Wednesday, July 20, 2011

Pie in the Sky!

The tone in G-10 FX was decidedly risk-positive, with typical FX risk proxies extending gains made in London as US equities reacted positively to progress on the debt ceiling debate (see USD). Indeed, to a large degree, it was a “buy USA” session with USTs rallying and the USD stronger vs. EUR, GBP, CHF and JPY. The positive risk environment helped NZD hold on to its gains, though CAD was not far behind as the BoC provided some fodder for the hawks. EUR struggled to keep pace, with the IMF and Merkel ensuring the focus does not drift too far from European woes.

USD: With the House of Representatives voting on the Republicans ‘Cut, Cap and Balance Act’ Tuesday evening, President Obama spoke last night reaffirming his commitment to veto the bill should it unexpectedly pass the Senate. On a positive spin, Obama did state that ‘some narrowing of the issues’ took place in recent talks, and urges Congress to begin ‘talking turkey’ Wednesday. Obama calls the new bipartisan ‘Gang of Six’ plan good news, which plans to cut debt by as much as $3.7 trillion over the 10 years. Obama states that the Gang of Six plan includes a ‘shared’ sacrifice and represents a ‘very significant step’, but adds that tough negotiations remain. Stocks rallied on the back of Obama’s comments, with S&P futures trading new highs of 1324.25. Treasuries also reacted positively, seeing new highs of 125.03 in 10-year futures while the 10-year rallied 12 bps, while the USD strengthened, seeing the DXY Index recover from earlier lows of 74.90 to trade upwards to session highs of 75.33 with USD/CHF rallying 90 pips to 0.8279 and USD/JPY rallying 30 pips to 79.28. Housing starts and building permits continued the string of better than expected housing data, though this does little to change the picture of an utterly depressed U.S. housing sector. After placing the US on review for a possible downgrade last week, Moody’s continued this evening by placing the Aaa-rated states of New Mexico, South Carolina, Virginia, Tennessee and Maryland on ‘downgrade’ review.

EUR & Periphery: The IMF emphasized the importance of rapidly bringing the EFSF to capacity and increasing its flexibility to allow secondary market intervention in sovereign debt and to act as a backstop for undercapitalised banks. Prior to this, Merkel ‘hosed down’ hopes that Thursday’s Euro leaders summit would provide a single solution for Greece, warning that “further steps will be necessary”. Between Merkel, the IMF and the US deficit plan, EUR/USD has remained pressured with EUR unable to match the performance of CAD, AUD and NZD in the risk on environment. EUR/CAD, EUR/AUD and EUR/NZD are 100 pips or more from their highs, with EUR/USD back to $1.4150 from highs of $1.4213.

CAD & BoC: The Bank of Canada left rates at 1.00%, as was universally expected, with its base case kept largely intact. Changes to the Bank’s forecasts were limited to a 0.1% downward revision to 2011 growth, with the output gap closure still targeted for mid-2012. For full details, we await the release of the Monetary Policy Report tomorrow morning. The statement balanced the need for risk management in relation to the European fiscal situation and U.S. growth slowdown, with the acknowledgement of “firmer than anticipated” domestic inflation, most of which was cited as due to “temporary factors”. The “eventually” qualifier was dropped from the statement, to note “some of the considerable monetary policy stimulus currently in place will be withdrawn”. While this leaves the door open to a move in September, the bar for such action remains high in terms of the resolution of sovereign debt issues abroad and an improvement in U.S. data. Nonetheless, this was enough to elicit a backup in front end rates (2-year +7 bps) and a corresponding sell-off in USD/CAD through 0.9500 (from 0.9550) before returning to the 0.95 pivot. The current cyclical low in USD/CAD at 0.9447 is now in sight.
AUD/USD has been as high as 1.0742 overnight (spot ~1.0720-25), helped along by press reports suggesting a rate cut was off the cards. NZD continues to outperform, with NZD/USD hitting a new post-float high of 0.8573. AUD/NZD dipped briefly below 1.25 before some soft Fonterra results hit tapes (dairy prices down another 5.1% after dropping 6.7% at the previous auction), and the cross is back to 1.2530-40.

Published: 20 July, 2011
written by: Bill Hubard , Chief Economist at