Euro buoyed by economic data

It turns out the dog days of summer have set it. Capital markets are trading sideways, amid a veritable absence of new developments. It is on this climate that the release of European portfolio data is sufficient to light a spark in currency markets. According to reports, foreigners poured $140 Billion into European capital markets, in June by myself. Many traders are confident that these portfolio inflows and the contemporary strong performance of European equities will provide a floor for the Euro currency. Others are counting on Asian Central Banks to prop up the Euro, by continuing to diversify their vast foreign currency echange holdings.

With the eurozone equity market continuing to accomplish strongly and suggestions that July’s Chinese revaluation might precipitate further reserve diversification into the euro, “global capital flows will have to be supportive of the euro through the second one half of 2005.”

Read More: Euro rallies as portfolio flows jump

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‘RedTower’ deemed most accurate currency forecaster

According to Bloomberg news, RedTower, a small Scottish money manager, used to be probably the most accurate currency forecaster last year. In a survey conducted among institutional forex traders, RedTower appropriately predicted the Euro would fall to $1.22, even as probably the most other analysts forecasted a prolonged period of appreciation. RedTower claims its prediction used to be in large part in keeping with international disparities in the cost of beer, proving that inspiration can come from probably the most unexpected places. In the similar survey, on the other hand, RedTower managers forecasted the cost of oil would not reach $45 by year-end. So much for clairvoyance… Bloomberg news reports:

It used to be the first time Redtower topped the ranking for currency forecasts, consistent with Bloomberg data. Bank of Tokyo Mitsubishi, HBOS Plc and Credit Suisse First Boston came second, third and fourth, respectively.

Read More: Winning Dollar Forecaster Gains Insights Drinking Dutch Beer

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Renewed Faith in Euro

Forex markets are arguably the least predictable of all capital markets. Traders and investors should reconcile technical analysis with economic indicators with fundamental considerations, which steadily paint vastly different pictures. This week, it sort of feels forex traders have had a collective change of heart, abandoning the USD and embracing the Euro. Traders bullish at the Euro argue host of economic indicators and political developments reveal the EU economy is bettering as politicians prepare to enact much-need structural reforms. Additionally, money managers at the moment are touting the Euro as a ‘defensive play,’ due in part to rising natural resource price. The Financial Times reports:

Mounting international confidence within the prospects for the eurozone used to be neatly encapsulated by portfolio flows data released in advance within the week, which showed the eurozone attracted net inflows into its equity and bond markets.

Read More: Increasing optimism buoys euro

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CPI validates Bernanke

Last week, Ben Bernanke, Chairman of America’s Federal Reserve Bank, announced that rates would be left unchanged because of slowing economic growth. USD bulls cringed on the possibility that the Fed used to be done finished climbing rates. Unfortunately for them, Mr. Bernanke’s assessment used to be born out by CPI data, released lately, which revealed growth in prices is indeed slowing. In fact, the per thirty days change in inflation used to be only .2%, the smallest increase in almost half a year. Yields on US debt instruments, including Treasury securities, fell around the board- bad news for traders who’re hoping foreigners will continue to finance the United States trade deficit. Bloomberg News reports:

The Fed is now done raising rates and shall be cutting them next year, said Andrew Balls, a global strategist at Pacific Investment Management Co.

Read More: U.S. Economy: Slowing Inflation Validates Bernanke

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Japan’s Fujii Still Confused about Intervention

My last update on the Japanese Yen was published on October 16 (“Japan Flip-Flops on Forex Intervention). As the title suggests, I sought to overview the many instances of equivocation committed by newly-appointed Finance Minister Hirohisa Fujii in the name of Japan’s forex policy. I concluded that at that time, it was probably still premature to talk about forex intervention, but that if “the Yen continues to appreciate, then Fujii may have imagine how fixed his [non-intervention] principles in point of fact are.”

Since then, two things have happened. [Well really only one thing, since the second is more of a “non-happening.”] Anyway, the first is that the Yen broke through the important technical/psychological level of 85 Yen/Dollar for the first time in 14 years. The second is that Mr. Fujii is still no closer to articulating a coherent approach to managing the Yen. Last week, alone, he referred to movements in the Japanese Yen as “extreme” and suggested that now was the time to remain vigilant and that “appropriate measures” are “imaginable.” A few days later, alternatively, he called intervention “unthinkable.”

Yen

Given this nearly uninterrupted record of waffling, one might think to accuse Mr. Fujii of deliberately trying to confuse the markets. After all, how else can one give an explanation for the hourly changes in his forex policy. It’s ironic that Fujii himself has told reporters that, “It’s wrong to fuss over the currency market’s daily movement,” considering that his feelings on intervention seem to fluctuate in accordance with the Yen.

