FX Strategy Weekly

- "The resilience of GBP and stale USD performance vs G10 currencies in a broader context of risk aversion is a new development and will bear close watching over the week ahead as we square up to heightened event risk from the US and the euro zone. Investor scepticism has been underlined by the 40% collapse in the Baltic Dry and a dreadful sequence of US housing data for May, drawing support for the JPY and CHF. A second disappointing US employment report in as many months threatens to further derail confidence and could add to the view that the Fed will eventually have to resume asset purchases. The ECB one-year tender expires on Thursday. The quarterly IMF Cofer statistics covering changes in Q1 FX reserve composition are due on Wednesday."
- "A solid weekly performance saw GBP rally against all G10 currencies bar the JPY as the correlation with risk turned lower. Bolstered by hawkish MPC minutes and the endorsement of the UK Budget by the credit ratings agencies lifted GBP/NOK to the top of the rankings with a 2.7% gain, followed by GBP/CAD (2.6%) and GBP/EUR (1.6%). China’s decision to de-peg the yuan from the USD resulted in USD/CNY hitting an all-time low at 6.7860, but the impact on the broader G10 was muted with JPY gains primarily attributed to the flight from risk. The CHF continues to attract solid demand since the June 17 SNB meeting, and progressed to below 1.35 vs the EUR. USD/CHF slipped below 1.10."
- "News that MPC member Sentance voted for a rate hike at the June meeting came as a shock and was the highlight of a week primarily dominated by the emergency Budget. Though the majority MPC view still points to low interest rates for longer, Mr Sentance’s dissent indicates that the policy debate could be become more fragmented if the recovery is sustained in the second half of the year. The regime of fiscal austerity imposed by the Chancellor leaves many question marks over the direction of the economy. The Budget foresees GDP growth of 1.2% this year and 2.3% in 2011, with CPI inflation on target. An additional £40bln of fiscal tightening means net borrowing is projected to fall from £155bln of GDP this year to £37bln by 2015."
- "A stellar performance for UK rates saw 5y swaps return to the lower end of the trading range and 10y yields slide to the lowest level since last October, cracking technical support at 3.44% and 3.40%. Key support runs at 3.35%. 3-mth Libor was unchanged at 0.73% for a 3rd week running, causing the 3mth Libor/5y swaps curve to flatten to 176bp, a twoweek low. The 3mth Libor/Ois spread ended the week marginally tighter at 23.5bp. The 2y/10y swaps curve flattened 6bp to 197bp. Failure to break 206bp leaves the curve vulnerable to a corrective flattening to 192bp. Following this week’s lull, gilt sales will resume next week with the auction of £800mln, 0.75%, 2047 IL paper."

LloydsTSB FX Strategy Weekly 20100625

USD currencies still expected to gain vs. EUR currencies

- "The latest IMM data covers the week from 15 to 22 June."
- "Net long USD positions were reduced slightly for a second week as the USD rally has begun to lose steam. Still, non-commercial investors are net long the USD against all the EUR currencies (GBP, EUR and CHF), but net short the USD against all the other G10 USD currencies (MXN, CAD, AUD, NZD, and JPY)."
- "As EUR/USD failed to break above 1.25, after correcting higher from its 7 June 1.1877 low, non-commercial investors have added fresh EUR shorts – taking net short EUR positions to 32% of open interest. This should imply that the upside risk to EUR/USD from a position squeeze has increased again, although there is still room for the market to add further short EUR/USD positions before reaching the crowded positioning levels seen during May – where net shorts reached 40% of open interest."
- "Non-commercial investors turned net long NZD again after briefly having been net short during the past two weeks. However, open interest is currently quite low in NZD, which means that one should be careful not to read too much into the data."
- "Open interest has declined in most currencies, potentially indicating lower liquidity in the market going into the summer period – though other factors could easily be driving this. Thin summer trading could be expected to bring higher volatility on the market. However, in previous research (see FX Crossroads: Post vacation blues), we have highlighted the lack of empirical evidence supporting this hypothesis. While there are signs that liquidity does indeed decrease during July, implied volatility does not seem to pick up. In contrast, implied volatility tends to pick up in the autumn."
DenDanske IMM Positioning 20100628

