Daily FX Market Roundup 09-19-12

FED, ECB and Now BoJ – Which Currency Will Lose the Race to the Bottom?
EUR – Need Political Differences to be Put Aside
GBP: No Consensus on the Need for More Stimulus
AUD: All Eyes on Chinese PMI
CAD: Oil Prices Down 3%
NZD: GDP Numbers on Tap
JPY: More Stimulus from the BoJ

FED, ECB and Now BoJ – Which Currency Will Lose the Race to the Bottom?

What a month it has been for monetary policy! Central banks around the world have gone pedal to the medal on monetary easing and are moving as fast as they can to jumpstart their economies. With the Bank of Japan joining the European Central Bank and the Federal Reserve in cranking up their asset purchase program, we now have 3 major central banks flooding the markets with liquidity putting the race to debase or devalue their currencies in full gear. Traditionally, monetary easing is negative for a country’s currency but with all 3 central banks moving at the same time, investors are wondering which currency will be the biggest loser.

To answer this question we first compare the announcements made by the 3central banks. Both the Fed and the ECB have unveiled unlimited asset purchase programs and while the ECB has the benefit of being the first to market, their program cannot start until a country formally requests for aid. So far, Spain, the Eurozone’s primary problem has shown little desire to ask the ECB for more help. In countries like Spain, many people believe that making a deal with the EU/IMF/ECB is akin to making a deal with the devil due to tougher austerity measures. In their ideal scenario, they would like to put off a sovereign bailout for as long as possible in hopes that in the end, they won’t need it. The Federal Reserve on the other hand expanded their asset purchase program immediately. So even though both central banks pledged to buy more bonds, the Fed is the only one of the two that has put money on table – which is exactly why in the long run, we expect the dollar to underperform the euro.

The greenback should also end up losing the race against the Japanese Yen because the Bank of Japan’s expansion was limited to Y10 trillion, an amount that most economists anticipated, albeit in October and not September. The main difference between the Fed and the BoJ is that the Fed surprised in terms of timing and magnitude. The U.S. central bank pulled out all of the stops and sent a strong message to the market by going above and beyond expectations. The Bank of Japan on the other hand simply sped up their timetable for monetary easing. Also, the BoJ has been far less effective than the Fed when it comes to influencing its exchange rate even though their past actions have successful boosted stocks prices and lowered bond yields. While we believe there is more downside pressure on the dollar than the Yen, USD/JPY weakness should also be limited to the 75.50 – 76 range because below 77, the risk of Japanese intervention increases significantly.

In the race to debase, we expect the U.S. dollar to be the biggest loser but that may not happen immediately. As we have seen after QE1 and QE2, it could take some time for the greenback to finally lose value. In the meantime, the concurrent easing by the Fed, ECB and the BoJ should reduce volatility in the FX market, which could lead to tighter ranges for major currencies. If the stability fuels further gains in equities, a risk on rally could also drive the dollar lower.

EUR – Need Political Differences to be Put Aside

The euro recuperated from its earlier weakness to end the day marginally higher against the U.S. dollar. The currency’s inability to extend its gains has a lot to do with the ongoing challenges posed by political differences. Investors are starting to realize that even the most ambitious effort from the ECB won’t be enough to save the Eurozone or the euro without serious political concessions from European governments. The latest pressure on the euro has been caused by talk that German coalition leaders want the banking union to be limited to only certain banks. Unfortunately this water downed proposal does not give Europe what it really needs which is an all encompassing solution that covers both large and small banks. The fight between the ECB and the Bundesbank has also been put into focus today after former ECB Chief Economist Issing said the dispute over the new bond purchase program needs to be put to rest. If you recall, the Bundesbank was the only one that opposed the bond purchase program announced at the beginning of the month and unfortunately disagreements like this benefits no one especially when the Germans hold the purse strings. This morning, Standard & Poor’s also said that it is unlikely Spain’s rating would be cut to junk. While this should be good news for the euro, it means that Spain won’t be asking for a sovereign bailout anytime soon, leaving the ECB’s Outright Monetary Transactions program untapped. Eurozone PMI numbers are scheduled for release on Thursday and both the service and manufacturing sector are expected to see a small improvement. As the most important piece of event risk for the euro this week, the PMIs should have some impact on the currency.

GBP: No Consensus on the Need for More Stimulus

The British pound ended the day unchanged against the U.S. dollar. The highly anticipated Bank of England minutes failed to provide any meaningful clues about the central bank’s future monetary policy plans. The committee voted unanimously to keep interest rates and the size of the asset purchase program unchanged. The details show the monetary policy committee completely divided on the need for further stimulus. Some members felt that further loosening was more likely to happen than not while others felt that stronger inflation reduced the need for additional support. Since the last monetary policy meeting, we have seen signs of improvement in the U.K. economy – whether these improvements last remain to be seen but with 3 major central banks already providing major liquidity to the market, the BoE has the luxury of time and can wait to see how the markets respond before jumping in with more stimulus. Retail sales are due for release tomorrow along with the CBI Trends report. With the impact of the Olympics fading, retail sales are expected to decline as well but with claimant count falling for the second month in a row in August, there is scope for an upside surprise.

AUD: All Eyes on Chinese PMI

The Australian and New Zealand dollars rebounded against the greenback as the Canadian dollar held steady. The underperformance of the CAD can be attributed to the sharp decline in oil prices. Since the end of last week, oil prices have fallen more than 7 percent on very little news. Weaker economic data from Australia and New Zealand did not stop the AUD and NZD from rallying. Australian leading indicators grew by 0.4% in July, slightly less than the prior month. New Zealand’s current account deficit also widened due to unusual seasonal distortions in service exports. Second quarter GDP numbers are due for release from New Zealand this evening but the main focus in Asia will be the Chinese manufacturing PMI numbers. An improvement in Chinese manufacturing activity will be positive for the commodity currencies while a stronger contraction would erase today’s gains in the AUD and NZD.

JPY: More Stimulus from the BoJ

One of the biggest stories today was the unexpected stimulus from the Bank of Japan. The central bank increased their asset purchase program by Y10 trillion or the equivalent of USD$126 billion, bringing their total to Y80 trillion. The program was also extended by 6 months to the end of 2013. Our readers will find the announcement less surprising since we have been writing about this possibility throughout the week. Our main argument for a move in September versus October was the shock factor that it could have on the Yen. While we were right on the timing of the BoJ’s announcement, the rally in USD/JPY that we had anticipated did not last. Although this was a major announcement from the Bank of Japan, the impact on the Japanese Yen was limited because the BoJ simply delivered on what economists had already anticipated one month early. If the Bank of Japan’s decision to ease early was motivated by a desire to weaken the Yen, they failed abysmally. Japanese trade numbers are due for release this evening and unfortunately the country’s trade deficit is expected to widen, illustrating the damaging impact that the strong Yen has had on the export sector.