Daily FX Market Roundup 10-23-12

USD: Will the FOMC Help Stabilize Risk?
EUR: German Finance Minister Warns Worst is Yet to Come
GBP: Low Rates are a Double Edged Sword
CAD: Bank of Canada Remains Most Hawkish G7 Central Bank
AUD: Q3 CPI Numbers Due
NZD: Gold Unchanged, Oil Down 2.5%
Why is Yen Still a Safe Haven Currency?

USD: Will the FOMC Help Stabilize Risk?

Today was one of those days where equities dictated the direction of currencies. The euro and other high beta currencies began their sell-off at the very start of the European trading session when equities in Europe tricked lower. The sell-off in risk deepened when U.S. traders joined the fray and took the S&P 500 down another 1.4%. The sharp decline in stocks over the last 72 hours signaled a dramatic turn in sentiment that has yet to be felt as thoroughly in currencies. While all of the major currencies weakened against the U.S. dollar and Japanese Yen, we have not seen the same milestones reached in currencies as we have in equities. The S&P 500 is trading at its lowest level in more than a month but the EUR/USD and USD/JPY are still trading closer to their 1 month highs than lows. The GBP and CAD are the only currencies to have fallen to 1 month lows against the greenback which was completely unexpected because the Bank of Canada is looking to raise rates and the Bank of England will most likely keep monetary policy steady next month. The only explanation for today’s risk aversion are disappointing earnings, warnings by U.S. corporations and concern about the less business friendly environment that could be provided under President Obama versus Republican Mitt Romney.

With new home sales being the only piece of U.S. data on the calendar tomorrow, the hope rests on the Fed. The Federal Reserve has a monetary policy announcement Wednesday afternoon (no press conferences or economic forecasts will be released). Having just announced a third round of Quantitative Easing last month, we do not anticipate any further stimulus from the U.S. central bank. However there have been number of improvements in the U.S. economy since the last meeting and we will be looking to see whether the Fed acknowledges the uptick in data. If they sound encouraged by the improvements in U.S. data, stocks could rebound, helping to ease some safe haven flows out of the U.S. dollar and Japanese Yen. If they err on the side of caution and express skepticism about how long the improvements will last, the sell-off in equities and currencies could deepen.

However before the FOMC makes its announcement, Chinese flash HSBC manufacturing PMI report will be released. An improvement will help to boost risk appetite whereas deterioration will increase risk aversion.

EUR: German Finance Minister Warns Worst is Yet to Come

The sell-off in the EUR/USD today is consistent with the performance of other European assets. Major stock indices in Europe are down between 1.5% and 2.2% while Spanish, Portuguese and Italian 10 year bond are up between 10bp and 20bp. European economic data continues to be disappointing with French business confidence and production outlook deteriorating in the month of October and Eurozone consumer confidence holding near a 3 year low. Although the consumer confidence index increased from -25.9 to -25.6, the improvement was so small that it isn’t worth any excitement. Tomorrow’s economic reports however will be very important. Eurozone manufacturing and service sector PMI reports will be released along with the German IFO. Economists are looking for a small improvement in activity and business confidence. The euro desperately needs some good data to recover from today’s weakness. However even if the numbers are good, the positive impact on the currency should be limited because investors will still be worried about the overall outlook for the region’s economy. It is hard to be optimistic when the Finance Minister of Germany warns that, “the worst is yet to come.” At a mechanical engineering conference today, he said, “Europe’s debt crisis seems to have entered a calm phase, but that’s only an illusion.” ECB Member Mersch agreed, warning that “The bleeding has been stopped, but the patient is not yet in the clear.”

