Better times for the pound and the dollar
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Better times for the pound and the dollar

It has been rare in the last couple of months, but the pound has been enjoying a better time of it over recent days. Most noticeable has been sterling’s strength against the more suspect euro. Since last Thursday when the ECB was less equivocal on rate hikes, EUR/GBP has fallen from above 0.90 to under 0.87 currently. Yesterday’s slightly hawkish Inflation Report provided the pound with some additional impetus. Should the recent tremulations on Europe’s periphery intensify then investors may prefer the pound over the euro for a little longer.

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Also of interest is the creeping gain in the dollar. Over the past week, the dollar index is up more than 3% – not a huge move but, for the beleaguered greenback, encouraging nonetheless. Last Friday’s positive payrolls report forced some shorts to cover. Also, the slow motion car-crash that is Greece is certainly casting a new light on the single currency, which has fallen from 1.49 to 1.42 in just one week. Finally, the US currency has benefitted from some risk aversion over recent days, especially in commodities and equities. For instance, Brent crude has dropped more than $5 in just the last 24 hours, while the gold price is back under $1,500 at the start of the London trading session. Silver, the speculator’s favourite in recent weeks, has lost 13% since this time yesterday. Soft commodities continue to decline as well, with both corn and wheat down more than 5% yesterday.


Aussie gets smacked by weak jobs data.
International investors have had a love affair with the Aussie for some time, with good reason, but there are some genuine doubts emerging regarding the pace of recovery down under. Employment fell by 22.1K last month, the largest monthly decline in two years and well below expectations. In response, the AUD fell more than 1% to below 1.06; at one stage yesterday, it was just under 1.09. The decline in employment has forced a re-appraisal of rate-hike expectations, following last week’s hawkishness from the RBA. Aussie bulls should be encouraged by the fact that last night’s low did not penetrate the low recorded a week back. Even so, these are more worrying times for traders and hedge fund managers who remain very long in the Aussie. The recent volatility is a potent warning sign that the risks have increased.  

Widening trend in US trade deficit continues. The USD48.2bn deficit recorded in April is not that far short of the level reached in June of last year, which was just shy of the USD50bn (deficit) level and keeps in place the widening trend seen over the past four months.   Not surprisingly, oil imports were mainly responsible for the wider deficit, with a continuation of this trend risking a reversal of the positive contribution net trade made to US GDP in Q1.

Bank of England continues to believe slowdown is temporary.
The FX markets understood the latest quarterly Inflation Report to mean that rates are more likely than before to rise this year, as seen in the 1 big-figure move in cable.   After more than two years during which the usual outcome has been to be disappointed by growth, this stance becomes more risky. It’s a constant belief that the light at the end of the tunnel is just around the corner, even though the longer it lasts, the more likely it is that the light will get dimmer. The longer sub-par growth goes on, the more likely that capacity (be it capital or labour skills) will be increasingly and permanently eroded. For now, the Bank is choosing not to take this argument that seriously but, as time goes on, the case for doing so grows. This is not necessarily good for inflation as it undermines the spare-capacity argument for inflation being pulled lower. However, when combined with the continued undershoots in growth forecasts from the Bank, a continuation of the current soft-patch is more of a risk than the Bank is letting on, especially with the squeeze on post-tax real incomes being even harsher than last year. It’s a potentially hawkish argument for a rate increase, but delivering when the economy has stalled and the banking system is still on the mend remains a tall order.

The ongoing Greek farce.
Kicking the debt can down the road is becoming an entrenched feature of European policy-making. Notwithstanding the overwhelming evidence that Greece has virtually no chance of paying back its rapidly accumulating debts, it appears that Europe’s policy officials will likely acquiesce and provide its troubled southern member with both more money and easier terms on its existing loan. In effect, Europe’s policy-makers are calculating that the cost of providing additional assistance to Greece in the short term would be less than the very risky and potentially damaging Pandora’s box that would be opened should Greece be forced to either restructure or default in full. At the end of the third quarter of last year, Greek banks held USD70bn of Greek government bonds on their balance sheets. Should these banks be forced to accept a write-down of, say, 50%, then they would be insolvent. Greek depositors in these banks would be unlikely to get much of their money back because, although the government has undertaken to provide savers with a deposit guarantee of EUR100K, it would have very little capacity to honour this pledge should there be a run on the major banks. Without overstating the risk, economic chaos would ensue. Greece will get more money. The terms of existing loans will be eased but Germany and the rest of northern Europe will need to extract some concessions from Greece in order to prevent a political backlash back home. The concessions had better be good. Tolerance of bailouts in the likes of Germany and Finland has virtually run out.


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