Thankfully, we may not have to deal with this carnival of uncertainty for much longer, as the Bank recently told reporters that “The government, not the BOJ, decides whether to intervene in currency markets.” At the same time, intervention would ultimately be carried out only under the auspices of the BOJ, which would presumably have the authority to determine a targeted valuation.
As for the million-Dollar question of whether intervention is more likely now that the Japanese Yen is closing in on a post-war record, it’s a bit more nebulous than it was in October. It seems that the political will now exists to intervene. The main obstacles are Fujii, himself, who had earlier pledged to administer a free-market approach to managing the Yen, and the international community.

Given that Japan still runs a trade surplus, it would be difficult to justify forex intervention. In addition, the Democratic Party of Japan (DPJ) made election promises to wean the Japanese economy off of its dependency on exports to drive growth and instead to cultivate a domestic consumer base. This promise was it seems that reiterated to US President Obama throughout his visit to Japan earlier this month, and would be greatly embarassing if Japanese economic officials reneged so soon thereafter.

At the same time, politicians (of any nationality) aren’t exactly known for their integrity and their consistency, so it wouldn’t be surprising if they made up our minds that in the context of the Yen’s continued strength that they made up our minds to take action. “The sense of caution over the possibility of intervention is definitely higher now after the breach of Y85.00. We are all watching for any more comments from the authorities.” Given the political implications, alternatively, it sort of feels the more likely course of action would involve a tweaking of monetary policy – quantitative easing, under the guise of deflation fighting – rather than outright intervention. Such would be less awkward than intervention, and probably more successful.

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Euro falters amid German political concerns

German elections are scheduled for this weekend, and currency traders are starting to price their predictions into the forex markets. The consensus implications for the Euro are as follows: a Gerhard Schroeder victory will likely send the Euro reeling, at the same time as an Angela Merkel victory will likely prop of the currency. Schroeder is the incumbent German Chancellor, and Merkel is the challenger. Investors usually feel a Merkel victory will benefit the German economy, for she has promised to put into effect certain structural reforms intended to restore Germany’s in poor health economy. Regardless of who wins, you’ll be able to expect significant Euro volatility within the days following the election. The Wall Street Journal reports:

“Germany faces the risk of a political deadlock after the elections . . . this doesn’t bode well for further reforms in Germany and due to this fact could weigh at the euro,” said a senior currency strategist.

Read More: Euro Falls on Views on Election

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Loonie in Trouble

In a up to date article published in the Toronto Star, a Canadian columnist outlined five reasons why the Canadian economy is in trouble.  Only a couple factors are unique to Canada, and several will also be subsumed under the credit crunch, but the pessimists are sounding broad alarm bells. First at the list is the looming drop in prices for commodities, the cornerstone of Canada’s economy. Oil recently sank below $100/barrel, and gold dropped 5% in at some point! In addition, China is threatening to curb demand with the intention to rein in inflation. 

The second and third causes for concern are a decline in bank credit and lack of confidence, respectively. Neither of these factors are endemic to Canada, as banks all over the world have unexpectedly developed an aversion to risk and have tightened lending accordingly. Next, corporate expansion (namely of American companies) is stalling; Home Depot and Proctor & Gamble have already announced a temporary hold on opening new stores in Canada.  The final factor(s) are American consumers, which collectively spend $9 Trillion per year.  The up to date tightening of wallets could spell massive trouble for Canada, since some of its provincial economies are primarily driven by cross-border sales to Americans.

In short, the Canadian economy could in reality contract in 2008.  But most likely the resulting decline in Canada’s currency, the loonie, would make Canadian exports comparatively more attractive and return the economy to firm footing in 2009.

Read More: 5 reasons to start worrying

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Inflation concerns buoys USD

The previous few months have witnessed a spate of bad news surrounding the USD. First, quarterly GDP data indicated the USA might have already got entered a period of recession, due in part to a slowing housing market. Then, the Federal Reserve Bank announced that it was once halting its interest rate hikes, after raising rates 17 consecutive times. Today, monthly inflation data revealed prices are growing faster than most economists had predicted, at an annualized rate of 5.5%. The sudden jump in inflation is being attributed to you guessed it- soaring energy costs. While economists would argue inflation is bad for the USD because it erodes the currency’s real value, many traders reacted positively to the news because they consider it will drive the Fed to hike rates further. AFX News reports:

“The Fed has been focused at the consumers’ perceptions of inflation of late and this may occasionally set off some alarm bells some of the FOMC hawks.”

Read More: Dollar edges up along side US inflation expectations

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Making Sense of the Yen: Forex Intervention, Debt and Deflation

Last week, Hirohisa Fujii resigned as finance minister of Japan. Since Fujii was an outspoken commentator on the Japanese Yen, the move sent a jolt through forex markets. Those who were expecting that his replacement, Deputy Prime Minister Naoto Kan, would be be more consistent than his predecessor were quickly disappointed, as Mr. Kan managed to contradict himself repeatedly within days of assuming his new post.

