Tag Archive | "Asset Prices"

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In Defense of Fundamental Analysis!

I was inspired to write this post by a recent article published by Counting Pips, entitled “The Problem with Forex Fundamental Analysis.” While the author, Warren Seah, delivers a stinging critique of fundamental analysis, I think most of his points are pretty hollow. For the sake of debate, I’d like to present my rebuttal.

Seah’s thesis can essentially be boiled down as follows: First, by the time traders have a chance to act on fundamental developments, it is inherently too late as such developments have already been priced into the exchange rates. Second, he argues that fundamental metrics are not automatically trustworthy, since the countries presenting them often have their own agendas. Finally, he asserts that the markets’ response to fundamental news releases is often illogical, and may only serve to confuse traders that would otherwise depend on technical signals to make trading decisions.

I think Seah’s first argument is inherently self-defeating. If one were to concede that all fundamental data has already been priced into currencies, that one would have to make the same concession with regard to price data, which is the backbone of technical analysis. In the end, all traders- regardless of analytical approach – believe that efficient markets theory is flawed, and that exchange rates (and other asset prices, for that matter) are not always correctly valued. The goal of any type of analysis is to identify and exploit such inefficiencies.

I think Seah’s second point, meanwhile, is somewhat irrelevant. Regardless of whether the official economic indicators are actually correct, the market will come to its own (implicit) consensus, and the data will still form the basis for investment decisions. In other words, given that comparative inflation rates can and do drive exchange rates, it’s important to be aware of such rates, be they explicitly provided by a government agency or implicitly priced in by investors. Whether the government agency’s figures are accurate or not doesn’t mean that currency investors shouldn’t worry about inflation.

With regard to the final point, I would agree that news releases can cause exchange rates to move illogically, but as Seah concedes, these inefficiencies will usually smooth themselves out over the following trading periods. A fundamental analyst with a long-term time horizon wouldn’t be swayed by such short-term fluctuations, especially if they are illogical. Thus, I would argue that news releases are more likely to interfere with short-term technical strategies than long-term fundamental strategies.

Ultimately, both fundamental factors AND technical factors drive exchange rates, with the latter primarily dictating short-term movements and the latter bearing more heavily on the medium-term and the long-term. By way of example, consider that all else being equal, a currency backed by low inflation, high economic growth, and high interest rates should outperform a currency with high inflation, low GDP growth, and low interest rates over the long-term. Since exchange rates don’t move up and down in straight lines, there will be plenty of opportunities for technical traders to earn a profit on a minute-by-minute and even week-by-week basis. The fact that very few technical traders will look at 5 year charts and very few fundamental traders will waste their time on 1-day charts largely explains the perceived value of both types of analysis.

Ideally, I would say that all traders should be aware of and make use of both types of analysis. In reality, though, I think this is akin to trying to have one’s cake and eat it too. I think it’s much more practical for traders to decide which type of analysis is better suited to their trading style and even their personality type, and analyze accordingly. For the best analogy, consider that Warren Buffet probably doesn’t know what a stochastic is, while quantitative hedge fund managers probably couldn’t care less about value. And yet it’s possible for both to earn consistent, out-sized returns.

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QE2 Weighs on Dollar

In a few weeks, the US could overtake China as the world’s biggest currency manipulator. Don’t get me wrong: I’m not predicting that the US will officially enter the global currency war. However, I think that the expansion of the Federal Reserve Bank’s quantitative easing program (dubbed QE2 by investors) will exert the same negative impact on the Dollar as if the US had followed China and intervened directly in the forex markets.

For the last month or so, markets have been bracing for QE2. At this point it is seen as a near certainty, with a Reuters poll showing that all 52 analysts that were surveyed believe that is inevitable. On Friday, Ben Bernanke eliminated any remaining doubts, when he declared that, “There would appear — all else being equal — to be a case for further action.” At this point, it is only a question of scope, with markets estimates ranging from $500 Billion to $2 Trillion. That would bring the total Quantitative Easing to perhaps $3 Trillion, exceeding China’s $2.65 Trillion foreign exchange reserves, and earning the distinction of being the largest, sustained currency intervention in the world.

