G7: together they stand…but divided?
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G7: together they stand…but divided?

This Friday’s meeting of G7 finance ministers and central bankers in Marseilles promises to be eventful, and quite possibly pivotal. After the SNB’s exceedingly bold and risky decision to set an explicit target for EUR/CHF, the new minister of finance in Japan has been making loud noises about raising the issue of the extraordinary strength of his currency at the meeting. Separately, finance officials are likely to discuss how they might respond both individually and collectively to the growing perception that most of their economies appear to be heading back into recession.

For its part, the ECB certainly has plenty of room for manoeuvre. For instance it could cut the refi rate by at least 50bp at some point (which would still leave some firepower for the future), and it could ramp up its SMP. The Fed is already likely to be discussing the need for additional monetary policy action – a twist operation (extending the average maturity of its balance sheet) seems highly likely. The Bank of England MPC is probably already contemplating the need for more QE, and the BoC could contemplate lowering rates given the clear weakening in growth. Elsewhere, Brazil and Turkey have both announced surprise cuts in key rates over recent weeks.

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Separately, there is some talk circulating in Washington that President Obama is considering significant tax cuts for the middle class as part of tomorrow’s address to Congress on America’s jobs crisis. It is speculated that the President may even push Congress to implement tax cuts in excess of those proposed by the Republicans. Another major feature of Obama’s jobs plan will be a significant boost to infrastructure spending. As he observed earlier this week, there are one million unemployed construction workers in the United States at the present time. Also under review is an extension of the 2% reduction in the employee payroll tax holiday. At times, President Obama has shown that he can be bold, and with his popularity rating continuing to decline as the economy swoons, he must know that now is the time for strong policy action.


SNB pulls out the kitchen sink. After weeks of conjecture, the SNB has bravely stepped forward and set a minimum EUR/CHF exchange rate of 1.20. In a statement announcing the decision, the SNB again reiterated that the Swiss franc was “massively overvalued” and that it was posing “acute” risks for the economy. Evidence of the damage the phenomenal exchange rate is wreaking on the economy was apparent again this morning, with the national CPI falling 0.3% last month, a YoY gain of just 0.2%. Just to ensure no-one was left in any doubt about the Swiss National Bank’s determination, the press release stated that it was aiming for “a substantial and sustained weakening of the Swiss franc”, that it would “no longer tolerate a EUR/CHF exchange rate below…1.20″ and that it would be prepared to “buy foreign currencies in unlimited quantities”. And the final exclamation was that “even a rate of CHF 1.20 per euro…is still too high”. It is the first time in more than thirty years that the bank has implemented a currency ceiling. Not surprisingly, the Swiss franc has been absolutely hammered by this announcement, with the Swissie up to 0.8600 (a loss of 8%) and EUR/CHF at 1.2050 (also up 8%). For a lot of investors who have flocked to the Swiss franc as a supposed safe haven, the SNB’s actions will be extremely costly. It is an open question as to whether the SNB has the balance sheet-firepower to buy foreign currency in unlimited quantities as it claims. In both 2010 and in the first half of this year, intervention proved extremely costly; CHF 20.8bn of losses last year and CHF 10.8bn in the first six months of 2011. Can the SNB realistically enforce this minimum exchange rate? What makes the SNB think that it will be successful this time? They would obviously be aware of the immense wall of safe haven-flows that have been pouring into the currency over the last few quarters, flows that have hardly slowed given the massive uncertainties currently afflicting global financial markets. Also making the task much more difficult is that the bank will be acting alone to protect its exchange rate – unilateral intervention invariably fails whereas joint intervention has a much better chance of success. How the SNB’s shareholders will feel about a commitment to buy foreign currencies in unlimited quantities will also be interesting. From our standpoint, this new strategy from the SNB is extremely high risk, and has significant potential to further damage its credibility.

SNB forces re-evaluation of safe havens. Yesterday’s dramatic SNB intervention triggered a frenzied re-evaluation of the relative attractiveness of the major currencies, and whether the traditional safe havens now offer the same security. Obviously the Swiss currency lost a lot of ground, as investors hurriedly reassessed the implications of the SNB’s announcement. Of interest is that the Japanese yen also softened, with USD/JPY up 1% at 77.50 at one point, as concern grew that the MoF might regard the SNB’s decision as an opportunity to undertake some further bold intervention of their own. Elsewhere, both the euro and the pound initially surged after the SNB announcement, with EUR almost reaching 1.43 and cable climbing above 1.62. However, both fell back quite sharply, EUR almost touching 1.40. Any fleeting thoughts that either currency might suddenly qualify as part of a new order for safe-haven currencies were rapidly scuppered. The two biggest FX winners in light of the SNB’s bravery were the dollar and the Norwegian krone, the latter now being thrust forward as a new leader of the safe-haven club.

Germany’s constitutional court decision due later today. Long-awaited, the German constitutional court decides this morning on the legality of Germany’s participation in euro-wide bailouts. Our sense is that it is unlikely to derail the momentum of ratification of the EFSF, but could well tighten up on the processes required for ratification of future changes to the EFSF and other changes in legislation which impact Germany’s relationship with the rest of the eurozone.   The issue is the no bail-out clause in the Maastricht Treaty (Article 103 states neither the Community nor any other Member State is liable for or can assume the commitments of any other Member State (which Germany insisted upon)), has been trampled upon over the past 18 months.   It’s not been broken, but lending to the likes of Greece at rates which are way below the credit risk involved is stretching it beyond a level which many Germans are comfortable with and in a way that was never anticipated at the outset of the single currency.   Many Germans are naturally uncomfortable with this. In Germany, even with this hurdle passed, it then falls to parliament to approve the EFSF expansion, which again is unlikely to be plain sailing.

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