Monday, July 13, 2009

FX Briefing : Yen and Dollar Rise on Growth Scepticism


  • Equity markets are nervous in the run-up to quarterly earnings reports
  • Industrial new orders and production in Germany pick up significantly in May
  • China keeps the debate on international currency system reform going

The release of US labour market data for the beginning of July triggered a change of mood in the markets. Market participants are beginning to wonder whether the "green shoots" of the last weeks and months will be able to survive in the harsh economic climate. One factor causing uncertainty in the equity markets is the imminent release of the quarterly earnings. Stock and commodity markets were for the most part under pressure this week. The markets remained sceptical, despite some favourable economic news, such as the improvement in the US ISM nonmanufacturing index, significant increases in industrial new orders and industrial production in Germany in May and an upwards revision of the IMF's growth projections.

The dollar and the yen in particular benefited from investors' rising risk aversion. USD-JPY slipped below 92 for a short time, which is a decline of over 4% compared to the end of last week. The appreciation was sufficient to prompt Japanese government representatives to announce that they were keeping a close watch on the development of the yen. Towards the weekend, USD-JPY recovered slightly to just under 93. Some of the "commodity currencies", including the Mexican peso, the rand, the real and also the Australian dollar, suffered the sharpest losses.

EUR-USD ended the week at around 1.39. The euro came under additional pressure on Friday due to an article in the Handelsblatt stating that at least 10 eastern European countries were currently in credit negotiations with the International Monetary Fund. These include Bosnia (whose request has already been granted), Serbia, Croatia, Macedonia, as well as Ukraine and Belarus, but also the EU countries Bulgaria, Romania, Latvia (again), and, possibly, Hungary.

This week's European economic data were a pleasant surprise. Manufacturing orders in Germany rose by 4.4% in May month-on month; the increase was broadly based; it covered all sectors, and more orders came both from Germany and from outside the eurozone. However, the recovery was strongest in the automobile sector, which is heavily subsidised in several countries. Industrial production rose by 3.7% in May, the manufacturing sector posted an even bigger increase.

The output drop in the second quarter was thus only around 1% quarter-on-quarter. Depending of course on how things developed in June, there is therefore a slight chance that real GDP might not have declined further in the second quarter. This notion is supported by the foreign trade figures, which suggest that net exports could have been slightly positive.

One should not get too euphoric, however: on the one hand, it should be borne in mind that the level was extremely low to start with. In fact, industrial production in May was still a good 18% lower than the previous year. Furthermore, the ifo index assessment of the business situation in June fell to its lowest level since reunification. A significant majority of companies polled saw the downward trend continuing. The improvement in net exports should also be treated with caution: it has come about primarily as a result of a large drop in real imports - which does not suggest an early economic recovery.

The participants in the G8, or G20 summit in the Italian city of L'Aquila tried for a time to skirt around the subject of currencies. The G8 and the "Big 5" emerging markets merely announced that they would refrain from competitive devaluation. However, it is hard to avoid the issue of the dollar's status as the major reserve currency: in his address to the participants of the summit, the Chinese Vice Minister Dai Bingguo, who was representing President Hu Jintao, explicitly demanded a "better system for reserve currency issuance and regulation". Surprisingly, President Nicolas Sarkozy was also in favour of a reform debate.

In actual fact, there is no real alternative for emerging markets with high currency reserves in the short to medium term. Monetary authorities can diversify their reserves to a greater extent, but are ultimately dependent on the big, liquid currencies. From a creditworthiness and liquidity point of view, it is difficult to include emerging market currencies.

The fact that China, the biggest advocate of reforms, has virtually pegged its currency to the dollar, makes the situation rather odd, however. The CNY is not even fully convertible, and thus not suitable for international use. It appears that China is using the discussion primarily as a lever for its claims for more influence in connection with the restructuring of the IMF. An institutional solution for an international currency system, which is no longer (predominantly) built around the dollar, is a very difficult and long-term project.


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