The Fed is faced with the quandary that its initial Quantitative Easing Program did not significantly stimulate the economy. It brought liquidity to the credit and financial markets – spurring higher asset prices – but this didn’t translate into business and consumer spending. Thus, the Fed is planning to double down on its bet, comforted by low inflation (currently at a 50 year low) and a stable balance sheet. In other words, it feels it has nothing to lose.

Unfortunately, it’s hard to find anyone who seriously believes that QE2 will have a positive impact on the economy. Most expect that it will buoy the financial markets (commodities and stocks), but will achieve little if anything else: “The actual problem with the economy is a lack of consumer demand, not the availability of bank loans, mortgage interest rates, or large amounts of cash held by corporations. Providing more liquidity for the financial system through QE2 won’t fix consumer balance sheets or unemployment.” The Fed is hoping that higher expectations for inflation (already reflected in lower bond prices) and low yields will spur consumers and corporations into action. Of course, it is also hopeful that a cheaper Dollar will drive GDP by narrowing the trade imbalance.

QE2- US Dollar Trade-Weighted Index 2008-2010
At the very least, we can almost guarantee that QE2 will continue to push the Dollar down. For comparison’s sake, consider that after the Fed announced its first Quantitative Easing plan, the Dollar fell 14% against the Euro in only a couple months. This time around, it has fallen for five weeks in a row, and the Fed hasn’t even formally unveiled QE2! It has fallen 13% on a trade-weighted basis, 14% against the Euro, to parity against the Australian and Canadian Dollars, and recently touched a 15-year low against the Yen, in spite of Japan’s equally loose monetary policy.

If the Dollar continues to fall, we could see a coordinated intervention by the rest of the world. Already, many countries’ Central Banks have entered the markets to try to achieve such an outcome. Individually, their efforts will prove fruitless, since the Fed has much deeper pockets. As one commentator summarized, It’s now becoming “awfully hypocritical for American officials to label the Chinese as currency manipulators? They are, but they’re not alone.”

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Keep an Eye on Central Banks

From monetary policy to quantitative easing to forex intervention, the world’s Central Banks are quite busy at the moment. Even though the worst of the credit crisis has past and the global economy has moved cautiously into recovery mode, there is still work to be done. Unemployment remains stubbornly high, inflation is too low, and asset prices are teetering on the edge of decline. In short, Central Banks will continue to hog the spotlight.

On the monetary policy front, Central Banks have begun to divide into two camps. One camp, consisting of the Federal Reserve Bank, European Central Bank, Bank of England, Bank of Japan, and Swiss National Bank (whose currencies, it should be noted, account for the majority of foreign exchange activity), remains frozen in place. Interest rates in all five countries/regions remain at rock bottom, near 0% in most cases. While the ECB’s benchmark interest rate is seemingly set higher than the others, its actual overnight rate is also close to 0%. Meanwhile, none of these Banks has given any indication that it will hike rates before the end of 2011.

In the other camp are the Banks of Canada, Australia, Brazil, and a handful of other emerging market Central Banks, all of which have cautiously moved to hike rates on the basis of economic recovery. Among industrialized countries, Australia (4.5%) is now at the head of the pack, with New Zealand (3%) in a distant second. Brazil’s benchmark Selic rate, at 10.75%, makes it the world leader among (widely-followed) emerging market countries. It is followed by Russia (7.75%), Turkey (7%), and India (6.1%), among others. The lone exception appears to be China, which maintains artificially low rates to influence the Yuan. [More on that below.]

None of the industrialized Central Banks have yet unwound their quantitative easing programs, unveiled at the peak of the credit crisis. The Fed’s balance sheet currently exceeds $2 Trillion; its asset-purchase program has driven Treasury rates and mortgage rates to record lows. The same goes for the Banks of England and Japan, the latter of which has actually moved to expand its program in a bid to hold down the Yen. Meanwhile, many of the credit lines that the ECB extended to beleaguered banks and other businesses remain outstanding, and have even expanded in recent months.

