There are definite signs that the global recovery is losing momentum. Between this morning’s softer U.S. economic reports, last night’s weaker Chinese data and this month’s disappointing U.S. retail sales and jobs numbers, central banks have a lot more to worry about in Q2 than Q1.
The U.S. dollar is trading higher against all of the major currencies this morning EXCEPT for the Japanese Yen on the back of weaker manufacturing activity in the NY region (the Empire State manufacturing index dropped to 3.05 from 9.24) and decline in foreign purchases of U.S. Treasuries. According to the Treasury’s International Capital flow report foreigners were net sellers of U.S. dollars in February which is bad news for the greenback. However the outflows can be largely attributed to concerns about U.S. budget cuts which have sense abated and we don’t think foreigners will continue to be net sellers of Treasuries going forward because Bank of Japan policies have forced the Japanese to go global while renewed concerns about sovereign risks in Europe including the problems in Cyprus given investors good reasons to buy U.S. dollars. If you think about it, the U.S. dollar and Japanese Yen are traditionally the most popular safe haven currencies but BoJ policies is making the Yen very unattractive, leaving the greenback as one of the few safe haven options with the possibility of capital preservation. As a result, foreign sales of U.S. Treasuries won’t last for long.
Meanwhile the simultaneous slowdown in the world’s 2 largest economies could slow the normalization of monetary policies around the world. At this stage, we are almost certainly that the Federal Reserve won’t be able to taper asset purchases until September at the earliest and could even postpone monetary policy changes to December.
China – The Pain of Overexpansion
China is beginning to feel the pains of overexpansion as slower growth in fixed capital investment, industrial production and retail sales starts to weigh on GDP. China’s economy expanded at an annualized rate of 7.7% in the first quarter, down from 7.9% in Q4. Considering that most economists were looking for faster growth, this pullback caught everyone by surprise and explains why the Australian and New Zealand dollars are the worst performing currencies this morning. Despite strong credit growth, a higher luxury tax, a smaller increase in disposable income, decline in government spending and softer inflation caused consumer spending growth to slow in the first 3 months of the year. The question now is whether the weakness in Chinese data will prompt the People’s Bank of China to consider shifting from neutral to easier monetary policy. We believe that the central bank will want to see if the slowdown is sustained in the second quarter before they change interest rates or the reserve requirement ratio so AUD and NZD traders shouldn’t expect any help from the PBoC.
USD/JPY – Below 98 After U.S. Treasury Report
USD/JPY also extended its losses to trade below 98. Last night’s softer Chinese economic reports may have contributed to a general sense of risk aversion that has also hurt the currency pair but short Yen traders grew nervous after a report from the U.S. Treasury that was released late Friday. In their semi-annual report on currencies,” the Treasury said “We will continue to press Japan to adhere to the commitments agreed in the G-7 and G-20, to remain oriented towards meeting respective domestic objectives using domestic instruments and to refrain from competitive devaluation and targeting its exchange rate for competitive purposes.” Some investors interpreted this to mean that the U.S. will criticize Japan’s policies but with the weaker Yen being a byproduct of monetary policy and not currency intervention, it may be difficult for the U.S. to justify doing so accurately.