Today’s FX View from IB:
The ECB was the last of the three major central banks to leave its short term benchmark rate unchanged today. On Wednesday the Fed reiterated the same message it conveyed in September by stating that policy would remain accommodative. With official short term yields steady investors focused on the posturing and variety of tones apparent within each statement. After today’s ECB press conference its president, Jean Claude Trichet tossed the challenge of a vulnerable dollar back into the court of the U.S. treasury when he stated that a strong dollar was in the interests of United States. Such sledgehammer diplomacy is unlikely to provoke the U.S. into intervention mode in what has been a rather orderly decline of the greenback.
At the same time Mr. Trichet effortlessly bolstered the appeal of the euro when he addressed the mopping up and drying out of the abundant liquidity measures applied to Eurozone financial institutions. In true inflation-hating central bank style he said, “The Governing Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion and that the liquidity provided is absorbed in order to counter effectively any threat to price stability over the medium to longer term.”
The euro popped its head up to $1.4919 as the hawkish banker created the impression that the next might be firmer monetary policy causing the yield difference to favor the euro. Still, the euro is weaker against the Japanese yen today at ¥134.64 after an Asian session saw modest equity price weakness. The impact was to lessen the appeal of the risk trade today.
The British pound is higher against both dollar and euro. While its benchmark remained unchanged, the Bank of England boosted its bond-buying spree by half of the amount predicted by analysts. The Bank announced that it would add a further £25 billion to the amount of previously purchased corporate and government bonds to stimulate lending. That will bring the grand total to £200 billion, and while it’s less than expected sterling bulls are quick to point to the fact that this lower amount is a sign that the economy needs less stimulus. In other words, the central bank is no longer trying to get the heavy ball in motion, it’s simply adding its bodyweight behind an object in motion.
The pound added to recent gains and rose to $1.6636 before a bout of mid-morning dollar strength reversed that direction and the pound now trades at $1.6552. The euro today buys 89.77 pennies. The Bank in announcing today’s policy changes tore a leaf from the Fed’s script when it said that current resource slack is likely to bear down on inflation for “some time to come.” The structure of U.S. and British forward curves is well out of line with this hint from the Bank of England, which implicitly states that official rates are not likely to move for some time to come.
The British recovery was further bolstered today by statistics released showing greater than anticipated growth in both manufacturing and industrial production today with the former showing the largest monthly gain in seven years with a 1.7% improvement. Both series beat expected data.
In recent days the Canadian dollar has found its footing after recent central bank inspired losses. Despite the threatening words from officials at the Bank of Canada underlying demand for minerals and raw materials is feeding a buying frenzy for the domestic dollar as the price of gold – which Canada has in abundance – goes through the roof. Today the Canadian dollar buys 93.88 U.S. cents.
The Aussie dollar can’t shake off its overnight hangover. The weaker Pacific and Asian session saw equity traders uninspired and the broad appetite for risk is today diminished. The Aussie has therefore fallen to 91.07 U.S. cents. The fact that the American equity markets are sharply higher is not seemingly harming the dollar at the same time.
Friday brings employment data and traders are braced for a rise in the rate of unemployment towards a double-digit rate from 9.8%. Whether this causes psychological changes at the consumer level remains to be seen, but with most analysts in agreement that the worst of the recession is over, the risk for the dollar appears to still be on the downside towards further weakness. A positive report or growth in hiring of temporary workers, which is a fortuitous sign for the labor market, could inspire a return of risk appetite elsewhere in the world. Given what the Fed says about the current rate of resource slack and therein the implications for inflation, it’s hard to see a positive report seriously boosting interest rate expectations that would favor the greenback.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.