Central Bank Credit Crisis Intervention 2007-2008

Central Banks have been especially busy in the currency markets. The Swiss National Bank (SNB) was the first to intervene, and as a result of spending €200 Billion, it managed to hold the Franc below €1.50. As a result of the EU sovereign debt crisis, however, the Franc broke through the peg and his since risen to a record high against the Euro. Unsurprisingly, the SNB has abandoned its forex intervention program. Throughout the past year, the Central Banks of Canada, Brazil, Thailand, Korea have threatened to intervene, but only Brazil has taken action so far, in the form of a levy on all foreign capital inflows. Last week, the Bank of Japan broke its 6-year period of inaction by intervening on behalf of the Yen, which instantly rose 3% on the move. The BOJ has pledge to remain involved, but the extent and duration is not clear.

Finally, the Bank of China allowed the Yuan to appreciate for the first time in two years, but its pace has been carefully controlled, to say the least. In the last few weeks, the Yuan has actually picked up speed, but critics insist that it remains undervalued. In addition, China has contradicted the Yuan’s rise against the Dollar through its purchases of Japanese bonds, which has spurred a rise in the Yen. This is both ironic and counter-productive to global economic recovery: “Since China is growing at 10%, it can afford to undermine exports and boost domestic demand by letting the yuan appreciate more rapidly against the dollar. But China doesn’t want to do that. In fact, although China’s State Administration of Foreign Exchange deregulated the currency market overnight, the measures, which allow some exporters to retain their foreign currency holdings for a year, should boost private demand for dollars, not yuan.”

The efforts listed above have undoubtedly moderated the impacts of the financial crisis and consequent economic downturn. However, the banks have found it impossible to engineer a convincing recovery, and at this point, there probably isn’t much more that they do can do. As a result, many analysts are now pinning their hopes on fiscal policy (despite its equally dubious track record). Perhaps, the title of this post should have been: Keep an Eye on Governments and their Stimulus Plans.

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Volatility, Carry, Risk, and the Forex Markets

Upon reviewing my previous post on the Brazilian Real (BRL), I now realize that it lacked context. In other words, while both the interest rate outlook and economic prospects of Brazil are both incredibly bright, who’s to say that this hasn’t already been priced into the Real? At the very least, more information is needed to determine whether the Real is valued fairly on an historical and/or relative basis. [Alas, the focus of this post isn’t on the Real specifically, but on the forex markets in general. Still, the concepts that will form the backbone of this post – volatility, risk, and carry – can be seen clearly through the prism of the Real.]

This doubt was sparked by an article that I read recently, entitled “Markets ‘Not Pricing’ Potential Risks,” which explored the idea that the renewed appetite for risk and consequent run-up in asset prices and re-allocation of capital is naively optimistic: ” ‘The unique environment we’re in now revolves around unprecedented level of government involvement in markets, which creates this complacency over risk because of this belief that governments will fix everything.’ Markets are under-pricing the risk that nations such as Dubai and Greece may default, and excess borrowing by others could lead to inflation.” From a financial standpoint, the practical implications of this idea is that the markets are underpricing risk.


In forex markets, complacency towards risk has manifested itself in the form of decreasing volatility. When you look at the 435 most commonly-traded currency pairs (actually most currency pairs involving the 35 most popular currencies), volatility is increasing for only nine of them. In addition, one month-volatility is now below 15% for all (widely-traded) currency pairs, which means that based on the most recent data, the highest, annualized standard deviation percentage change for every currency pair is only 15%. [It’s difficult to translate that concept into plain-English, but the basic idea is that all currencies are (actually, only 68% of the time) currently fluctuating by less than 15% from the mean on an annualized basis. The idea of standard deviation is murky for non-mathematicians, so it’s probably more useful to look at it on a relative and historical basis, rather than in absolute terms. In other words, the 15% figure can not be explained very well in an of itself; one must see how it compares to other currency pairs and to other time periods].

The fact that volatility is currently low suggests that the carry trade, for example, is set to become increasingly viable, especially when you factor in upcoming interest rate hikes. On the other hand, real interest rate differentials are currently modest (from a historical standpoint), and the concern is that rate hikes could be accompanied by rising volatility. The Brazilian Real, for example, “has a risk-adjusted carry of 45 percent, based on Morgan Stanley estimates, which means its carry rates had been better than current levels 55 percent of the time the last five years.” When you look at conditions from a few years ago, when volatility was at record low levels and interest rate differentials were larger than historically average, it’s obvious that the hey-day for the carry trade was in the past. It may come again in the future, but it certainly isn’t now.

