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The recovery in the Aussie seen over the past few sessions was brought to a halt overnight, AUD/USD stalling above the 1.06 level.   The minutes of the latest RBA meeting were one factor in eliciting a more cautious approach – the door was left open to further easing should the global environment deteriorate.

Also in the background is the slower pace of growth expected in China, which is expected to impact the domestic economy, but the Aussie has remained surprisingly resilient to such fears. Video:

There can be no doubt however that the dynamics of FX markets have changed over the past few weeks and this has broken some of the established dynamics (such as between the Aussie and global stocks), so it’s more the change in global risk dynamics (and appetite for higher yielders) that has softened the Aussie, rather than domestic factors exclusively.

Guest post by Forex Broker FxPro

Commentary

FX and bonds. One of the notable factors of last week was the sharp sell-off seen in bond markets, which pushed US yields up to towards the 2.30% level, from a start of just above 2.00%. There was a rise in German yields, although not quite as pronounced, with the 10Y up around 20 basis points to 2.00%. There has been some talk that this could be the start of a more extensive sell-off in fixed income markets. Leaving aside the issues in peripheral eurozone countries, yields in many markets have been at historically low levels and, whilst the reasons for this are many and varied, this nevertheless makes investors concerned that the scope for a sell-off is that much greater. There are even comparisons being made with the bear bond market of 1994. But that comparison is probably taking things a little too far. Back then, the initial catalyst for the move was the action of the US Federal Reserve tightening interest rates, something which is not likely to happen anytime soon, despite the better than expected data of late. This should keep short interest rates (2Y and less) fairly well anchored. These shorter-term rates tend to be the more influential on currency values than longer-term rates of 10Y or more. That said, the fact that nearly half of US marketable debt outstanding is held overseas means that big changes in 10Y rates have the potential to be far more influential on the currency than was the case previously when bond markets sold-off sharply.

Sterling’s big week. It’s a big week for sterling, with the Chancellor presenting his annual budget speech tomorrow. Sterling has performed well of late, being the strongest performer over the past week and during the past two sessions.  This week’s budget is focusing the debate on whether the Chancellor is pursuing the right strategy of focusing on austerity. Just looking at the numbers, so far the plan appears to be having some success. The borrowing numbers for the current fiscal year are likely to be only modestly above the forecasts made this time last year (but still around 8% of GDP). Yes, the economy has struggled with GDP contracting again in the last quarter of last year, but the indications for the current quarter suggest modest underlying growth. Furthermore, a much longer average maturity of outstanding debt in the UK means that the annual re-funding requirements of the UK are comparatively lower than many eurozone nations. Sterling has also benefitted as currencies have become less correlated with the general ebb and flow of risk appetite, which has reduced the focus on the high-yielders (such as the Aussie, Brazilian real and others) and switched attention a little more onto underlying fundamentals. And although the UK may still be a long way from being out of the woods, with the Bank currently conducting further QE operations, there is a perception that in terms of facing up to the fiscal side, it are ahead of many others. It’s up to the Chancellor to ensure that this perception remains in place once his plans for the next year and beyond are laid out.

Booming German house prices.  One of the big beneficiaries of Europe’s sovereign debt and banking debacle has been German house prices, which have been moving steadily higher over the past couple of years.   Flush with deposits sent from Europe’s troubled south, financial institutions in the north have been desperate to lend to German households whose balance sheets are generally under-leveraged and in good shape. Exceedingly low interest rates are contributing to stronger loan demand, as are rising employment and the healthy growth in real incomes.   German property is also regarded as a safe-haven by high net worth investors not just in Europe but also in Asia. Two other factors contributing to the pressure on house prices are the rapid growth in migration into major German cities from small towns and rural areas and the sluggish pace of new construction. Unsurprisingly, rental costs are also rising steeply.   Desirable neighbourhoods in some of Germany’s most popular cities such as Berlin, Hamburg and Munich have experienced a jump in property prices of more than 10% over the past year. In contrast, house prices in the likes of Spain, Greece and Portugal all tumbled by double digits in percentage terms in 2011.   For their part, both the Bundesbank and the ECB are already on heightened alert, aware of the danger to the German economy should prices continue to climb sharply.