GBP: Low Rates are a Double Edged Sword

Despite stronger housing market numbers, the British pound weakened against the U.S. dollar. According to the British Bankers’ Association, loans for house purchases increased in the month of September. Low interest rates continue to support the housing market helping to boost mortgage approvals rose from 30,683 to 31,175. Yet low rates are a double edged sword because it also creates low return. The Financial Services Authority issued a warning today that low interest rates are creating potentially large risks for UK insurers seeking returns high enough to meet their commitments to policyholders. According to the Financial Times, which covered this report “ The sector typically holds about two-thirds of its assets in fixed income securities, but is planning to increase its holdings of assets such as private equity, property and emerging market debt. UK regulators, who will take charge of supervising both banks and insurers next year, have made it clear they will not hesitate to demand additional capital or business model changes if they believe financial stability is at risk.” Bank of England Governor King also spoke this afternoon and his dovish tone added pressure to the British pound. He said it is hard to know if some recent positive signs will persist but the BoE stands ready to inject more stimulus if needed. The Confederation of British Industry will release its industrial trends survey Wednesday morning. This report will provide insight into how the manufacturing sector has been performing.

CAD: Bank of Canada Remains Most Hawkish G7 Central Bank

While the Australian and New Zealand dollars fell sharply against the greenback, the Canadian dollar ended the North American session unchanged thanks to the Bank of Canada who continued to talk about the need to raise rates. The CAD soared after BoC Governor Carney completely psyched investors out (ourselves included) by warning last week that growth forecasts would be revised lower. While they did lower growth forecasts for 2014, they also RAISED their growth forecast for 2012 and kept their 2013 forecasts unchanged. A lot can change in 2 years time and investors are only focused on the immediate 1 to 12 month outlook, which the Bank of Canada upgraded slightly. This shows that Canadian policymakers aren’t nearly as concerned about the economic outlook as they led everyone to believe. Furthermore, the central bank continued to say that “some modest withdrawal of monetary stimulus will likely be required” because they believe that businesses and consumers will lead moderate growth in Canada, helping it reach capacity by the end of 2013. Considering that retail sales growth slowed in August, these comments suggest they anticipate stronger consumer spending in the months to come. Action speaks louder than words and the BoC’s surprise decision to maintain their hawkish monetary policy suggests they aren’t too worried about the Canadian dollar being worth more than the U.S dollar, even though they say they are. With today’s announcement, the BoC is still the only major G7 central bank thinking about raising rates which this should renew the rally in the Canadian dollar. Australian consumer prices are scheduled for release later this evening. Softer inflationary pressures will boost expectations for another rate cut by the Reserve Bank before the end of the year. The RBNZ also has a monetary policy announcement on Wednesday. We don’t know much about new RBNZ Governor Graeme Wheeler’s stance on monetary policy so this will be his first opportunity to share his views with the world.

Why is Yen Still a Safe Haven Currency?

For the first time in 3 months, USD/JPY touched 80 but failed to exceed this level as the meltdown in U.S. stocks drove the Japanese Yen higher against all of the major currencies. At the end of the day, the primary driver of Yen flows continue to be risk appetite but the decline in 10 year U.S. yields also contributed to USD/JPY’s weakness. Now that Japan runs a trade deficit, we have been asked often about why the Yen is still considered a safe haven currency and the reasons are two fold. First and foremost, Japan still maintains a current account surplus, which is the broadest measure of the country’s trade activity. Even though the goods and services (trade balance) for more than a year, the income balance is still huge and more than offsets the trade deficit. The Japanese are huge foreign investors and the income balance tracks the interest payment, profit and dividends received on foreign investments. Continued speculation that the Japanese government is pressuring the Bank of Japan to ease has limited the slide in USD/JPY. While earlier rumors were denied by the Finance Minister the Japanese economy needs all the help it can get and there’s no doubt that the government is at least trying to persuade the BoJ to provide additional support. According to the latest consumer spending reports, demand remains weak. Supermarket sales declined at a faster pace last met, offset only slightly by a smaller decline in nationwide department store sales. Given the strength of the Yen and the weakness of global demand, it should not be a surprise that small business confidence slipped to a 15 month low in October.

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