Notwithstanding some determined efforts by policy officials over recent months, there seems to be no stopping the juggernaut that is the Chinese economy. In the first quarter of this year, GDP in China grew by 9.7%, above expectations and essentially in line with the 9.8% increase recorded in Q4. Propelling growth in the first quarter was booming domestic demand – fixed-asset investment surged by 25% on a year earlier, and retail sales were up 17% YoY (in March). Inflation in March accelerated to 5.4% YoY, the fastest rate of increase in prices for three years. Despite numerous hikes in bank reserve requirements, interest rate increases, changes in qualitative lending criteria and a stronger exchange rate, Beijing has had little success thus far in terms of containing inflationary pressures.
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That said, China understands that previous policy measures will take time to feed through. In addition, the pace of inflation is such that it is starting to inhibit spending, especially in those areas of the country where a high proportion of income is spent on spiralling food prices. Attempting to get inflation under control remains the number one priority for policy officials – as such, further tightening such as an increase in key rates and another hike in reserve requirements are likely in the near term.
Commentary
Back to reality for the euro. The fall in the euro during yesterday’s morning session was mostly due to reawakened fears that either larger bailouts and/or restructurings by some of the PIGS may be required sooner rather than later. From an early high above 1.45, the EUR dipped to 1.4365 at one stage before recovering some of the ground that it had lost. Comments from German Finance Minister Schaeuble in Die Welt, acknowledging the possibility of some sort of debt restructuring in Greece, was the initial catalyst for the weaker tone. This was also followed up by remarks from S&P, which were merely stating what the market had already reflected, namely that the risk of a Greek debt restructuring had increased. The 5Y credit-default swap on Greece pushed out to 1100bp, a new record high. S&P suggests a 50-70% haircut on Greek debt in the scenario of a default, something which the market is currently giving a 60% probability to over the coming five years, with around 20% probability in the coming year (although take this with a pinch of salt given liquidity issues on shorter-dates CDS). Of course, none of this is necessarily big news, with both S&P and Schaeuble reflecting (and not even fully) what the market is currently pricing. Nevertheless, combined with fresh noises from Finland on its reluctance to pay up for Portugal (not a surprise given the election this week), today’s series of events have served to remind investors that there’s still plenty more to come on the eurozone sovereign story.
That noxious dollar. Apart from a brief respite yesterday afternoon, there has been little reprieve for the ailing US currency over the course of this week, the dollar index sinking to a new 16mth low of 74.62 in early trading on Thursday. Indeed, this index is threatening to break through the low of 74.227 recorded in late November 2009. Since the middle of last year (at the height of the euro sovereign debt crisis), the dollar index has fallen by almost 16%, with almost half of that decline having occurred in just the past three months. Of interest is that increased signs that the US expansion has become more sustainable over recent months have made absolutely no difference to the dollar’s downtrend whatsoever. As with many other currencies, the dollar’s demise has been all about interest rates, or rather the perception that, despite an improving economy, the Federal Reserve is unlikely to alter its commitment to an extended period of ultra loose monetary policy. In both labour and product markets, policy-makers continue to argue that there is simply too much spare capacity to justify altering their current policy stance any time soon. For carry traders, the prospect of continued low interest rates has been manna from heaven, especially now that both of the major political parties appear to be signing up to radical medium term fiscal surgery, which will almost certainly make it harder to alter monetary policy. Dollar bears need to be more careful these days, however – according to the latest figures from the CFTC, dollar short positions are at extremely elevated levels historically.
The reserves surge. The increase in China’s FX reserves in March took the outstanding level over the USD 3trln level for the first time, offering further confirmation that the increase in Asian FX reserves are proving to be an ever more powerful force in the global FX market. The pace of Chinese reserve accumulation during the first quarter was the second highest on record in dollar terms and if this recent pace of expansion continues, then China’s total FX reserves will surpass the size of the German economy within six months. China holds half of all Asian reserves and just over 30% of the global total. For Asia as a whole, data released to date suggest that the pace of reserve accumulation was also strong elsewhere, with overall Asian reserves rising nearly USD 250bln during the first quarter. That’s about equivalent to the annual output of Finland. It’s not news that Asian central banks remain keen to diversify their reserves away from the dollar, not least given the fact that the US is at present not poised to start tightening policy and fiscal risks remain on the sidelines. Even if the details of where these reserves are sitting are more scarce (as is the case with China), the likelihood is that that a far lower proportion of new reserves are being recycled back into dollars than the current share of the dollar in outstanding reserves, which is just over 60% based on known data. With emerging markets back on a more robust footing after a wobbly start to the year, there is every reason to suspect that this pace of reserve accumulation and diversification will continue in the coming quarter.
The soaring kiwi… It may seem like a misnomer (because kiwi’s are a flightless bird), but the New Zealand dollar has been soaring over the past few weeks. After a very challenging period, culminating in last month’s decline to below 0.72, the kiwi has jumped by around 10%, and is now not that far away from last November’s high just below 0.80. Indeed, since the date of co-ordinated intervention by the G7, the New Zealand currency has easily been the best performer amongst the major developed world currencies. Earlier this year, the kiwi underperformed, in part due to concerns that the devastating earthquake in Christchurch would damage the economy. However, boosted by a very favourable terms-of-trade (which registered a 36yr high in the final quarter of last year), the kiwi has definitely come back into favour. Also providing some real impetus for the currency has been the infamous carry trade, which likewise has benefitted its cross-Tasman cousin the Aussie dollar. Recently, kiwi longs cheered comments made by RBNZ Governor Bollard, who stated that the income boost from higher commodity prices would boost purchasing power and probably result in both stronger spending and rising inflation expectations. Ahead of the World Cup later this year, the kiwi is set to attract some increased demand from passionate rugby fans prepared to make the trip down under.
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