From a practical standpoint, if you’re thinking about getting involved in the carry trade, you’ll want to choose a currency pair where the real (after adjusting for inflation) interest rate differential is high and volatility is low. You can cross-reference interest differentials with these charts – which uses recent mean return and volatility as the basis for forecasting confidence intervals – to get an idea about which pairs offer the best value (i.e. higher rate differentials at lower volatility). Just be aware that a sudden upswing in volatility could put a big dent in your risk-adjusted returns.

tock, currency and bond investors are underestimating the risk that government efforts to stabilize markets may fail,

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Chinese RMB Set to Appreciate in 2010

The Chinese Yuan (RMB) spent all of 2009 pegged to the Dollar at 6.83. Since the Dollar depreciated against almost every other currency during that time period, the Yuan has fallen against these currencies, undoing most of its appreciation in 2008. As a result of both international pressure and internal economic conditions, however, the Yuan’s stasis should come to an end soon. The only questions are when, how and to what extent.

Chinese Yuan (RMB) 2000-2010
In hindsight, the Central Bank (i.e. state economic planners) of China were probably justified in holding the Yuan in 2008. At a time when forex markets (and other capital markets, for that matter) were behaving erratically, the Yuan was a baston of stability. China’s premier, Wen Jiabao, recently boasted, “Keeping the yuan’s value basically steady is our contribution to the international community at a time when the world’s major currencies have been devalued.” In fact, there is evidence that the Central Bank went against market forces in the opposite direction during the height of the credit crisis, and successfully prevented the Yuan from depreciating, thus proving that a currency peg can work both ways. The result was price stability, and a boost to exporters that had been damaged by the falloff in foreign demand for Chinese goods.

With the global economy emerging from recession, the argument for maintaining the peg is becoming less tenable. China’s economy, itself, grew at an impressive 8.5% in 2009, and is forecast to grow even faster in 2010, by 9.5%. Thanks to a surge in bank lending and the government’s massive economic stimulus program, inflation is also ticking up. It has been approximated at 2.5%, but is contradicted by spikes of 50%+ in the prices of certain staple goods, and certainly doesn’t take into account the rise in asset prices. China’s benchmark stock market index surged 90% in 2009, and property prices increased by 30% in some areas.

The dual concerns, of course, are that the money supply is expanding too fast and that bubbles are forming in certain asset markets. The weak RMB is certainly not helping either. Thanks to relaxed capital market controls and expectations of further appreciation, speculative “hot money” is once again pouring into China. Holding down the Yuan in the face of such pressure is becoming prohibitivel expensive: “China’s foreign-exchange reserves climbed 17 percent in the first nine months of 2009 to $2.27 trillion, the world’s largest holdings.” Some of the demand is naturally being tempered by bubble concerns, but the trend is still money coming into China.

There is also the argument, much mooted in economics circles, that an appreciation of the RMB would be good for the Chinese economy. Because of a perennially weak currency, its economy has become to addicted to exports to drive growth. “As a report from research firm Euromonitor International notes, in U.S. dollar terms, China’s consumer market lags those of the U.S., Japan and much of Europe, with private consumption just over one third of GDP in 2008.” This is probably a product of social and cultural forces, which still emphasize saving. Skeptics of the usefulnes of RMB appreciation point out that rebalancing the Chinese economy would start with changing the culture of saving, but a stronger currency would certainly provide a powerful incentive. Not to mention that a more valuable RMB would give Chinese companies more leverage in consummating outbound corporate M&A deals and natural resource acquisitions that they have been so keen on in recent years.

