The price action seen on both Friday and also yesterday reflects the fact that, it’s all about positioning in the FX markets for the moment. This has been most evident on the euro, not only in the weekly CFTC data which is reflecting a record amount of speculative shorts, but also in the price action.
The single currency has pulled away from a threatened break of the year’s low, not that surprising after a run which saw EUR/USD up on only two of the last fourteen trading days. The Aussie has also corrected from the recent lows, partially reversing a downtrend of similar style as seen in EUR/USD. Even though the relationship between the two has broken down a little of late, stocks also look set for a second day of gains after the recent down-run. Video:
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The underlying themes remain in place, namely continued concerns surrounding Greece and the other peripheral eurozone nations, so the current correction should not be aligned with a perception that things are improving underneath, because they are not.
Commentary
Sterling’s growing reluctance. Last week was the first in eight that sterling fell on a broad trade-weighted basis, having appreciated more than 3% over the past two months. You have to go back to June 2009 to find a similar stretch of weekly gains on the trade-weighted index. Given that the euro area is the main trading partner of the UK it is natural that a fair proportion of this can be put down to the weakness of the euro, EUR/GBP having moved higher on the sterling index in only one of these down-weeks. There are a number of factors that have accounted for the strength in sterling, not least a belief that it has received some benefit from diversification away from the single currency itself. Related is the fact that it has not been subject to the safe risk-flows to the same degree as many other currencies. To put it another way, sterling is neither the yen nor is it the Aussie. It’s sat quite happily somewhere between the two when it comes to the ebb and flow of risk sentiment. One of the potential near-term threats remains the inflation outlook. Although expectations are for the headline rate to continue to fall (from the 3.5% level reached in March), there has been a fairly consistent overshoot of inflation relative to expectations, particularly those of the central bank. As such, even though some of the growth numbers have disappointed of late, the simple belief that lower growth will lead to lower inflation (than otherwise) has been severely undermined in the UK in recent years. If we see more of this from the CPI data today and MPC minutes tomorrow, the pound may struggle to benefit from a waning expectation of more QE and may worry more that the UK is facing a longer-term inflation problem.
China’s shifting policy mantra. With many parts of Europe still burning, risk assets stabilised somewhat yesterday following a significant shift in rhetoric by China’s major policy-maker. Premier Wen Jiabao promised to put “stabilising growth in a more important position”, notably omitting any mention of containing inflation. At the very least, Wen’s remarks suggest that Beijing has become quite concerned about the loss of growth-momentum in the economy and, moreover, appears ready to respond with more substantive policy measures. Before the end of the current quarter, another reduction in bank reserve requirements would not be a surprise, infrastructure projects could be accelerated and the government may implement some stimulatory fiscal measures. Also, once inflation falls to 3% or less, which may not be that far away, then a rate cut is on the cards. China has allowed the currency to weaken a little recently as well, lightening the load for exporters who have been really struggling. If China really bites the bullet on growth-oriented policies in the near term then this may offset some of the frightening developments in Europe that have been so unsettling for risk assets recently.
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