In This Issue.
* Flight to safety, but was it necessary???
* STL Fed Head Bullard says we are at a turning point...
* China lets the renminbi rise...
* Australian officials bypass the US$...
And, Now, Today's Pfennig For Your Thoughts!
A questionable flight to safety...
Good day... It was a ‘risk-off’ day in the currency markets yesterday as traders continued to digest data suggesting manufacturing in both the Chinese and European economies is slowing. Currency investors moved back into the ‘safe haven’ currencies of the Japanese yen and US$, pushing the yen up over 1% and the dollar index to a weekly high. I mentioned the Chinese report yesterday morning, but failed to give many details. The report was produced by HSBC Holdings PLC and Markit Economics and reported an index of factory output in China dropped to 48.1 in March. As with most of these indexed reports, a number below 50 indicates a contraction. China continues to be the globes economic engine, so any report that shows that engine is slowing causes drama in the markets.
Readers of the Pfennig can probably surmise that I think the markets were over-reacting to this report. The Chinese government stated last year that they were looking to ‘tap the brakes’ and wanted to see their economies rapid growth slow. They knew there was a serious risk of inflating bubbles in their markets, and a slowdown was needed. To their credit, they were transparent in their intentions to slow growth from the red hot double digits to a more sustainable 7.5%. But ‘traders’ make money on volatility, and the release of the HSBC/Markit report gave them an opportunity to push the markets around. The commodity based currencies were the worst hit, and the damage continued through most of morning.
Numbers released out of Europe only increased currency traders concern regarding the global recovery. A report from the UK yesterday showed retail sales fell more than expected in February and a report from Ireland showed that countries economy slipped back into recession in the fourth quarter. All of this data had investors running for cover yesterday morning, and the yen and US$ were the two currencies they sought out for shelter.
But a funny thing happened in late trading yesterday as the dollar reversed its earlier gains and started to move lower. I couldn’t find anything in particular which drove the dollar down, but it may have been sparked by comments made by St. Louis Fed President James Bullard who was in Hong Kong. Bullard suggested US monetary policy may be at a turning point, suggesting our days of ultra easy money may be coming to an end. With policy currently “on pause, it may be a good time to take stock of whether we may be at a turning point,” Bullard said in a speech. “As the US economy continues to rebound and repair,” further action “may create an over commitment to ultra-easy monetary policy.” Bullards comments sent a warning to the markets that the low interest rates which they have become addicted to are not going to last forever. While some would think higher US rates should push the dollar up (interest rate differentials have been one of the main drivers of currency markets in the past), higher rates could also put our recovery in jeopardy which worries investors.
Data released in the US seemed to support Bullard’s thoughts that the US is passing through a turning point. Initial jobless claims were a bit lower than expected, at 348k compared to an adjusted 353k new claims last week. Leading indicators were also positive, moving up .7% compared to economist’s expectations of a .6% increase. This morning we will get a report of new home sales for February which are predicted to have increased 1.3% during February after falling .9% last month.
A couple of the ‘big boys’ announced changes to their currency opinions yesterday. Goldman Sachs recommended investors should sell the US$ vs. the Japanese yen to take advantage of a possible reversal of the recent movement in these two currencies. “There is a substantial risk that the sharp move in the yen will reverse at least partially in the new fiscal year,” Goldman Sachs analysts wrote. “Seasonal patterns point in that direction. The surprise improvement in the February trade balance in Japan supports our view and we are now also coming very close to fiscal year end in Japan.” So the folks over at Goldman are going against the grain and believe the yen will appreciate. Perhaps this report was one of the reasons the yen jumped over 1% yesterday (The folks over at Goldman certainly still swing the big stick in the markets).
Citigroup adjusted the allocations of the currencies which make up their ‘Model Portfolio’, increasing the percentage allotted to the Swedish krona and decreasing the weighting of the Canadian dollar. Currency analysts at Citi believe the Swedish currency is relatively cheap compared to its European peers. They also feel the Canadian dollar is near enough to the top of its trading range that it is prudent to take some profits. I guess they wish they would have made the call on the loonie a few days ago, as the Canadian dollar fell to parity with the US$ yesterday for the first time in nearly two weeks. A report showed retail sales grew slower than predicted during the month of January and this combined with another drop in the price of crude oil caused the loonie to fall nearly 1% in the past two days to settle in just above parity.
