Risk assets pull back on global economic slowdown; Greece concerns

Tom Tong27/Ιούν/2011Currency Updates

Financial markets had a volatile week in which most assets lost ground. The steady drumbeat of negative macroeconomic news worldwide continued. This week, European PMIs surprised to the downside, and the Federal Reserve revised its growth forecasts for the US sharply downwards. The Greek government survived (as expected) a no-confidence motion in Parliament, and approval of yet another round of harsh austerity measures is expected next week. However, markets are sceptical that this new bailout will succeed, and peripheral spreads broke to new highs. Amid the gloom and uncertainty risk assets traded lower, led by commodities and news that the International Energy Agency would release oil from strategic reserves into markets, pushing oil sharply downward. Government bonds rallied to yet another high for the year.


No significant macroeconomic news out of the UK last week. The minutes of the Bank of England were the main event. There were two changes of significance. First, the majority in favour of leaving rates unchanged at 0.5% had increased to 8-2, following the replacement of Andrew Sentance by a more dovish member, Ben Broadbent. Second, it was clear that other members had joined Posen in foreseeing the possibility of another round of Gilt purchases if the economy did not pick up. In general, the tone of the minutes was generally dovish and cautious, and short Sterling rates dropped sharply as hike expectations continue to be pushed further out the curve. Unsurprisingly, sterling traded softly all last week, dropping 1.4% against the dollar and 0.5% against the euro.


It was a difficult week for the euro. The critical PMI business sentiments both surprised to the downside. While the overall levels are still consistent with decent output growth, two issues cloud the prospect. First, the euro-wide figures have been dropping rapidly, with the blended composite index down 2 points in June after having dropped 2 points in May. Second, the regional discrepancies between core Europe and the rest are widening. This implies very weak growth in the periphery. On the sovereign risk side, the Greek Government survived a confidence motion in Parliament. However, peripheral bond markets were not reassured, and tier one peripheral spreads (Spain, Italy and Belgium) blew out to new all-time records. Given the downpour of bad news, it is actually surprising how well the common currency held up, dropping only a bit over 1% against the US dollar.


Macroeconomic data was mixed out of the US last week. While the second-tier business surveys continued their sharp slide, the highly volatile durable goods orders number came out somewhat better than expected. We consider the surveys to be somewhat more timely and stable than durable goods, and therefore consider that last week did not provide on net positive news about the US economy. The Federal Reserve further dampened the mood, sharply revising down its projections for growth for this year and the next. The dollar reacted to the mixed news (weak economic number of the US, flight-to-safety bid) by rising slightly in trade-weighted terms.

Other G10

The price action in JPY lately has been somewhat puzzling. Its previous tight correlation with US rates has broken down, and it does not seem to trade much as a safe haven either. The threat of intervention below the 80 level keeps it somewhat anchored at that level, and the current soft tone in risk assets prevents the dollar from rising much above 81. JPY ended the week nearly unchanged against the dollar, and this recent breakdown in correlations is worth watching carefully.

All three dollar bloc currencies generally tracked the equity markets during the week. However, AUD was generally weaker, dragged down by falling commodity prices and signs that the RBA is in no hurry to hike rates again. NZD held up rather well, as the New Zealand economy shows signs of rebounding from the damage of the Christchurch earthquake. The Canadian dollar ended the week nearly unchanged against the greenback, while NZD rose about 1% and AUD dropped about 0.5%.

Another week another record high for the Swiss franc against both the US dollar and the euro. Peripheral woes and generalized risk aversion have given CHF new legs, and the rally is kept going by the absence of Swiss National Bank intervention and the continued unwinding of legacy carry trades that used the CHF as funding currency. It remains to be seen how much longer the Swiss export machine can hold on in the face of relentless franc appreciation.


Written by Tom Tong

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