The dollar bears retain their strong grip

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  • BoE still swimming in a sea of uncertainty
  • Risk appetite returns with a flourish
  • China changing tune on the yuan
  • Green light for Aussie gains

The dollar bears retained their vice-like grip on the forex market on Wednesday with the greenback sinking 1% by the end of the morning session. It was the currencies of those countries where the central banks are either hiking rates or which already have relatively high interest rates that prospered the most. Leading the way was the Aussie, which soared nearly 1.5% to another new record post-float high of 1.0687, with further overnight gains helped by government comments expressing no concern with the current level of the currency. The dollar has further softened overnight, helped by further strong corporate earnings and this has pushed EUR/USD above the 1.46 level during Asia trade. Volumes are likely to fall rapidly today ahead of the long Easter weekend.

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Commentary

Green light for Aussie gains. Former PM Rudd (now foreign minister) did nothing to dissuade Aussie bulls overnight, expressing no concern with the level of the Aussie and stating that “we are not in the business of regulating exchange rates”. Both domestic and international developments have propelled the Australian currency higher; gold and silver prices have surged once more, US corporate earnings results are mostly beating expectations, and traders are again investing heavily in the carry trade (to the detriment of the Japanese yen). In addition, Australian export prices jumped 5.2% in the first quarter, re-emphasising the continued improvement in the terms-of-trade that has provided so much support for the currency over recent years. It remains the best of times for the Aussie.

BoE still swimming in a sea of uncertainty. Sterling has softened a touch in the wake of the minutes of the April MPC meeting, which revealed the voting pattern of the committee as unchanged vs. the previous month. As such, the spread of prevailing views of the committee remained wide, with one voting for further QE and the same three voting for higher rates (one of these for a 50bp tightening). However, one of the reasons for the softer tone to sterling is the fact that those members wishing to hold rates steady, who had wavered a little in March, strengthened their resolve in April. This time those looking at holding rates steady argued: “The news over the month about demand and activity had probably been to the downside”. In other words, the ‘no-change’ camp was feeling slightly vindicated by events. For now at least, it’s difficult to envisage the Bank shifting to higher rates in May, despite the greater propensity for rate changes to occur in Inflation Report months. Falling real incomes, with continued softness in the labour market, have strengthened the case that the squeeze on the household sector will start to impact on some areas of the inflation numbers, notwithstanding the higher commodity prices over recent weeks.

Risk appetite returns with a flourish. After a sharp flight from risk on the first day of this week, investors rapidly recovered their poise on both Tuesday and Wednesday. Decent manufacturing and services PMI data out of Germany and France, better-than-expected housing news from the US, and strong earnings news from the likes of Intel and IBM helped placate fears that the pace of global growth might be slowing. The gold price cracked $1,500 an ounce, European equities essentially recovered all of the ground they gave up on Monday and bond yields gave back some of the gains made on Monday. In the forex market, the dollar has again been on the back foot, as is so often the case these days whenever risk appetite returns. Noticeable has been the single currency’s ability to climb higher in the face of persistent talk that a Greek debt-restructuring is drawing ever closer. The EUR is comfortably back above 1.44, a marked turnaround from Monday’s sharp plunge when it briefly dipped below 1.42. Apart from the continuing signs of economic strength in both Germany and France, strong demand from Asian and Middle Eastern sovereigns provided the euro with some welcome support. As we have witnessed on so many occasions this year, whenever the euro looks vulnerable in any way, sovereign demand from Asia in particular is not far away, such is its desire to diversify out of the dollar. European politicians may be desperate for the euro to survive and prosper, but so to (it seems) does Asia.

China changing tune on the yuan. Concerned by the continued acceleration in both liquidity growth and inflation, policy-makers are increasingly attracted to the idea that currency appreciation can play a critical role in attempting to contain these pressures. It should be recognised that this is definitely not a sudden policy change by policy-makers, but one that has been quietly emerging over recent months. Such has been the upward pressure on prices that policy officials are increasingly prepared to utilise more fully all of the available policy tools at their disposal. Bank reserve requirements have been raised significantly over recent months in an attempt to rein in excessive liquidity growth; key interest rates have been lifted on a number of occasions as well and the PBOC has implemented various qualitative measures designed to tighten credit growth. Importantly, China now seems prepared to allow the currency to play a more active role in domestic macro-economic management. For all of the protestations of Western commentators, China is making rapid progress towards its goal of achieving much greater currency convertibility for the yuan.

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