The Chinese currency surged higher overnight as the PBOC increased the fixing rate by the largest margin this year. The central bank also cut reserve requirements for its rural banking system in order to boost lending. Officials in China believe the economy will bottom in the first or second quarter and that the country has already passed through the tightest credit conditions in this cycle. And Moody’s Investor Services helped boost confidence in the Chinese banking system saying Premier Wen Jiabao’s policies will limit the increase in bad debt that analysts say will mar profit reports this month. Moody’s said Wen’s efforts to curb property speculation are “having the desired effect”.
Chuck has been detailing the efforts of China to gain acceptance of their Chinese Renminbi for use in global trade. One of the ways they have been pushing their currency into the markets has been through the use of ‘swap agreements’ with some of their major trading partners. The countries use these swap agreements to bypass the US$ which is typically used for global trade, and instead use the local currencies. China has entered into these swap agreements with several of their trading partners (20 to be exact) the largest of which was Brazil. But they had not entered into a swap agreement with any of the ‘major’ countries until yesterday when the Reserve Bank of Australia announced they had agreed to a $31 billion currency swap with China. According to a statement from the RBA, “The main purpose of the swap agreements are to support trade and investment between Australia and China, particularly in local currency terms, and to strengthen bilateral financial co-operation.” The amount of $31 billion isn’t dramatic in the big picture of global trade, but it is quite obvious China is looking to decrease their reliance on US$, and therefore decreasing the globe’s dependence on the greenback. The RBA statement went on to say “The agreement reflects the increasing opportunities available to settle trade between the two countries in Chinese renminbi and to make RMB-denominated investments.”
The US$ is slowly losing its grip on its ‘reserve currency’ status. And the impact won’t just a hit to our nation’s collective ego. Our status as the globe’s reserve currency has kept our interest rates down and demand for our currency up. Countries across the globe have to have dollars in order to trade as most of the major commodities are traded in dollars (OIL is a prime example). This forces these countries to hold dollars in reserve, as they will need them to trade, and they purchase our treasury instruments in order to ‘park’ these dollars. So having the dollar as the reserve currency has allowed the US to continue to issue bonds at lower rates than we would be able to if we weren’t home to the world’s reserve currency. China doesn’t ‘have it in’ for the dollar, but are obviously looking to give the Renminbi a higher profile in the global economy.
Then there was this… Jack Stapleton, my good friend and the new Director of our EverBank Infinity Banking Program here sent me a story yesterday morning which suggests the stronger CAD$ may be having a positive impact on US auto manufacturing. The story which was written by Peter Wadkins over at ThomsonReuters detailed the data on Canadian and US manufacturing numbers and compared them to automobile sales. Canadian auto sales are up, but wholesale sales (most of which are shipped to the US) were down. At the same time, US manufacturing in the Midwest has rebounded higher over the past few months – mostly due to increased auto and auto parts manufacturing. Wadkins theorizes that the strong CAD$ has the big 3 auto manufacturers beginning to shift production back to the US. If this becomes a trend, we could see Canadian leaders start trying to do something about the strength of the Canadian dollar.
To recap... The US$ rallied yesterday morning as investors moved into the US$ and yen as safe havens. The reason for the big exodus from ‘risk’ trades was the report I wrote about yesterday which suggested China will be slowing. The US$ reversed course midway through the trading day and continued to fall overnight. Goldman Sachs suggested investors should sell the US$ vs. JPY and Citigroup increased their allocation to Swedish krona while reducing the Canadian dollar. The Chinese currency surged overnight and the RBA and PBOC announced a swap agreement which bypasses the US$. Finally, a story shared by one of my coworkers suggests the big 3 automakers may be moving some of their manufacturing back to the US.
Currencies today 3/23/2012. American Style: A$ $1.0402, kiwi .8128, C$ $1.0045, euro 1.3249, sterling 1.5856, Swiss $1.0992. European Style: rand 7.7253, krone 5.7640, SEK 6.74, forint 222.37, zloty 3.1480, koruna 18.6995, RUB 29.3398, yen 82.66, sing 1.2639, HKD 7.7658, INR 51.2175, China 6.3076, pesos 12.8333, BRL 1.8192, Dollar Index 79.453, Oil $105.93, 10-year 2.26%, Silver $31.6725, and Gold $1,650.91.
That's it for today... And the end of a relatively calm week for the currency and metals markets. It was kind of nice not having to deal with any wild market swings, and the Euro debt problem barely made an appearance in this week’s Pfennig. We are marching toward our T24 conversion next weekend, which will mark the successful end of a 4 year project. Looking forward to spending some time with my family this weekend, hopefully the rain which is starting this morning will push through by this evening. Everyone go have a Fantastic Friday, and a wonderful weekend!! Thanks for reading the Pfennig!
Chris Gaffney, CFA
EverBank World Markets