On January 6, he said it would be “nice” to see the Yen weaken, going so far as to designate 95 Yen/Dollar as the level he had in mind. One day later, he said that the markets should if truth be told resolve the Yen: “If currency levels deviate sharply from the estimates, that could have more than a few effects on the economy.” After he was rebuked by Prime Minister Yukio Hatoyama, who noted that the government should not talk to reporters about forex, he went on tell US Treasury Secretary that forex levels should be stable. In short, Japan’s official governmental position on the Yen still remains muddled, and it’s no less clear whether it’s going to – or even should – intervene.

Japanese yen
Fortunately, they may not have to. Not only because the Yen still remains more than 5% off of the record highs of November, but also because economic and financial forces are coalescing that could send the Yen downward. Despite a recovery in exports, the Japanese economy remains beleaguered, having most recently contracted to the lowest level since 1991, as part of a “tumble [that] is unprecedented some of the biggest economies.” Now that we are into 2010, it can be said officially that Japan has now suffered from the “second lost decade in a row.”

When economic growth collapsed in 1990, Japanese consumers became famously frugal, and the domestic market still hasn’t recovered. Neither has the stock market, for that matter: “The Nikkei is 44.3% below where it stood at the end of 1999. It is 72.9% below its peak near the end of 1989.” The performance of the bond market, meanwhile, has been a mirror image, rallying 78% since 1990.

Japan Nikkei stock market and bond market 1989 - 2009

The resulting decline in real interest rates has combined with economic stagnation to produce a perennial state of deflation. In fact, prices are once again falling, this time by an annualized pace of 2%.

Deflation in Japan 2009
As many economists have been quick to diagnose, the problem lies in a tremendous (perhaps the world’s largest) imbalance between savings and investment, as “Japan still has ¥1,500 trillion ($16.3 trillion) of savings.” It’s not clear how long this can last, alternatively, as Japanese demographic changes tax the nation’s pool of savings. “More than a fifth of Japanese are over 65…The nation’s population began shrinking in 2006 from 127.8 million, and will drop by 3.2 percent in the coming decade.”

This brings me to the final component of Japan’s perfect economic storm: debt. Japan’s gross national debt is projected by the IMF to touch 225% of GDP this year, and 250% as early as 2014. As a result of the aging population, the pool of cash available for lending to the government is shrinking at the same rate as the tax base, which is exerting fiscal pressure on the government from both sides. According to one commentator, “Japan’s fiscal conditions are close to a melting point.” Another frets: “I doubt there is any yield that international capital markets can find acceptable that will not bankrupt the Japanese state.”

US and Japan budget deficit 2002 - 2009
What is the government doing about all of this? Frankly, not too much. It is spending money like crazy – exacerbating its fiscal state and pushing it closer to insolvency – in a (vain) attempt to prime the economic pump and avoid deflation from further entrenching. The Central Bank, meanwhile, just announced a new round of quantitative easing, also aimed at fighting deflation. At only 2% of GDP, alternatively, the measures are “pretty tame” and unlikely to accomplish much. Considering that its monetary base has only expanded by 5% this year (compared to 71% in the US), it still has a variety of scope to operate. At the present time, alternatively, it is still reluctant to do so.

Ironically, the aging population phenomenon could end up restoring Japan’s economy to equilibrium. The worse Japan’s fiscal problems grow to be, the sooner it’s going to be forced to simply print money, so to deflate its debt and avoid default. This will stimulate the economy and put upward pressure on prices (solving two problems), and exert strong downward pressure on the Yen. The way I see it, that’s four birds with one stone!

As for the Yen, then, I would expect it to hover over the near-term, since price stability and a strong credit rating don’t signal immediate catastrophe. No, Japan’s economic problems are more long-term, which means it could be a whilst before they more clearly manifst themselves.

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British Pound may decline as growth flattens

For the previous couple of years, speculators searching for high interest rates have poured ‘hot money’ into Britain, causing the Pound to appreciate.  Now, it kind of feels the Pound could also be overvalued, rendering British exports uncompetitive.  A new spate of economic data indicates the British economy is slowing all of a sudden. In addition, a British housing bubble has begun to deflate, causing a subsequent decline in consumption. As Britain’s Central Bank prepares to lower interest rates, it kind of feels investment will follow the same downward path as consumption. It may take an important correction of Britain’s exchange rate to stem the decline of its economy. The Times Online reports:

With sterling’s valuation the point of interest of renewed attention, pressure at the pound will almost indubitably intensify as currency markets home in at the more and more apparent vulnerabilities of Britain’s economy.

Read More: Faltering growth knocks pound’s potency

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