Tuesday FX View: Closing Ranks on the Dollar

by: Interactive Brokers

The prospects of a year-end dollar rally on increasing risk aversion took a hit thanks to a confluence of events spearheaded by growing evidence of regional Asian strength. A rising Japanese yen shocked the Bank of Japan into further quantitative measures aimed at reviving spending and the third rise in Australian interest rates in as many months enhanced the appeal of the local dollar. Eurozone data firmed to provide evidence that Germany’s €85 billion ($128 billion) fiscal stimulus package is hitting home. None of the above events is a potential driver for greenback strength leading a moody dollar index down by another 0.5% on Tuesday.

There is no shortage of market-driving news events today. Possibly the most important is the confirmation from a purchasing managers index compiled by HSBC that the manufacturing side of the Chinese economy grew at its fastest pace in five years. The index came in at 55.7, while the official government data was a little less optimistic yet maintained its 18-month high. Each report has a different compilation methodology.

The data put paid any recent fears over a lull in global activity and sets the stage for ongoing strength out of the Asian economy for the first half of 2010 with China acting as the motor. It also boosts the prospects for a fourth quarter growth rate of 10.5% this year above the official government target of 8%. The voracious pace of lending made to corporations and consumers seems to be paying off at a time of subdued global demand thanks to an impaired financial situation. The Asian-Pacific region of course was less impacted than the western economies, but maintaining economic momentum in the aftermath was the real challenge.

That leads to the equally important and unexpected news out of the Japan overnight where the government has been demanding the Bank of Japan to act to prop up an economy heavily reliant on the needs of exporters over the years. The BoJ held an emergency meeting last night, which many took as a queue for either unilateral or coordinated intervention aimed at stemming the rise of the Japanese yen. Recently it reached a 15-year high against the dollar below ¥85. Ahead of the outcome of the meeting the dollar rose to ¥87.50.

In the event the BoJ announced additional quantitative measures aimed at maintaining what it still referred to as a modest recovery and one that it expects to carry through to mid-2010. Governor Shirakawa, who is scheduled to meet Prime Minister Hatoyama later in the week, said that the recent strength in the value of the yen and declining share prices might conspire to undermine corporate sentiment and so harm the economy.

The BoJ announced a program of additional three-month loans to be made available to commercial banks to the tune of an equivalent $115 billion. The hope is that this will spur lending and improve demand. The rising value of the yen has driven down the cost of imports and compounds weaker prices. October consumer price data reflected an eighth sequential decline in the consumer price index, which fell 2.2% on an annualized basis. The BoJ predicts this will extend to fiscal 2011.

Mr. Sakakibara, formerly known during his term as a government minister as Mr. Yen, played down the potential impact on aggregate demand as a result of today’s measures. He also projected that the yen would continue to rise towards ¥80 as deflation persisted. As he pointed out it’s not the need for liquidity measures, which he described as already abundant, rather it’s the lack of willing borrowers.

The euro rose to ¥130.79 against the Japanese currency.

In Australia, confirming the rude health of the Chinese economy, the Reserve Bank added a third consecutive quarter point on to its benchmark measure of interest rates lifting the rate to 3.75%. During October employers added jobs, while government stimulus still in place has boosted home values by 10% in 2009. The increasing pace of Chinese demand for raw materials has helped buoy the Australian economy into what the deputy governor at the RBA recently couched as a “new upswing that maybe around for a couple of years.”

The Australian move relegated the recent drama over the situation in Dubai to the minor leagues by attributing a further tightening in monetary policy to a broad improvement in recent financial markets around the world. Today the state of Dubai described half of its outstanding loans as “stable.” The Aussie dollar initially declined in response to the outlook for further monetary tightening, before Chinese data provided further wind to its sails and as I write the Aussie buys 92.19 U.S. cents.

While overall Eurozone unemployment rose to 9.8%, the data for its core German economy fared better as the employers surprised economists with the creation of 7,000 new jobs contrary to an expected decline of 5,000 workers. The November reading for German unemployment fell to 8.1% from 8.2% in October. Retail sales increased for the first time in three months, rising by 0.5% in October. The reading was slightly above forecast. Commencing in January the German economy will feel the boost of additional stimulus measures of €20 billion from its government, and the same amount will likely boost the economy through 2011 after Chancellor Merkel’s €85 billion package.

The diminution of the situation in Dubai in addition to the improvement in European data helped spur appetite for the euro, which is currently tracing higher at $1.5073. Worldwide stock markets rose, except in the Mid-East where local investors are treading cautiously. The MSCI Asia Pacific index rose earlier by 1.4% to a five-week high. The price of gold also rose to yet another record just pennies above $1,200 per ounce.

One of the biggest gains against the dollar came today from the British pound following a further increase in home prices according to data from the Nationwide and Halifax building societies. Both companies have different composition methods for their data, but the Nationwide showed a 0.5% monthly and 2.7% year-over-year increase in prices for homes. The pound added despite data from the CIPS indicating a slower pace of manufacturing expansion during November. Sterling currently buys $1.6574 and one euro today buys 91.02 pence.