With the currency market in full risk-off mode this morning, let's be clear that this is a move driven by deleveraging and not relative balance sheet expansion. The decision to cut interest rates by the central banks of South Korea and Brazil over the past 24 hours confirms that policymakers around the world are intimidated by the risk of slower global growth in the second half of the year.
With no major economic data or news catalyst, investors had been gradually swapping euros and other risky currencies for the U.S. dollar and Japanese yen throughout the European trading session. This selling exacerbated into North America with the EUR/USD breaking below 1.22 and hitting a fresh 2-year low in the process. The modest rise in Spanish bond yields cannot be blamed for the euro's weakness and the amount of tension in the market tells us that this move is driven by concerns for global. The rate cut by South Korea was its first in 3 years and while Brazil took interest rates to a record low. Second-quarter Chinese GDP numbers are due for release this evening and investors fear that growth will slip below 8% for the first time since the 2008-2009 Financial Crisis. The prospect and reality of a simultaneous slowdown in three of the world's largest economic centers set off a wave of deleveraging that drove investors into the arms of the U.S. dollar and Japanese yen. As we have warned previously, the second half of the year will be weaker than the first, which means there will be more action from central banks this year. Relative balance sheet expansion isn't as much of an issue because it will be difficult for the Federal Reserve to just stand on the sidelines much longer when everyone else is increasing support for their domestic economies.
Central Bank Intervention?
The latest euro weakness also renewed concerns about intervention. While we believe that the European Central Bank won't stand in the way of further euro weakness because it adds support for the region's economy there is no question that the euro sell-off is making the Swiss National Bank and the Bank of Japan very nervous. As a result, there is a good chance for SNB intervention in EUR/CHF quietly or overtly over the next few weeks and possibly even over the next few days.