Friday October 22, 2010 - 15:37:22 GMT
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FX Briefing - Dollar remains under pressure.
FX Briefing 22 October 2010
ļ Chinese central bank raises lending and deposit rates
ļ Eurozone leading indicators, ifo business climate improve again in October
Dollar remains under pressure.
The forex market remains volatile. According to the CFTC report, speculative investors in US futures markets are continuing to bet against the dollar. Net long positions have reached high levelsā on EUR, JPY, CHF, AUD and NZD. If all market players are on the same side, the movement tends to lose momentum. At the same time, the risk of a reversal increases, as very short-term investors are quick to react to headwinds.
Such a correction occurred at the beginning of this week. EUR-USD slipped as low as 1.37 for a time, and USD-JPY rose to almost 82. This was partly prompted by an interview with ECB president Jean-Claude Trichet, in which he opposed Bundesbank president Axel Weberās relatively aggressive stance, and partly by a drop in the US stock market which triggered a wider retreat from risk positions.
The dollarās strength was only short-lived, however. On Wednesday, there was a turnaround;
EUR-USD headed back to 1.40, USD-JPY is slightly over 81. The prospect of the Fed embarking on a fresh round of quantitative easing is still weighing on the greenback. After Fed Chairman Ben Bernanke had spoken out in favour of this, several of his colleagues followed suit.
The most concrete suggestion so far has come from James Bullard, president of the St Louis
Federal Reserve, who is in favour of the central bank buying $100bn worth of Treasuries prior to the FOMC meeting in December: furthermore, the Open Market Committee should give guidance on whether a further $100bn of assets is likely to be purchased in the period following the meeting. A decision for the period up to 27 January would then be taken in December and guidance given on the period from the end of January to the middle of March ā and so on. In view of these deliberations, US bond market yields are stuck at low levels, particularly in the short maturity segment. Yields on 2-year Treasuries are a mere 0.35%, which is fuelling the search for alternative investment options, particularly abroad or in foreign currencies.
As the majority of emerging market central banks are currently more concerned about stemming capital inflows and preventing their currencies from appreciating, the Chinese central bankās interest rate rise on Wednesday caused quite a stir initially. After leaving interest rates unchanged for almost three years, the PBoC raised the reference rate for one-year loans and one-year deposits by 25 basis points to 5.56 and 2.50% respectively. In the first instance, this fuelled haven demand for the dollar, and commodity prices fell for the most part. Market participantsā main worry seemed to be that the interest rate step could have been a sort of emergency braking measure ahead of the release of inflation and other key economic data.
But the Chinese economic data published on Thursday give no reason to assume that Chinese monetary policy is planning to slam on the brakes. Growth slowed down slightly in the third quarter to 9.6%. The increase in consumer prices accelerated somewhat again in September, but at 3.6% year-on-year (after 3.5% in August) is hardly cause for alarm. The interest rate decision was probably aimed primarily at keeping growing risks due to too much liquidity, loose lending and asset price bubbles under control.
The PBoCās interest rate hikes underline once more that the US central bank (and also, apparently, the Bank of England) is moving in the opposite direction to the rest of the world. In the eurozone, interest rates continued to rise ā partly because of the tighter liquidity supply in the money market, and partly because of the improvement in the economic outlook. The 3M Euribor has now breached 1% again, 2-year Bund yields are around 1% (and thus 65 basis points higher than their Treasury counterparts). Yields on 10-year Bunds are almost 2.50%; thus the interest rate advantage enjoyed by the US up to now at the long end of the curve has virtually flattened out.
The October survey indicators for Germany and the eurozone were surprisingly upbeat. When growth fears escalated in the US a few months ago, forecasters immediately warned that growth could collapse in the euro area. However, the laws of gravity do not seem to apply here. The upswing seems to be continuing into the fourth quarter, which is particularly encouraging. The leading indicators actually show an additional upward trend in October: the purchasing managersā index for the manufacturing sector in the eurozone rose by 0.4 to 54.1; the business confidence survey in France improved significantly in spite of the strikes, particularly the outlook for the production sector. And the ifo business climate index climbed a further 0.8 to 107.6 ā with not only the assessment of the current situation improving, but also, rather surprisingly, that of the future situation too.
We are therefore expecting the ECB to continue to work towards normalising monetary policy. This includes reverting to variable-rate tenders for refinancing operations ā probably at the beginning of 2011; government bond purchases could be formally discontinued. The next step āfrom about the middle of 2011 ā would then be āconventionalā again.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2175
Matthias Grabbe / Klaus NĆ¤fken
+49 69 718-2146 / -2683
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