Euro area: Fiscal tightening is unlikely to kill growth

- "The debt crisis has accelerated fiscal tightening in the euro area. If the tightening is accelerated too much, it will kill growth."
- "We have estimated the impact of the tightening that has already been put forward. This is projected to dampen euro area growth by 1.0 percentage points in 2011."
- "The debt crisis has also resulted in significant euro weakening. This counters the negative impact of the fiscal tightening as it improves euro area competitiveness."
- "Euro weakening is estimated to lift euro area growth in 2011 by 0.8 percentage points. The net effect of fiscal tightening and euro depreciation on growth is modest."
- "The most open economies should benefit the most from the euro weakening while the negative impact of the debt crisis has been most felt in southern Europe."
- "The negative impact from fiscal tightening is also countered by a positive growth contribution from interest rates, which due to the debt crisis are expected to stay low for longer."
- "The overall effect of the debt crisis might however be somewhat more negative as the crisis has increased uncertainty and resulted in tighter credit conditions, affecting weaker countries and institutions most."
DenDanske Research Euroland 20100628

The competitiveness of the periphery; the cash position of Spain

- "With fiscal consolidation and private-sector deleveraging across the Euro-zone underway, peripheral countries in particular will need to improve their export competitiveness and rebalance their economies towards external demand. While the weakening of the Euro so far this year should certainly help in this regard, the overall starting position for these countries is, at face value, not particularly favourable: by most standard measures, they have suffered a marked deterioration in price competitiveness over the past decade."
- "However, our analysis produces a more encouraging result: when we examine the
historical relationship between these measures of competitiveness and relative export performance, we find that their explanatory power for Euro-zone countries is rather limited. In particular, they seem to overstate the extent to which competitiveness has deteriorated in certain countries, partly because they fail to take into account the extent to which price and cost increases have been driven by quality improvements. For this reason, we think the competitiveness situation in the periphery may not be as dire as the indicators suggest, and that the price adjustments (i.e., internal devaluation) needed to generate export gains may not have to be as draconian as most envision."
- "Spain’s public finances remain under the spotlight. One reason is that in July Spain will need to finance its monthly cash deficit (some €10bn-€15bn) and refinance the redemption of €24.7bn in government paper. Our second focus assesses its financing prospects, and the type and order of magnitude of any possible funding squeeze—as well as the tools the government has at its disposal to resolve it adequately."
GoldmanSachs European Weekly Analyst 20100624

Japan and the post-crisis world

- "As is by now well known, Japan is on the verge of losing its number two status in the ranking of the world’s largest economies. For the past decade, Japan has struggled to keep up with the pace of growth in other major developed economies, the BRICs and other emerging economies. China has increased its size to seven times that of Japan, and even some of the Euro economies have increased in size more than Japan in US$ terms (both exaggerated by the weakness of the Dollar). Unsurprisingly, therefore, financial market participants now tend to think about Japan and its markets against this backdrop."
- "However, recent developments paint a less gloomy picture. First, the cyclical recovery of the economy is on a par with that in the US and Europe—and possibly even better. Second, following another change in the Prime Minister, the conditions for Japan to make progress on its taxation system and its fiscal challenges now appear to be in place. Moreover, Japan is in the same continent as most of the key exciting economies of the next decade and beyond. Hence, Japan’s experience and historical success as an exporter should allow it to benefit from the continued emergence of China and India, and, within the context of the N-11 economies, Indonesia and perhaps some of the other Asian economies too."
- "We currently forecast that JGBs will underperform other major markets by the end of the year. We also expect a weaker Yen and a stronger performance of Japanese stocks (although we expect other global markets to outperform). It will be interesting to see how the outlook for Japan pans out in coming weeks and months. But it may be that Japan will not be as uninteresting’ as many overseas investors typically think.
GoldmanSachs Global Economics Weekly 20100623

Dipsy doodle

- Macro viewpoint: Dipsy doodle "Perhaps the biggest concern is in the housing market. In the past week, new home sales plunged 32.7% to a 300,000 annual pace in May. This is the weakest level of sales in the 47 year history of the series. Clearly, the housing market remains deeply depressed.
- Fed watch: Launching QE II? "The June FOMC statement did not contain any surprises. But reading between the lines, some investors are asking: does the Fed now expect a double-dip or deflation? We think not, but are somewhat concerned about its policy options should either occur.
- The week ahead: Waiting for nonfarm Friday "With the capital markets on pins and needles, next week’s bevy of economic data is particularly critical. The main event will be Friday’s employment report. We expect private nonfarm payrolls to advance 150,000 in June after a disappointing 41,000 increase in May. With the Census employment rolling off appreciably, headline nonfarm employment is expected to decline by 100,000, and the
unemployment rate is expected to tick up to 9.8% from 9.7%.
Merrill Lynch US Economic Weekly 20100625