FX Comment: in the summer lull
When you read “markets rallied on hope for China stimulus” in one place and “markets rallied on data not as bad as feared” in another, you know that the markets may lack direction - just as the media.
Indeed, looking at the USD, world’s major currency, not much change happened over the past week – even though it was volatile, the USD index (DXY) finished where it started, and below the 83.55 mark (Figure 1).
Figure 1. USD index
Figure 2. EURUSD
As expected the EURUSD crash-like moves seen the week before wasn’t repeated and instead the EURUSD took smaller steps down, only to reverse some of the losses on Friday on the “risk on” mood. Looking at the drivers it is difficult to justify last week’s downward move, as euro-wide GDP-weighted CDS spread narrowed (12bps), EURUSD risk reversals, 2Y EUR-USD IRS spread and EURUSD basis remained broadly unchanged.
It feels like the markets are getting tired of the European crisis debate. So Germany’s Merkel has less chance to move the markets with such comments as on Sunday, where she again reiterated that any attempts toward shared liability without control will “have no chance with me or with Germany”. The lack of direction on the EURUSD can be justified by the relative monies – US Fed and ECB have been on hold” with balance sheet expansion for a while (Figure 3), hence going forward the key markets’ focus will be who will do more, ECB or Fed? Bernanke’s testimony on Tuesday and Wednesday hence is one of this week’s key watches. But, quite frankly, nothing has happened recently to justify the shift in the stance. Fed’s index of financial conditions is also far from the crisis teritory (Figure 4) The data must deteriorate much more before they hint on balance sheet expansion. Among such data are today’s retail sales, Empire state survey, tomorrow’s industrial production, Wednesday’s housing starts and Philadelphia Fed survey on Thursday.
Figure 3. Fed-to-ECB balance sheet
Figure 4. Financial Stress Index
Elsewehere the commodity currencies keep up well as the commodity prices keep trending up (Figure 6), with Brent oil back to triple digits, but also industrial metals such as copper still on the uptrend looking at daily data series. Why, oh why – look at China economic surprises for clues (Figure 5). With the bearish global macro view dominating, it requires a substantial worsening on the macro front to shift the markets into “risk off”, in my view. Before that comes, remain net long commodity and Emerging Markets FX (the latter best served against both EUR and USD in the short term – you know why).
Figure 5. China economic surprise index and AUDUSD
Figure 6. Commodity price index and commodity FX