Key News
* Fujii May ‘Take Action’ on Yen (Bloomberg)
* RBA likely to keep interest rates unchanged at 3pc (The Australian)
* G7 Fallout Leaves USD Southbound, Euro In Limbo (WSJ)
* Trichet, Lagarde Push China to Let Currency Gain Against Euro (Reuters)
The Event Agenda
Morning Run-Down
Though all G-7 members have individually expressed concern about currency strength (and relative weakness of the U.S. dollar), the communiqué did not reflect any changes in the group’s official position on currencies.
The communiqué did include note of the pledges by the G-20…
1) Coordinated exits,
2) Regulation,
3) And a framework for strong, sustainable, and balanced growth.
Its comments on exchange rates were identical to its April statement …
“Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate.”
And this statement on China remained identical to the April statement….
”We welcome China’s continued commitment to move to a more flexible exchange rate, which should lead to continued appreciation of the Renminbi in effective terms and help promote more balanced growth in China and in the world economy.”
The pledge to balance economies to achieve more sustainable growth is strongly directed toward China. After allowing its currency to appreciate about 6% annually for three years, China has returned to an effective peg to keep its currency weak in the crisis environment. A stronger currency in China would slow its exports, forcing the development of more domestic led growth. But the market doesn’t expect that to happen anytime soon (see the chart below).
Japan’s Finance Minister has done a 180 over the course of a few weeks. His initial position that a strong yen could be good for the Japanese economy has now flipped and aggressively in the opposite direction. Following the G-7 meeting, the Japanese FinMin has threatened to take action if the yen moves in a “biased direction.”
The Reserve Bank of Australia meets to set interest rates tonight. Though economists think there is a slim chance that the central bank will make its first move away from “emergency” monetary stimulus, the market has increasingly upped its bet that the RBA will act…pricing in a 58% chance of a ¼ point rate hike. That would make Australia the first major economy to begin a move higher in interest rates. The Aussie dollar has rallied this morning on that speculation. The Aussie dollar has already climbed 41% higher on expectations that Australia would be an early (if not the first) mover on rates. A November hike remains more likely.
The Bank of England and European Central Bank both meet later this week to set interest rates. Both central banks will leave rates unchanged, but the decisions on the unconventional measures will be the areas to watch. The ECB will likely continue to offer unlimited one-year loans to European banks (currently at 1%)…. a program that has already pumped over $1 trillion into financial institutions. And the BOE should be watched closely for consideration of cutting interest paid on bank deposits. The BOE’s tendency is toward more accommodation, which would be negative for the pound.
Key Charts
While the ISM Non Manufacturing Index returned to growth in Sept., the price index plunged…
China has effectively gone back to the peg since the beginning of the global financial crisis. The below chart shows the government manipulated exchange rate of USD/CNY (red line) versus the market’s expectations for the exchange rate in 12-months (blue line). You can see that the market has gone from pricing in sizable appreciation of the Yuan until early 2008 … to pricing in depreciation when the crisis was at the peak in late 2008. Now the market is pricing in virtually no change over the next twelve months (just 2% appreciation). That means, market participants don’t expect China to play ball with the G-20 rebalancing theme…
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