The dollar has softened over the past 24 hours in the hope that the US Federal Reserve chairman is once again going to save the day and hint at further quantitative easing to come. There are two immediate issues with this. First, it’s pretty clear from the recent minutes and other communications that the Fed has made further easing measures conditional on a further deterioration of the economy and principally the labour market, which has been the ongoing area of disappointment. The latest jobs numbers, both on payrolls and claims have not been sufficient to elicit such a hint in our view. But there’s also the question of just what the Fed can deliver and its effectiveness. This was evident in comments from one of the Fed governors yesterday (known ‘hawk’ Lacker), who stated “The thing I worry about is that expectations for what the Federal Reserve…can do for real growth and labour market outcomes has become over-inflated”. We wait to see what Bernanke delivers at his half-yearly testimony today, but those expecting a stronger hint of more monetary stimulus to come are likely to be disappointed.
The drowning euro. It’s the euro crosses that are really catching the attention. Against each of the Aussie, Canadian dollar and the Kiwi, the euro has recently recorded new record lows this month, while vs. the Japanese yen the single currency is once again threatening to break the early June low of 95.60. Especially unsettling on Monday were the various reports that the ECB is now prepared to allow senior unsecured note-holders of Spanish banks to be subjected to significant capital losses. In late New York and Asia trade, the single currency has made back some ground, helped by the weaker dollar in anticipation of Bernanke’s testimony later today. But we expect there is going to be some disappointment with Bernanke’s message, which could see the dollar retrace some of the overnight weakness.
Sterling stronger ahead of CPI data. Today’s inflation numbers are expected to show the headline rate steady at 2.8% in June, but with more QE now delivered, sterling should be more relaxed about the outcome. We’ve highlighted before the resilience of sterling and this was again evident in Monday’s session, with EUR/GBP pushing the lows both into midday and also the European close. The 0.80 level on EUR/GBP proved to be a key area of resistance back in 2008, with the cross moving higher on the escalation of the financial crisis towards the end of that year and although the cross moved below 0.80 in May of this year, the moves proved to be fleeting. This time around, the downside momentum has been stronger. Of course, it’s not all been about sterling, with the euro having a fairly difficult month so far. We’ve seen interest rate differentials move modestly in favour of sterling during this time, eurozone 2yr rates moving down faster than their sterling equivalent. As we’ve discussed before, the UK currency has benefitted from diversification flows during the first half of the year as investors looked to bypass the euro area. From a domestic perspective however, sterling’s strength vs. its main trading partner naturally creates fresh challenges and undermines the long-term desire of the Bank of England to see a rebalancing of the UK economy towards greater reliance on net exports and also investment. So, whilst some may see the Bank’s latest extension of its quantitative easing program as a means of lowering sterling and helping to achieve this rebalancing aim (although naturally the Bank is not going to state it this way), any such desires are likely meet with disappointment, with this latest down-move on EUR/GBP looking likely to be sustained in the second half of the year.
China hopes remain strong. The visit of premier Wen Jiabao to the Sichuan province earlier this week was timely, given that this area has led China’s growth transformation. He was more candid out the outlook, stating “It should be clearly understood that the momentum for a stable rebound in the economy has not yet been established”. For the leader of one of the world’s largest economies, the directness of Wen’s warning is unusual and should be commended. Furthermore, Wen vowed that policy-makers would step up their fine-tuning efforts. The State Council is due to meet tomorrow, so it is possible that further measures could be announced very soon thereafter. Last week, the PBOC claimed that the world situation was extremely complicated and that weak global demand would scupper China’s recovery prospects. Meanwhile, the currency continues to weaken against the dollar and the stock-market continues to swoon. The Shanghai Composite has dropped by more than 12% since early May; it remains one of the world’s worst performing bourses in Asia for the year-to-date .