Unease down under

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Ahead of today’s ECB and BoE meetings, and the impending Greek PSI announcement, both investors and traders displayed an understandable reluctance to commit to risk yesterday, although overnight nerves steadied just a little.

For example, the single currency is back near 1.32, after lingering threateningly near 1.31 yesterday afternoon. The recovery is partly on the back of positive noises regarding participation in the Greek debt-swap, with the minimum participatory level (below which would mean a disorderly default) apparently set to be reached.

Despite the partial overnight recovery, equity markets are on edge too and commodity prices are on the defensive. The gold price for instance has really struggled of late, falling USD 100 since late last month.

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A sharp decline in both German industrial orders and Spanish industrial production contributed to the underlying tension. Unsurprisingly, high-beta currencies in Asia have been tentative while the yuan has been softening as well.


Commentary

Beyond the Greek PSI. We have not talked about Greece that much over the past couple of weeks, but it is worth reflecting on ahead of the PSI deadline this afternoon. Whilst markets are all about pricing in uncertain events, the truth is that there are a lot of binary outcomes from this deal which the markets will find difficult to allow for. Will CDS be triggered? Will CACs be activated? The truth is that should the results be known late today, early Friday, there is going to be much to digest. In the meantime, there have been lots of reports of which banks are participating, veiled threats from the Greek authorities, and warnings of dire consequences from the IIF (via leaked reports) if it does not come off. For now, markets appear to be thinking that achieving a 90% or more participation rate may be a stretch because the 14% of participants not subject to Greek law are mostly the ones that are reportedly holding out on the deal. This level matters the most, because it determines whether credit default swaps (CDS) are triggered. But what really matters beyond this week is the extent to which the EU powers can convince investors that this really is a one-off. Any residual fears in peripheral eurozone nations that they could be next have the potential to be the most disruptive force going forward, and Portugal currently looks to be the most vulnerable to such perceptions.

RBA refuses to countenance Aussie FX intervention. Excessive currency strength has become a tremendous policy vexation for some central banks over the past couple of years. In Japan, the BoJ’s FX-intervention war-chest is now colossal, such is the concern in Tokyo regarding the negative impact that an overvalued yen poses to the economy. Recently, the BoJ significantly expanded its asset-purchases program and implemented an inflation target designed to demonstrate that it is determined to fight the deflationary effects of the strong currency. In Switzerland, the SNB implemented a ceiling for EUR/CHF of 1.20 six months ago and vowed to protect it with ‘unlimited’ purchases of foreign exchange. Also, in Brazil, the central bank has been buying dollars to thwart currency strength, alongside its sovereign wealth fund. Both Brazil and Switzerland have employed militaristic language to describe the critical nature of their currency operations. In sharp contrast, central bankers down under have a very different perspective. Consistent with the laconic cultural dynamic which so distinguishes the national character, the RBA is much more relaxed with the incredibly high currency. In a speech delivered earlier yesterday, RBA Deputy Governor Lowe claimed quite rightly that “it is difficult to make a strong case that the exchange rate is fundamentally misaligned”, because it is essentially consistent with the boom in the terms of trade (the relationship between export and import prices). As a result, Lowe contends that “the hurdle for intervention (is) quite high”. For international investors and traders, this hands-off attitude towards the currency is a major attraction. In the major advanced economies, central bankers have deliberately been debasing their currencies for some time. Moreover, some have been prepared to undertake massive intervention to prevent additional currency strength. This laissez-faire approach to the currency reflects extremely positively on the RBA. FX reserve managers and sovereign wealth funds in particular are enamoured by currencies that the central banks allow to float without impediment. These days they are few and far between.

Reasons to question the ECB. ECB President Draghi will face a tough time later today. There is minimal chance that the ECB will have anything to announce on rates or liquidity at this month’s meeting. That said, the President is likely to face many questions on the numerous aspects of ECB policy.  It has always been keen to split what it does with rates (monetary policy) with liquidity provision (reducing financial stress), but invariably the two are linked, not least because the wall of liquidity has pushed down market rates substantially below the ECB’s key rate of 1%.  Indeed, since the last meeting, the overnight rate has fallen to a new low of 0.34% and 3-mth Libor (if anyone trusts it anymore) has moved below the policy rate by the most (0.18%) in 18 months.  But Draghi will face tough questioning on the ECB’s balance sheet (the size and quality of it), the bond-buying program (is it dead?) and on the latest 3Y liquidity injection (will it help the real economy). His approach has been more direct than his predecessor and his candour has helped markets, but (quite rightly) there are a lot of questions to be asked of the ECB at this point in time.

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