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These days it is very difficult to find much that is positive to say about the pound. Yesterday’s MPC Minutes put the knife a little deeper into the British economy, with a number of MPC members expressing fears that an increase in the policy rate now “could adversely affect consumer confidence”.  Furthermore, there were still fears over the downside risks to household spending. The labour market data released at the same time as the MPC minutes showed a fairly lacklustre picture. For the third time in four months, the claimant count measure of unemployment increased in April. Just as worrying, underlying average weekly earnings (ex-bonus) fell to 2.1% YoY, suggesting that wage growth may be turning as well as the labour market. Given the latest increase in inflation, the squeeze on real incomes is very severe this year, even more so than last year. Sterling has struggled against this backdrop of rising inflation, near zero rates and diminished prospects for a near-term rate increase. The toxic combination of high inflation, low rates and limited growth prospects could well weigh on the currency for a while longer.

Guest post by FXPro

Commentary


Warning signs for dollar shorts.
For some very considerable time, the conventional wisdom in the forex market has been to be short dollars. The rationale included the weakness of the US economy and the need to have a competitive exchange rate in order to achieve much needed rebalancing, the Fed’s commitment to an extended period of low interest rates (which in turn encouraged the carry trade), and concerns over America’s fiscal obesity. For the most part, this approach has worked well, with the dollar index falling by around 15% over the past year. However, there are some signs that this trade is getting a little crowded. Over recent weeks, net dollar short positions (sum of CFTC net non-commercial in EUR, JPY, GBP, CHF AUD and gold), as derived from the US Commodities Futures Trading Commission, have hovered at a very elevated of around $45-50bn. In the past, when short positions have become this extreme, it has coincided not long after with a significant short-covering rally. In addition, since the start of the year, despite a significant addition to dollar short positions, the return from being short the dollar has not been particularly significant, implying diminishing returns for being short. The price action in the dollar recently might also be telling. With risk aversion rising this month, the dollar index has managed a fairly rapid gain of around 3.5%. Such a significant price response for what has been a fairly tepid avoidance of risk thus far once again confirms that there appears to be a lot of money that is sensitive (and potentially vulnerable to) a sharp rise in the dollar.

A very deep recession in Japan. BOJ chief Shirakawa was on the money a few days ago when he described the Japanese economy as being in a very severe state. First quarter GDP fell 0.9%, much worse than expected, with the previous quarter revised considerably lower to -0.8% from -0.3% previously. The current quarter could be even worse, with consumer spending likely to decline and exports down sharply. From Q3, reconstruction after the devastating earthquake and subsequent tsunami will provide some support for the economy. Japan experienced four consecutive quarters of contracting GDP during the global financial crisis. In response, the Japanese yen has barely moved, suggesting that the market essentially expected very poor numbers.

The worm may be turning for the Aussie. Right now, trading the AUD is not for the faint-hearted. Having recorded a fresh one month low late on Tuesday of 1.0505 and looking decidedly vulnerable, the Aussie suddenly turned on a dime and late in Tuesday’s Asian session looked set to threaten the 1.07 level. However, the bears re-emerged and the AUD is now back at 1.06. Not helping the tone was the announcement by Moody’s that it was downgrading Australia’s four major banks by one notch to Aa2, citing worries over their reliance on foreign wholesale markets. In addition, consumer confidence is in retreat, with the Westpac-MI measure falling 1.3% in the current month to an 11m low. In China, Australia’s major trading partner, there was also the news that house price growth in the major cities appears to be slowing. Commodity price developments are also weighing on the nerves of Aussie bulls, with Brent crude dipping below $110 briefly yesterday. The days of making easy money by simply being long the Aussie look to be over.

Spain’s saviour – booming exports. It remains an easy task to talk down the Spanish economy, what with house prices declining and an unemployment rate of more than 20%. Even so, the economy eked out a 0.3% gain the first quarter, despite unprecedented fiscal austerity. Thankfully, it is the trade sector that is providing Spain with some much-needed impetus – in the year ended Q1, export volumes were up by more than 11%. The consumer meanwhile remains circumspect, with spending up just 0.7% YoY in the first quarter. Both Q2 and Q3 are likely to be very weak given the fiscal consolidation coming down the pipe.

The enduring appeal of the Swiss franc. Against the backdrop of increased investor uncertainty in the current quarter, it is the Swiss franc that once again is the currency of choice for many. Since the end of March, the Swissie is up nearly 4.5% against the dollar, 3.7% vis-a-vis the euro, and just over 3% against the pound. Notwithstanding the general increase in risk appetite so far this year, the Swiss franc is the second best-performing major currency, behind the euro. The SNB continues to welcome the strong exchange rate, as it helps to tighten financial conditions at a time when there is some concern about imported price pressures. A recent report on consumer confidence suggested that households had become much more circumspect last month about their ability to save money. It is little wonder that international investors continue to hold the franc in such high regard. The Euro is once more beset by heightened concerns over the latest instalment of its sovereign debt crisis, the pound is being hobbled by an economy bereft of growth and experiencing high inflation at the same time, the dollar continues to be deliberately debased, and the Japanese yen is less attractive given the dire state of the economy. On this reasoning alone, the Swiss franc is likely to remain a favourite for a while yet.