China's Outbound  M&A 2000-2009
On the other side of the debate are skeptics of a different sort- those that think RMB appreciation is justified by forward-looking macroeconomic fundamentals. Some fear hyperinflation of the sort that China faced in 2007 and was only brought under control by the global economic recession and concomitant decline in resource prices. “Franklin Allen, a professor of finance at Wharton [University of Pennsylvania], estimates the likelihood of inflation reaching between 10% and 20% to be around one in five.” Any inflation beyond what is experienced in other economies would have to be reflected in the RMB. In a hyperinflation scenario, the Central Bank might even have to deliberately depreciate the currency.

Then there are the skeptics that forecast an economic crash in China. James Chanos, a wealthy hedge fund manager is leading this chorus, “warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse.’ ”

While this view is gaining some traction, it is still relegated to the minority. Investors and economists are now operating under the firm assumption that China will allow the RMB to resume its appreciation soon. As for when, it could be any day, though probably not for a few months still. As for the questions of how and to what extent, some economists have argued for a one-off appreciation (10% has been suggested) in order to discourage future inflows of speculative capital. Most analysts, though, expect the rise to be gradual. Futures prices currently reflect a 3% rise over the next year, and the consensus among economists is similar. It also depends on how the Dollar performs over the near-term: “If better-than-expected growth in the U.S. helps the greenback recover this year…That would take some of the pressure off Chinese policy makers.”

Personally, I think expectations of a 3-4% rise over the next twelve months are pretty reasonable. The Chinese government doesn’t have much to gain (neither politically nor economically) from a rapid appreciation in the currency, so if/when the RMB rises, it will probably only be in “baby steps.”

RMB USD 2009 Futures

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Central Banks of the World: Unite!

Karl Marx would be pleased…well, maybe not. In any event, the world’s Central Banks are tired of the weak Dollar, and are separately taking matters into their own hands. [Before I continue, I should probably acknowledge the inherent dangers of lumping every Central Bank together under one umbrella. Still, given the current market environment, and the fact that all Central Banks are acting uni-directionally, it seems like a fair categorization].

As I was saying, Central Banks – especially in the developing world – are extremely unhappy with the Dollar’s continued decline, and with the opposing strength in their respective currencies. Over the last year, these Central Banks have waded into the forex markets, one after another, in a non-concerted effort to stem the gains in their currencies. As the Dollar’s decline has gained new momentum, so have they redoubled and intensified their efforts.

In the last couple weeks alone, at least a dozen (and these are only the ones on my radar screen) have issued threats and/or taken action aimed directly at the “speculators,” which are blamed for the across-the-board rise in emerging market currencies and asset prices. Their concerns are twofold: that currency appreciation could choke off economic recovery, and that speculative investment is driving the creation of new asset price bubbles.

While their goals are largely the same, their tactics differ. Some are testing the old approach of simply buying Dollars on the spot market. Thailand, Israel, South Korea, Philipines, and Russia, for example, are now intervening heavily on a regular basis. “Experts estimate that some of the largest emerging economies may have spent as much as $150 billion on currency intervention over the past two months, judging from the growth of their international reserves, according to data from Brown Brothers Harriman.”

Central Bank Forex Intervention

Other Central Banks have resorted to policy-making measures; Taiwan and Brazil are perhaps the best examples here. The former has essentially banned foreigners from opening new time deposits in the country, while the latter has just imposed a 1.5% tax on investment in Brazilian ADR shares to match the 2% tax on new FDI. In addition, sources claim that other measures are being considered, including “an overseas sovereign bonds issue denominated in Brazilian reals and a change in rules that would allow foreign equities investors to deposit guarantees overseas.”

South Korea and Sri Lanka have been even more creative in restraining their currencies. Sri Lanka is now making it easier for its citizens to take money out of the country, while South Korea is now placing limits on the hedging activities of exporters, who “have sold large amounts of dollars in the forward market to hedge foreign orders, putting upward pressure on the won.”

Still other Banks are still in the “rhetorical” stage of intervention, whereby they simply convey to investors that they are monitoring forex markets for “instability” and “irregularities.” Such code-words are designed to signal that rapid currency appreciation will not be accepted idly. “People see the central bank looking closely at the dollar and think maybe it’s a good time to unwind some of their positions,” explained one analyst in response to “rhetorical intervention” by the Bank of Chile.

