After a (frankly) sparkling first couple of weeks of this month, Monday witnessed some profit-taking in the greenback. Other than dollar longs taking profit, a slight improvement in risk appetite and some market participants taking a more benign view of Greek developments, it was difficult to pinpoint any other particular rationale for the price action. Two major beneficiaries were the Swedish krona and the Swiss franc, both up a full 1%. The EUR, which in Monday’s Asian session briefly fell below 1.4050, slowly recovered to reach 1.42. News out of Brussels that European leaders had agreed on a Portuguese bailout gave the single currency a boost. The Aussie likewise fared better, reaching 1.06. As always, the pound was caught in the middle, outperforming the weaker dollar but losing out to both the euro and the franc. Overnight the yen has lost ground against most major currencies, amidst rumours of large M&A flows.
Guest post by FXPro
Commentary
Making sense of the perverse. How difficult it can be on occasions to understand the ways in which markets respond to fundamental developments. On Monday, the US officially reached their $14.3bn debt ceiling. And yet, over recent weeks, both the dollar and US treasuries have performed very well. In just the last two weeks, the greenback has gained around 4% in trade-weighted terms, while the 10yr treasury yield has fallen by 60bp to 3.16% in the past three months. Various officials at the Treasury Department are imploring the politicians not to underestimate the gravity of the situation, with the potential for investors to lose confidence in the willingness of the United States to meet their obligations. For their part, the Treasury has said that they can employ various measures to prevent a default until August 2nd. It remains a risk for markets, one that will rise appreciably if no deal has been done as we get closer to the August 2nd deadline. The GOP’s strategy is to link raising the debt ceiling to longer term fiscal consolidation, one which most Democrats are railing against. Ultimately, the markets assume (probably correctly) that the politicians will end up striking a deal, but there is likely to be plenty of water that passes under the bridge in the mean time.
Inflation still looms large in both China and India. Notwithstanding the recent pullback in energy and non-energy commodity prices, both China and India continue to confront the scourge of rising inflation. Yesterday, an academic advisor to the PBOC suggested that his country needed to continue to lift interest rates progressively because real (after-tax) deposit rates remained negative. According to Li Daokui, ‘maintaining positive interest rates is a basic requirement for the Chinese economy to manage inflationary expectations for depositors’. Some local commentators suggest that inflation could climb to as high as 6% by mid-year, compared with a one-year deposit rate of just 3.25%. Next door in India, the concern over rising inflation seems even more acute. In March, consumer prices rose by 9% YoY, well above the central bank’s target. Earlier this month, the Indian central bank raised the benchmark repo rate by 50bp to 7.25%, an increase of 250bp over the past 14m. To make the central bank’s task even more challenging, gasoline prices were raised by as much as 8.5% on the weekend because of mounting losses at state-run refiners and to rein in the cost of government subsidies. In addition, the government will meet soon to consider lifting the price of diesel, LPG and kerosene, all of which have been capped for a significant length of time. Political unrest at the rapid increase in prices is growing. Little wonder that the Sensex has lost more than 10% year-to-date.
The tipping-point yet to come in commodities. The body-blow dealt to commodity markets early on in May is still having repercussions on many levels. It’s in the non-energy sector where the correction has been most sustained, if not enhanced. Silver provides the best illustration of this, with prices once again threatening the lows achieved in the early part of May. An increase in margin calls pushed silver lower ahead of most other commodities, with this causing a fair amount of the leveraged community to throw in the towel. Data on ETF holdings also suggests that funds have substantially cut back on physical holdings of silver, with only a marginal rebound seen since the early part of last week. This was a market that most knew to be in bubble territory and for now, there is a great reluctance to jump back in. Of more economic significance is what goes on in the energy space, at least in terms of impacting inflation and also reducing the squeeze on consumers. So far, the 10% or so fall in crude prices has not fed through to pump prices, but if the fall in crude holds in place, the potential decline in pump prices could easily unwind at least half of the increase seen so far this year. The same holds true for the UK (although retail prices are by nature less volatile vs. the US owing to tax), where the squeeze on real incomes is proving to be particularly severe. Furthermore, there have been a number of factors which have pushed headline inflation higher, so lower fuel prices would also serve to relieve some of the pressure here. The pass-through in both countries could well be key in determining the extent to which Q2 growth holds up after the Q1 disappointment seen both in the US and the UK.
A less rosy time for the Aussie. It is a much less rosy time for the Aussie these days. Triggered by growing concern over Greece’s rapidly deteriorating plight and further risk aversion by investors and traders alike, growth assets and currencies have continued to struggle over recent trading sessions. For the Aussie, which posted a new post-float record high above 1.10 two weeks ago, the warning signs have been there for a few weeks. Worries about the global economy starting to suffer in response to much higher energy and non-energy prices have definitely hurt the Australian currency, at a time when hedge fund managers and traders were holding very significant long positions. Interestingly, it is not just offshore developments that are weighing on the Aussie. Domestically, the economy is less inviolable these days as well. House prices are no longer rising, employment recorded its largest one month decline in April for two years, and home loan approvals fell in March to the lowest level for more than a decade. The expectation that the RBA may hike rates again soon is also hurting consumer sentiment. In the last three Asian trading sessions, the AUD has tested and broke through the 5th May low, potentially implying that there are still many sellers looking for an exit. The bears are taking a much keener interest in the Aussie right now.
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