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Friday October 15, 2010 - 17:03:06 GMT
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FX Briefing - Fed and ECB: drifting apart

FX Briefing 15 October 2010



Singapore to accelerate SGD appreciation

Chinese trade balance surplus and currency reserves rise strongly in Q3

FOMC getting close to launching QE2

Axel Weber, President of the Bundesbank, wants to return to variable rate tender


Fed and ECB: drifting apart


The potential easing of US monetary policy and the ensuing capital flows into emerging markets and other growth regions continue to dominate the financial markets. Following a short spell of consolidation in the first half of the week, with EUR-USD falling slightly below 1.38, the greenback came under significant sales pressure again starting on Thursday. The euro even rose above 1.41 at times. Sterling, with GBP-USD rising to over 1.60, and the Australian dollar, which was trading almost at parity, also marked new highs. USD-JPY, on the other hand, fell to below 81 and USD-CHF to below 0.95. Even USD-CNY fell to 6.65 yuan to the US dollar, declining by 0.2%, a substantial rate by Chinese standards.


Singapore: Appreciating faster

The reasons for this renewed spell of weakness are attributable mainly to Asia. China, for instance, posted a high trade surplus of $66bn in the third quarter and a sharp rise in its currency reserves by $194bn to $2.65 trillion. These figures are underpinning the calls by the US for the yuan to appreciate.


The decision made by the Monetary Authority of Singapore (MAS) to aim at a stronger appreciation of the SGD and to widen its currency trading band had some effect on the markets. 1  Since April, the SGD has gained almost 3% against the target currency basket and almost 7% against the dollar. A steeper appreciation curve therefore produces a relatively substantial appreciation against the dollar, all the more so when the currencies

of the other important Asian trading partners are also firming against the dollar. Widening the target band provides additional scope for further appreciation. The forex markets interpreted the intended appreciation of the SGD as an indication that Asian governments were starting to accommodate pressure exerted by US policy and the markets.


FOMC: Preparing QE2

The minutes of the FOMC meeting of 21 September reveal the intention to prepare the markets for further quantitative easing. But they also illustrate the strong debate about the need, effectiveness and concrete implementation of the securities purchasing plans. Comments made by Jeffrey Lacker, president of the Richmond Fed, are remarkable in this context. He stated that he was unlikely to support the purchase programme if the economy continued to develop as expected. He doubted that monetary policy was in a position to overcome the current obstacles to growth. A better idea about the overall direction to be taken by the Open Market Committee might be provided by Fed chief Ben Bernanke this afternoon.


Economic data did not play any major role this week. US trade balance figures for August weighed down on the dollar: the deficit that had clearly fallen to $43bn in July rose to $46bn, largely due to higher oil and consumer good imports and considerably lower aircraft exports than in the previous month. The trend towards a widening of the deficit, which set in when growth was picking up again in mid-2009, therefore seems set to continue. Although the foreign trade deficit is clearly lower than in the years until 2008, it appears to be growing ever faster, the modest growth in domestic demand notwithstanding. If the economy were to pick up significantly in the medium term, the deficit would probably widen further. This would again support a correction in exchange rates. In the short term, the higher deficit might above all translate into slightly negative net exports in Q3.


ECB: Early return to variable rate tender

In terms of the euro zone, Axel Weber, president of the German Bundesbank, played a prominent role on account of his relatively unmistakable statements that the “crisis management mode” should come to an end. Weber advocated an immediate stop to the Securities Markets Program allowing the purchase of government bonds. As Weber had already publicly voiced his dissent when the measures were introduced in May, his demands are not really surprising. As regards money market policy, Weber is advocating a quick return to the interest rate tender. According to Weber, the risk of interest rates being driven up excessively due to aggressive bidding on the part of problem banks that depend on ECB refinancing would be overcome by providing allotment volumes that are higher than the calculated liquidity requirements. Initially, the liquidity situation would therefore not be much different from the current one. The ECB would, however, regain direct control over the liquidity supply. The Bundesbank president is also suggesting that this oversupply should be phased out gradually.


The ECB has promised to continue its refinancing operations with full allotment up until the end of the minimum reserve period in December/ January. If the statements by Axel Weber reflect the stance of the ECB’s Governing Council, we would expect a return to the interest rate tender at the beginning of 2011. The proposals made by Weber would provide for an elegant and smooth transition from the fixed-rate tender with full allotment to the normal interest rate tender. If this method were to be used, the ECB would furthermore benefit from leeway and flexibility when exiting its non-conventional monetary policy measures, as it could then control the pace and, if need be, speed it up significantly.


The fact that monetary policy in the USA and in the euro-zone are moving in opposite directions again points to a firming of the EUR-USD rate. When compared with the currencies of other industrialised nations, the euro is still valued quite modestly in historical terms.


Stephan Rieke +49 69 718-4114


1 Monetary policy in Singapore is implemented via an exchange rate target. The MAS manages the currency by keeping it within a band around a basket of currencies. It does neither disclose the exact composition of the currency basket nor quantify the monitoring band.


Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


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