Unfortunately for these Central Banks, their efforts are ultimately unlikely to be successful. They can probably succeed in slowing, or even temporarily halting the rise in their respective currencies, but won’t be able to achieve a permanent cessation. That’s because the forces they are fighting against are simply too large ($3 Trillion per day of forex turnover) and too determined (Russian and Brazilian interest rates are both above 8%, compared to 0% in the US) to be stopped. “It’s [intervention] not working, and it’s a good thing that it’s not working. Emerging-market currencies are appreciating and they’re going to keep on appreciating against currencies from the old world. [Central Banks] has to adapt to that,” declared one trader. Still, you can’t blame them for trying.

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Emerging Markets Bubble Continues to Inflate, but for How Long?

Yesterday, emerging markets (proxied by the MSCI Emerging Markets Index) recorded their biggest fall since July, ending a week of solid gains. Still, this one-day slide of 1.4% pales in comparison to the nearly 100% gain that the index has achieved since bottoming last March. In other words, while investors might be starting to pull back, the direction of asset prices is still upward.

Emerging Market Stocks

As for what’s causing this across-the-board appreciation, that was the subject of my previous post (Inverse Correlation between Dollar and Everything Else…Still), in which I merely stated the obvious; that the Fed’s year-long program of negative real interest rates and quantitative easing (i.e. wholesale money printing) has unleashed a flood of cash into global capital markets. Since we’re not just talking about the Dollar, here, it makes sense to point out that the Fed’s easy money policies have been copied by Central Banks in most other industrialized countries, including the UK, Canada, Switzerland, Sweden, and to a lesser extent, the EU.

As for why emerging market assets and currencies seem to be outpacing appreciation in other asset classes, that’s also not difficult to explain. First of all, by some measures, emerging market stocks have hardly outperformed other assets. Oil, for example, has risen by 131% in less than a year, to say nothing of other commodities. Still, by other measures, growth has been remarkable. Most emerging market stock indexes and currencies have fully erased (or come close to erasing) the losses recorded during the peak of the credit crisis. Bonds, meanwhile, have gone one step further. Yields are collapsing, and prices have exploded – by 25% in the last year, sending the JP Morgan Emerging Market Bond Index to a new record.

Emerging Market Currencies

Is it safe to call this a bubble? Intuition would suggest so; given that all assets are rising across the board, without regard to particular fundamentals, it would seem that only a herd/bubble mentality could offer an explanation. Some analysts, in fact, have given up completely on fundamental analysis, instead using fund inflows (i.e. investor demand) to predict whether some emerging market assets will continue rising. As Nouriel Roubini (the NYU economist that famously predicted the credit crisis) summarizes: “Traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade.” P/E ratios are nearly twice as high in some emerging markets, compared to stocks in the S&P 500.

On the other side of the equation are the bulls and the efficient market theorists.”By historical price-to-earnings ratios — the ratio of stock prices to per-share profits — these levels can be justified, if the economic recovery continues. With massive layoffs, business costs have been cut sharply. “The hope is that when consumers and companies start spending, the added sales will drop quickly to the bottom line [profits].” Other proponents argue that the rise in asset prices is exactly what the Fed wants, since it implies that the markets are once again characterized by stability and liquidity.

Regardless of whether growth materializes, however, that doesn’t change the fact that the free ride can’t and won’t last forever. At some point, Central Banks will be forced to raise interest rates and start withdrawing Trillions of Dollars from global capital market. This will cause the Dollar to rise, and investors to rapidly unwind their carry trade positions. Warns Roubini, “A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.”

If the tech-bubble and real-estate bubble taught us anything, it is that there is no free lunch in the markets. It is not possible for all investors in all assets classes to simultaneously win. At least, in the long-term. In the short-term, meanwhile – it pains me to say this – let the party continue. My only warning is this: when the music stops, don’t be the one caught with your pants down…

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Euro, Franc Eyed as SNB Announces Currency Policy

