will be interesting to see the reaction of the stock market, recently reacting as though on steroids in anticipation of shock and awe QE, deflates with a whimper or reacts violently as though the legs have been kicked from beneath it.
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The UK’s unexpectedly strong growth over the last quarter gave sterling a significant boost. The surprise rise in 3rd quarter GDP to 0.8% was led by the services and construction sector, prompting economists to up their growth forecasts for 2010 to around 1.8%. Sentiment was also helped by Standard & Poors affirmation of the UK’s AAA rating and restoring its outlook from ‘negative’ to stable as they stated “the coalition parties have shown a high degree of cohesion in putting the UK’s public finances onto what we view to be more sustainable footing”. The S&P announcement was seen by George Osborne as a “vote of confidence” in the government in a “double-dose of good news” for the economy. However, markets need to be aware of the fact that the recent cuts announced in the UK have not fed through the economy yet. Above-trend growth coupled with above-target inflation will leave the Bank of England with little reason to return to quantitative easing and adds weight to Sentance’s hawkish stance that it is high time for a rate hike.
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For the majority of the session yesterday, pushing stocks and commodities higher, as comments from the weekend’s G20 meeting continued to filter through markets. It was only later in the day that USD pared some of its losses after the US Treasury sold $10 billion of Inflation Protected Securities at a negative yield for the first time in history. Should the Fed be successful in fuelling inflation with these tools, it may persuade investors to buy dollar-denominated assets and in due course prove to be positive for the currency.
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I don’t know about you, but the gap between what is promised before a G20 finance meeting and what is announced afterwards seems to be growing. The theme at this meeting was, unsurprisingly, currencies and specifically how to stop nations engaging in beggar-thy-neighbour competitive exchange rate devaluations, to keep exports cheap in the face to falling domestic demand. As you can imagine, this path would be disastrous for world trade and global growth in general, which need stability to allow goods, services and capital to flow freely from country to country. What was agreed by the G20 was that the scenario above would not be allowed to happen, but the agreement stopped short of actual commitment. The US proposed that export surpluses be capped at 4% of GDP, a sensible idea, but the current global imbalances mean that is about as likely to happen as the G20 coming up with a concrete commitment on anything. Although it is disappointing that nothing solid was agreed, the news is generally positive and has helped stocks to gain in nearly trading and the Dollar and Euro to gain against the Pound. The US seems satisfied that China will allow the Yuan to appreciate and it now looks unlikely that the punitive import taxes the US were threatening to slap on Chinese exports will go ahead.
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A day of little action yesterday with attention focused on the G20 meeting in South Korea. The Dollar did soften during the European trading day, but not on anything tangible - more on speculation of an impasse on the G20 discussions rather than fundamentals or economic news. Sterling did not fare well however with continued concern over the UK economic outlook. Today, we are not scheduled to receive any 1st tier economic data from either the UK or the US. This will necessitate traders being left to their own devices for today and accordingly, I find it very unlikely that we will see the Dollar make much headway before the weekend break. Buying the Greenback on an assumption that the G20 participants will be able to come to any agreement on currencies’ values or global economic rebalancing looks a very dangerous strategy and therefore I expect Euro/Dollar to ease back up into the high 1.39s before London’s close.
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