G7 offering little of substance so far

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The official communiqué from the meeting of G7 finance ministers and central bankers over the weekend failed to provide any real inspiration for markets.  Whilst it did acknowledge that: “…there are now clear signs of a slowdown in global growth”, there was no sense of common purpose with regards to the G7’s approach to tackling this; rather a further reminder of what individual countries are doing and a commitment to “rebalance and strengthen global growth”. 

What we don’t know is what was discussed behind the scenes and what pressure was applied to certain countries to do their part.  The new Japanese finance minister pledged to take “bold actions” with regards to further yen strength, although this appeared to fall on deaf ears, with the yen the strongest performer in Asian trade.  The G7 meeting appeared to acknowledge that it was facing common problems, but was implementing individual solutions.

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Commentary

The G7 slowdown.  We wrote last week about the fact that there is more that unites than divides the G7 and the latest data from Canada bears this out, as did the downward revision to Japanese GDP last week.  The Canadian jobs data showed employment falling by the largest amount for nearly a year, leading to an upward move in the unemployment rate from 7.2% to 7.3%. There have been bumps in the downtrend in the rate evident over the past two years, so this may be just one of those.  That said, it serves to further strengthen the case for keeping rates on hold, and with the policy rate hiked to 1% (and short end rates tight to this level), the scope for easing policy is better than the rest of the G7, if needed. However, Canada is in a stronger position vs. US, especially on the labour market front, with employment having returned to its pre-crisis peak in the early part of this year.  In the US, it remains nearly 5% below.

Greek default speculation mounds.  Behind the scenes, there is further speculation that Germany is preparing for the consequences of Greece failing to meet the conditions for the next payment of its bailout package.  Merkel is due to meet European Commission President Barroso today to talk over the Greek issue.  The main concern is with the impact on German banks should Greece default on its obligations.  At the same time, French banks are in focus as Moody’s review period for France (three banks are on watch for a downgrade) comes to an end, with the value of the banks (BNP, Soc Gen and Credit Agricole) having halved over this time.  In the past, pressure on the banking sector has more often than not weighted on the single currency, which currently stands just above 1.35 after Friday’s rout.

Shifting sands in FX.  There was again some aggressive selling of the single currency Friday, with the EUR now convincingly clear of the bottom end of the 1.40-1.45 trading range that has been in existence for essentially the past six months. Given the worsening sovereign debt and banking crisis in the eurozone, this weakness in the euro is hardly surprising. Indeed, many commentators, ourselves included, have wondered for some time why it has taken this long. The softness last week was especially significant given the SNB’s declaration that it is prepared to be a buyer of unlimited euros if there is any strength in the Swiss currency that takes it too close to the 1.20 level. The single currency has also lost ground against the pound; EUR/GBP fell to a 14-week low and traded below the 200d moving average.  Rising to the top has been the greenback – over the past two weeks, the dollar index is up nearly 4%. Obama’s jobs package has certainly given the currency a boost. In addition, the dollar has attracted some considerable safe-haven flows – both the SNB and Japan’s MoF have put up the shutters to short-term capital flow, and US banks are regarded as a much better bet than Europe’s right now. The last two weeks have been the best for the dollar in nearly a year. Now is not a great time to be short the dollar.  Also of interest is the faltering price action in gold. Many analysts expected that gold’s attraction would only increase after the SNB’s dramatic intervention last week. However, the gold price has dropped $50 from its earlier high, and has lost nearly 5% since the SNB’s announcement.

Fed twist operation success is far from assured.  The FOMC’s last move, extending considerably the commitment to keep rates low (to two years) was notable on one level, but also largely ineffective given that markets were not far from pricing this outcome anyway.  In different circumstances, this would have had far more impact.  Ahead of the Fed meeting on 20-21 September, the main talk centres around ‘Operation Twist’ which would involve the Fed selling shorter-dated securities and buying longer-dated ones in an attempt to push down yields further down the curve, with subsequent falls in corporate and mortgage rates.  Even though it would not involve the Fed increasing its holdings of Treasury securities, it’s far from a free lunch.  The resulting flattening of the curve will put more strain on the balance sheet of banks in particular, which rely on borrowing on short maturities (where costs will rise) and lending this on longer maturities (which will become less profitable).  So even though the cost of credit may fall, the supply could well decrease as well as banks have to further deleverage and put aside further provisions to meet capital ratios. As with the last announcement on language, a twist operation later this month may be significant in terms of an addition to policy, but like last month’s change of language, could well prove largely ineffective in terms of providing a boost to overall activity.

 

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