EUR: Hit by Profit Taking and Poss German Vote Delay

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Daily FX Market Roundup 09-10-12

EUR: Hit by Profit Taking and Possible German Vote Delay
Dollar Gains Momentum in Last Hours of Trading
GBP: Biggest Consequence of EZ Stability
CAD: Rises to 1 Year High
AUD: Hit by Weaker Chinese Data
NZD: Fails to Extend Gains
JPY: GDP Growth Figures Revised Lower

EUR: Hit by Profit Taking and Possible German Vote Delay

The volatility in the FX markets today paled in comparison to the big moves that we saw at the end of last week. With no major Eurozone or U.S. economic data on the calendar, the price action in the currency, equity and bond markets suggests that investors are cautious about adding to any existing positions ahead of the German Constitutional Court ruling on Wednesday and the Federal Reserve’s monetary policy announcement on Thursday. After Friday’s strong rally, it is not a surprise to see the euro and other risk currencies give up part of their gains against the U.S. dollar. While the Federal Reserve’s monetary policy announcement is one of the most important event risks this week, the front of the week will be all about Europe and the back of the week will be focused on North America. Tuesday should be another quiet trading day but on Wednesday, the EU will unveil its proposals for a banking union, the Dutch will hold an election and the German Constitutional Court will provide its ruling on the injuction to block Europe’s rescue fund. Talk that Germany’s highest court could delay its decision on the rescue fund following a complaint filed by a German MP contributed to today’s weakness in the euro. Any delay in the decision could affect the ECB’s bond purchase program. Of course, an initial request for bond purchases would need to be made by the Spanish or Italian government before the central bank can move forward anyway. So far Spain, the country closest to needing a bailout has denied inquiring or pressuring the ECB to buy bonds.

Nonetheless even if there is a delay, we don’t expect the German Constitutional Court ruling to pose much threat to the euro. The political and economic consequences of standing in the way of the ECB’s new bond purchase program and Europe’s rescue fund are just too severe. There is very little chance that the 8 scarlet-robed justices of Germany’s top court will risk sending Europe back into turmoil particularly since this is only the first step of a two-step process. The court is only voting on an injunction to block the country’s ratification of the ESM. A final ruling on the Constitutionality of the ESM is set for December and all other nations outside of Germany, Italy and Estonia have ratified the rescue fund. The court could ask for more involvement of Parliament, which would make getting German support for new bailout deals more challenging but this would most likely come with the December decision and not this week’s vote. Given the severity of the consequences economically and politically, we don’t think the German court has the guts to stand in the way of the rescue fund and if we are right the green light could revive the rally in the euro.

Dollar Gains Momentum in Last Hours of Trading

Profit taking in risk currencies drove the U.S. dollar higher throughout the North American trading session. The rally gained momentum when the sell-off in equities accelerated in the last hour of trading. The big story in the U.S. today was consumer credit, which fell for the first time since April 2011. Consumer credit is a piece of data that rarely gets any attention except on days as quiet as this one. The decline in consumer credit is both good and bad or the U.S. economy. On the one hand, it means that Americans are putting less on their credit cards but on the other, it means that consumers are so worried about the economic outlook that they have become wary of committing to any big ticket purchases. The decline was primarily due to a 6.8 percent drop in revolving credit, which includes credit card usage. Unfortunately given the soft non-farm payrolls report, the first decline in 15 months is more likely attributed to consumer caution than anything else. The Federal Reserve monetary policy announcement on Thursday is the biggest event risk this week and unlike the German Constitutional Court ruling, which everyone is certain will go well, economists and investors are still divided on whether the Fed will implement QE3. Even here at BK, I am calling for a greater than 75% chance of QE3 and yet Boris has made a case for why QE3 is unlikely. This debate is happening across Wall Street and ensures that Thursday will be an interesting and active day in the FX market. The U.S. Trade Balance report is scheduled for release tomorrow along with the IBD/TIPP Economic Optimism index. Slightly weaker manufacturing activity points the possibility of a wider trade deficit while the recent rally in equities is expected to support sentiment.

GBP: Biggest Consequence of EZ Stability

It has also been a quiet day in the U.K. with no major economic data on the calendar. As a result, the British pound weakened against the U.S. dollar but firmed slightly against the euro. The biggest consequence of stability in the Eurozone is the flow of funds out of the U.K. Throughout Europe’s financial crisis many investors in the region parked their money in U.K. assets. If there is reason to believe that the outlook will brighten and the crisis will start to abate permanently, those funds could shift out of sterlings and back into euros. Bank of England policymakers won’t have any problems with this of course because a weaker currency will only help their goal of pulling the country out of recession. On Saturday, Bank of England Chief Economist Dale warned that more Quantitative Easing may not be the right response to weakness in the economy. He stressed that the central bank’s main goal is to control inflation and not hit a growth target, which is why responding to weak GDP may not be appropriate. Unfortunately focusing on price stability alone could also be a mistake in our opinion and thankfully the rest of the monetary policy committee doesn’t agree with Dale who was one of only 2 MPC members to vote against Quantitative Easing in July. The RICS house price balance is scheduled for release this evening followed by the U.K. Trade Balance in the morning. The rebound in manufacturing activity in August points to a narrower trade deficit for the month of July.

CAD: Hits 1 Year High

While the Australian and New Zealand dollars weakened against the greenback, the Canadian dollar rose to a 1 year high. There was no economic data to attribute the rally in the CAD to and oil prices declined but last week there was plenty of good news out of Canada and on this quiet day, investors are reflecting on the divergences in the U.S. and Canadian economies. Job growth in Canada rebounded significantly in the month of August while manufacturing activity held near a 5 month high, which provides reasons for the Bank of Canada to talk about raising interest rates. The U.S. Federal Reserve on the other hand is getting ready to ease again this week. The Australian and New Zealand dollars were hit by weaker Chinese economic data. Although China’s trade balance grew more than expected, export growth fell short of expectations and imports fell 2.6 percent. Retail sales, fixed investment and industrial production growth also slowed while producer prices eased. Consumer prices grew at a faster pace, which unfortunately is not good news for Chinese consumers. The latest disappointments validated the market’s concerns for slower Chinese growth and led some economists to downgrade their third quarter Chinese GDP forecasts. New Zealand credit card numbers are scheduled for release this evening followed by housing starts and the International Merchandise Trade balance from Canada on Tuesday.

JPY: GDP Growth Figures Revised Lower

The Japanese Yen traded higher against all of the major currencies with the exception of the U.S. and Canadian dollars. The latest Japanese economic reports highlight the serious challenges that Japan’s economy continues to face. Weaker global growth and a strong currency has turned Japan’s trade surplus into a trade deficit, again. In the month of July, Japan reported a trade deficit of JPY373.6B, which would have probably hit the Yen harder if not for an increase in the country’s current account surplus to JPY625B form JPY433B. Unfortunately the deterioration in trade and overall weakness in Japan’s economy has led the government to cut its quarterly growth figures. Originally, the economy was estimated to have expanded by 0.3 percent in the second quarter but growth was a mere 0.2 percent. None of the initiatives that the government has taken to stimulate the economy has really worked and part of the reason is because the weakness stems from external factors that out of their hands. Japan’s economy will recover when the global economy recovers but that may be sometime from now.

Kathy Lien
Managing Director

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