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  • Sterling suffers on revised rate outlook
  • Portugal agrees aid plan with IMF and EU
  • Asia discusses pooling FX reserves
  • US debt-limit may not reached until early August
  • A more vulnerable Aussie
  • Greek debt restructuring pressures ease slightly

 

Two themes dominated forex markets on the first proper day of trading since before the RW (Royal Wedding). The first was a swing back towards safe-haven currencies in the aftermath of the death of bin Laden and the concern that it could raise the threat of recrimination against strategic targets in the West. In addition, investors are conscious that Asian central banks are still minded to tighten monetary policy further in response to heightened fears about rising inflation. India’s surprise 50bp rate hike yesterday has been partly responsible for some profit-taking in Asian equities over the last couple of days. In addition, the PBOC has warned that the economy “faces increasing pressure from imported inflation”.

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Both the Japanese yen and the Swiss franc have done well, and (for a change) so too has the dollar. Conversely, high-beta currencies are lower, with the Aussie dropping back below 1.08 at one stage overnight. Aussie/JPY, the darling of the carry traders over recent weeks, has lost 1.5% over the past 24 hours.  Commodity prices were also lower – Brent crude fell below $122 overnight, down from $126 late on Monday, while silver prices have plummeted by more than 15% in the past couple of days. A second theme was the continued decline in the pound, with cable falling below 1.65 (see below). EUR/GBP reached the 0.90 level, a fall of 7% in less than three months.

 

Commentary

Sterling suffers on revised rate outlook. Sterling has suffered once more in the first half of this week. Bank of England Governor King’s comments on Monday regarding the indebtedness of the UK economy, with the suggestion that higher rates would make the economic consequences more severe, did the currency no favours. It has to be noted that he was not specifically referring to the central bank policy rate and not specifically referring to the UK. Nevertheless, the market took it as an indication of his continued reluctance to sanction higher rates in the UK in the near future.

 

Also weighing on the pound yesterday was the weaker manufacturing PMI data for April, the headline falling to a seven-month low at 54.6, down from 61.5 at the start of the year. The data showed domestic orders slowing down considerably, which will no doubt bring fresh fears about the durability of the recovery given that, up to now, the manufacturing sector had been one of the brighter spots in terms of growth. The latest CBI survey reaffirmed the sense that the economy is in the doldrums, with expected sales recording the lowest reading for a year. Expectations of higher rates provided the main wind in the sails for sterling earlier this year and, with just one tightening now expected by December this year, there could still be some room for the market to further re-assess the outlook for policy.

 

Portugal agrees aid plan with IMF and EU. Portugal’s caretaker Prime Minister Jose Socrates announced late last night that an agreement had been reached with both the IMF and the EU on an aid plan for Portugal worth €78bn. Under the three year agreement, Portugal would reduce the budget deficit to 5.9% of GDP this year (down from 9.1% in 2010), and then progressively lower it to 3% of GDP by 2013. Socrates stated that the strategy for achieving these fiscal aims was very similar to the austerity package proposed when he was in power up until recently.

 

Asia discusses pooling FX reserves. Asian central banks have been discussing a proposal whereby they pool the immense firepower of their FX reserves to diversify into areas such as infrastructure. Currently, Asia’s FX reserves are more than $6trln. Some Asian central banks have been switching out of dollars into yuan. There is also a debate in the region about whether the volume of reserves is excessive, especially given the very low level of interest rates.

US debt-limit deadline not reached until early August. According to the Treasury Secretary, the U.S. is not expected to reach its $14.29trln debt limit until early August. Apparently the Treasury will this week start taking steps to provide extra borrowing room. The situation has been helped by stronger-than-expected tax receipts. Failure of Congress to approve a debt-limit increase by May 16th will result in the Treasury implementing a ‘debt-issuance suspension period’. Short term interest rates in the U.S. remained exceptionally low on Tuesday; the 12mth Treasury bill yield fell to a record low of just 0.17%.

A more vulnerable Aussie. After penetrating the 1.10 level twice on Monday, and in the process achieving yet another post-float record high, the Aussie has fallen back sharply over the past two days and in Asian trading overnight briefly fell below 1.08. Part of the explanation is the improved showing by the greenback, which seems to be attracting a little safe-haven interest in response to the death of bin Laden and concerns about Asian inflation. However, some of the AUD’s softness reflects local fundamentals that are perhaps not as supportive these days. Firstly, the domestic economy is going through a tougher time, and not just because of the deleterious effect of the devastating floods in Queensland. The earnings reporting season is now underway and numerous profit downgrades are expected, especially from exporters and manufacturers exposed to the ultra-strong currency. Also, residential property prices are slowing/falling, as consumers rein in their spending – for example, the saving rate is currently at a 20yr high. In the first quarter, house prices fell by 1.7%, as the number of properties coming onto the market soared in response to rising mortgage interest rates. Secondly, the central bank seems especially conscious of the impact that the strong currency is having on trade-related industries, as noted in the statement released after last night’s meeting. Thirdly, next week’s budget is expected to be tough, as Treasurer Swan attempts to lower the budget deficit. And finally, traders and hedge funds continue to hold huge long positions in the Aussie. In the short term, it would be no surprise if the Aussie were more vulnerable.


Greek debt restructuring odds decline.
The odds are still very significant, but according to the CDS market, they have shortened noticeably over the past week. Greek 5yr CDS have fallen by nearly 150bp over the past week, as the market seems to be thinking that a restructuring is less imminent than previously thought. For their part, Greek government officials continue to strenuously deny that it is under consideration.