Major currencies trade in narrow range in another dreadful week for world markets.

Tom Tong22/Αυγ/2011Currency Updates

The worsening macroeconomic outlook across the major developed economies again shook risk assets last week. Equities and commodities dropped sharply, led again to the downside by the battered European bank shares. While equities and commodities closed generally above the lows made in the previous week, Bund and treasury yields broke cleanly to the downside. US 10 year treasury yields dropped briefly below the 2% level, which had not happened since the market controls in place during World War II. The dichotomy between investors views and the obsessions of policymakers could not be starker; while the former are clearly worried about a relapse into recession, discount entirely recession, and are willing to buy safe Government bonds at extraordinarily low yields, the later continue to emphasize austerity across the board, in spite of the inevitable effects in consumer demand and business confidence. Meanwhile, currency markets continue to trade in a narrow range, exhibiting far less volatility than other risk assets, as traders cannot seem to quite make their minds up as to which major currency has the worst prospects, and most G10 currencies, with the conspicuous exceptions of the remaining safe havens (Swiss Franc and Japanese Yen), ended the week not far from where they started it.


The trend of negative macroeconomic surprises did not spare the UK last week. Unemployment in June unexpectedly rose, while retail sales in July were weaker than expected; the riots only added to the generalized sense of gloom. The Bank of England is increasingly concerned about the sputtering recovery, and it is now unanimous in its decision to keep interest rates at rock bottom levels. The likelihood of another round of quantitative easing is increasing, though as of the last meeting three weeks ago only one MPC member explicitly advocated it. The UK has led the developed world in the implementation of aggressive austerity measures, and the results are not encouraging. However, markets estimated that the news was less dismal than those out of Europe and the US, and Sterling rose 1.3% against the dollar and .5% against the common currency.


More dismal macroeconomic news out of the Eurozone last week. GDP growth disappointed, increasing just 0.8% QoQ saar. More worryingly, it looks like the economic stall is now spreading to the core European countries, as the disappointment relative to expectations was driven by low prints in France and Germany. European core inflation also surprised sharply to the downside, and it is looking increasingly likely that the recent ECB hikes are another policy mistake by Trichet, much like his ill time hike in 2008. Markets are now pricing a moderate chance that those hikes will be reversed. As to the peripheral crisis, it seems that political progress has once again stalled. There is no sign that the bailout facility will be increased from its current size, German leadership has ruled out the possibility of European-wide sovereign bonds, and Finland is now demanding special treatment on the form of collateral for its share of the second Greek bailout. Fortunately, sovereign spreads are being kept in line (for now) by aggressive ECB purchases of Spanish and Italian bonds. To this political impasse is now added the undeniably sharper slowdown in core Europe’s growth. In this environment, it is quite surprising that the Euro managed to end the week nearly 1% higher against the dollar.


The tentative sign of stabilization in the tone of US macroeconomic data disappeared last week amid a dismal batch of business and consumer confidence numbers. The regional Philadelphia Fed index of manufacturing collapsed to a recessionary level of -30.7, when expectations were for a slightly optimistic 2.0. While this is a fairly narrow index, it confirms the drop in the Empire regional manufacturing index and presages an end to the growth in industrial production that had been one of the few bright spots in the US recovery. As analysts and banks revise their expectations for US growth down and the chances of a US recession up, the greenback is failing to find its usual bid as a safe haven. The dollar remains firmly entrenched in a very narrow range in trade-weighted terms, a very unusual pattern in a time of generalized deleveraging. While it is hard to be bearish on the dollar given the dismal prospects in Europe, it will be difficult for the dollar to stage a sustained rally unless macroeconomic data in the US stabilizes and investors are reassured that a recession is not in the offing.


Written by Tom Tong

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