The Swiss Franc may see volatility late into the European session as the Swiss National Bank makes their quarterly monetary policy announcement, including an update on their policy of intervention into the currency market to prevent the appreciation of the currency. As with most major central banks, there is little doubt that the SNB will leave benchmark interest rates unchanged. Rather, traders will focus on any updates to policymakers’ commitment to keep a lid on the value of the Swiss Franc with direct intervention into the currency markets. Consumer prices printed a bit better in August, rebounding from the low set in July, and a similar moderation in Producer Prices earlier this week foreshadows slightly better results for the headline inflation gauge in the months ahead. Still, it is surely much too early to say that the specter of deflation has dissipated, so the SNB is unlikely to do a complete about-face on exchange rate policy. To that effect, the markets will look for a more nuanced hint at the bank’s bias going forward, such as an upward revision of inflation expectations. The 1.50 level in EURCHF seems to have been the threshold of the SNB’s comfort zone, and traders would be wise to watch the behavior of the cross vis-à-vis this juncture ahead of the policy announcement.

UK Retail Sales are expected to rise 2.7% in the year to August, snapping two months of consecutive gains in the annual growth rate. The metric has seen atypical volatility over recent months as rising unemployment grappled with rebounding asset prices and government stimulus for dominance over consumer sentiment. Looking ahead, we see the downside scenario as more plausible. Fiscal support is inherently limited with the UK budget deficit already set to average close to 13% of GDP though 2010, threatening the country’s sovereign credit rating. Meanwhile, global equities are looking increasingly overdone having finished August at the highest level relative to earnings since May 2003. The upward trend in unemployment looks far more permanent, however, with a survey of economists polled by Bloomberg expecting the jobless rate to top 9% by the end of next year. This will trim incomes and discourage spending, weighing on retail activity in the months ahead.

The Euro Zone Trade Balance surplus is set to expand to 6.4 billion euro in July, the most in over two years. Exports figures may prove disappointing, however: industrial production fell more than economists expected in the same period while the currency has been pushing higher in trade-weighted terms since late April, now up over 5.6%, making European-made goods comparatively more expensive and thereby less attractive to foreign buyers. A drop in imports seems like a much more plausible driver for an improvement in the headline figure, especially considering the sharp decline in Swiss industrial output reported earlier this week. As we have previously noted, manufactured goods top the list of Swiss export commodities, so the drop in production is indicative of lackluster demand in key overseas markets, where the top three Euro Zone economies alone account for close to 50% of demand.

Asia Session Highlights

Japan’s Tertiary Industry Index grew slightly more than economists expected, adding 0.6% in July to show that demand for services has rebounded to the highest level since February. The result likely owes to continued support from the government’s record-setting 25 trillion yen stimulus package. Indeed, government spending accounted for the bulk of economic growth in the second quarter. The question now facing Japan as well as most other developed countries is what happens when the flow of public funds invariably dries up. On balance, unemployment continues to push higher, trimming incomes and hinting at turn lower in spending (including that on services) in the months ahead.

New Zealand’s Business NZ Performance of Manufacturing Index fell to 48.7 in August from 49.6 in the previous month, showing the pace of contraction in the industrial sector quickened for the first time since May. The sub-index measuring New Orders led the metric lower, dropping by -5.1 points to register the largest decline in 9 months, while output shrank the most since February. The report follows news that manufacturing sales dropped the most on record in the second quarter, adding yet more weight to last week’s comments from Reserve Bank of New Zealand Governor Alan Bollard, who said the stronger New Zealand Dollar puts business profits “under pressure” and warned that “If the exchange rate were to continue its recent appreciation…the sustainability of the present recovery will be brought into question.”

The Bank of Japan unanimously agreed to keep interest rates unchanged at 0.10%, as expected, but policymakers raised their forecasts for economic growth as economic conditions begin to “show signs of recovery”, calling for growth to begin to rebound in the second half of the 2009 fiscal year (the 12 months ending April 2010). The bank still sees downside risks to the economy, however, saying fiancial conditions continue to be “severe” while consumption remains weak and capital spending is still falling. Policymakers made no changes to their asset-buying and lending programs. On balance, BOJ Governor Maasaki Shirakawa concluded that “risks to the economy are still on the downside [with the outlook] attended by a significant level of uncertainty.”

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Posted in Forex Trading NewsComments Off on Euro, Franc Eyed as SNB Announces Currency Policy