The capital market is undergoing its self-regulated Q1 reality check of pitting financial markets progress against the real economy. The discouraging story surrounding the global real economy has resulted in risk-off trading strategies winning out. Perceived safe-haven assets such as the dollar and German bunds are rallying this morning after the more hawkish tone from the FOMC minutes and a series of softer data either side of the Atlantic disappoints.
Yesterday’s minutes of the Federal Open Market Committee’s meeting released shown that U.S. policy makers are divided about the strategy behind "helicopter" Ben’s program of buying bonds until there is “substantial” improvement in a U.S. labor market. Some policymakers are concerned that the central bank’s "easy" money policy could lead to further financial markets instability and making it will more difficult to exit such programs cleanly.
Rising fears over the potential costs from further QA could persuade Fed officials to materially change their purchasing asset strategy sooner than many have been expecting. Some policy members agree that an earlier end to asset purchases might be needed, while others warn against a premature withdrawal of stimulus. Perhaps the Fed needs to be more flexible and vary the pace of its +$85b monthly bond purchases? As its stands, any fear of an early exit is supporting the dollar across the board.
This morning’s market action has born witness to the 17-member single currency managing to seek new recent lows outright after today’s soft euro data. The headline releases confirm that the region's self improvement has been more of a financial story while the real economy continues to struggle with the sustainable growth question. Eurozone’s business activity shrinking further this month suggests that the region's 10-month downturn will persist in Q1.
The data continues to show a large divergence between the region's two largest economies. Germany shows continued growth, while French business activity shrank at the quickest pace in four-years. For the region as a whole, the bloc's PMI fell to 47.3 this month from 48.6 and provides proof that the region is on course for further contraction for a fourth consecutive quarter. Is this market now in danger of witnessing long EUR/JPY unwinding? Investors have been shortening the currency from the land of the rising sun for a few months now and a number of these weak shorts have to be nervous.
The EUR does not have a monopoly play of currency moves. Some of the proverbial commonwealth currencies are currently having a tough go of it. The loonie is attempting to break through its seven month low, sterling has its sights on thrashing last years outright bottom, and the kiwi seems to be simply misunderstood.
The BoE requires help. Yesterday they indicated that they are willing to look at more ways to boosting growth to the U.K.’s triple-dip economy, however, they also require Prime Minster Cameron’s party to provide some independent creativity. Outgoing Governor, Mervyn King, along with two fellow members, was defeated in a push for extra stimulus at this month's MPC meeting. All three voted to increase the QE package by +GBP25m, stating that further asset purchases would help the U.K. economy without influencing inflation.
U.K. policy members want a change, but are clearly divided on how best to do it. In stark contrast, sterling’s recent value does not show the same signs of indecisiveness. Investors this week have been a happy and healthy seller of the currency across the board. Governor King is running out of opportunities to give the British economy one last "shot in the arm" before the ‘hotshot’ underling from the Bank of Canada, Carney, takes the helm. Member consensus believes that policies targeted at specific bottlenecks in the economy might be better suited rather than simply printing money. The MPC is clearly feeling the heat just like the currency. GBP continues to be awash with talks of large stops building further south of 1.5185.
Is the Canadian economic miracle beginning to be challenged? The recent loonie's under-performance has not been helped by the Reserve Bank of New Zealand’s Governor Wheeler’s comments that his country’s currency is “significantly over valued.” The CAD is determined to beat the 11-month low with substance recorded earlier this morning. Last week, the market noted that the current trade weighted index (TWI) has the majors undervalued by -8% when compared to the mean of the last three-decades. The minors or tier II reserves on the other hand are overvalued by +11% (AUD, CAD, SEK and NZD). Analysts note that the spread between the major and minor is the widest it has been for the same time period (19).
This excuse is old news. So, what is the real excuse to want to dislike the commodity pool of currencies? Yesterday’s -8.5% fall in January’s U.S. housing starts indicates that the real estate market of Canada’s largest trading partner, is not yet out of the woods. Some of the loonies’ recent bout of weakness may be attributed to the concerns about what the impact of U.S. spending cuts will be.
Further fundamental threats from Canadian wholesale trade data (-0.9%) well under expectation and last week’s manufacturing sales declining (-3.1%), by the biggest amount in nine-months, has the CAD wanting to under-perform. Aiding the dollar’s ride higher is Canadian corporates paring and layering of their dollar offers on top, while the bid side dollar corporates have moved their own orders higher.
Governor Wheelers explaining that the NZD was “overvalued” got all of the markets attention mid-week. Investors seem to have overlooked other sections of his speech in which he indicated that the central bank could do nothing about it. On reading the whole speech, he argues that a cut in interest rates would not relieve the pressure on the currency and RBNZ intervention would not have a sustainable impact. So in hindsight, New Zealand declaring surrender in the currency war is a tad too early. A little relief rally is probably in order for both GBP and NZD, the loonie however looks ill with dealers continuing to see better levels to want own the currency outright.
With the eurozone's PMI’s adding venom to the single currency sell off so far, weak longs are in danger of being taken out of their positions. Investors have been selling assets, particularly commodity assets; to raise much needed cash to stave off margin calls. There have been rumors that a "long" commodity U.S. hedge fund has been systematically selling off their precious metals positions for liquidity purposes, resulting in outlier price movement in the asset over the past 24-hours. Expect more similar trading stories to dominate price movements rather than the plain vanilla technical and fundamental reasons. For now, the single currency looks like a sick puppy wanting to head lower!