Sunday, January 10, 2010

FX Briefing : Dollar Starts the New Year on a Firm Footing

Highlights
  • FOMC agrees to bide its time; minutes show considerable dissent
  • ECB executive board member Stark is not expecting EU to help Greece
  • Japan's new finance minister in favour of weaker yen

Between Christmas and New Year, the US currency remained firm for the most part. The dollar was boosted primarily by hopes of the economic recovery continuing and the upbeat mood in equity markets. Although the Fed is trying hard not to alarm bond markets prematurely, market participants are bracing themselves for a tightening in US monetary policy. However, opinions on the timing and pace of tightening vary considerably, both within the Open Market Committee (as illustrated by the recently published minutes of the December meeting) and in the general public.

The minutes of the meeting of 21 December show that FOMC members' views differ substantially. Some are worried mainly about inflation risks as a result of monetary policy being too loose for too long; others fear renewed financial market disruption and a relapse into recession when the Fed withdraws its helping hand. At the moment, those in favour of maintaining monetary policy seem to have the upper hand. Remarkably, there is even a group in favour of increasing certain asset purchasing facilities. But time is on the side of the FOMC hawks: the longer the recovery continues, and in particular, the more the labour market stabilises, the stronger they will become.

In this environment, the dollar has managed to hold on to its gains made in the first half of December. In relatively thin trading over the last three weeks, EUR-USD traded sideways in a narrow range between 1.42 and 1.45, and is currently just over 1.43.

The European data painted a mixed picture. The sentiment indicators continued their upward trend. After the ifo institute's surprisingly strong figures in December, most purchasing manager indices and the EU Commission survey results posted increases. Germany's trade balance improved significantly, exports and industrial production rose. In the consumer sector, however, things are looking rather gloomy: retail sales in Germany and the eurozone and French consumer spending on manufactured goods fell, consumer sentiment in Germany and French consumer confidence dropped. Furthermore, industrial new orders in Germany have so far declined in Q4, particularly due to fewer orders from abroad.

The euro dipped briefly on comments made by ECB executive board member J├╝rgen Stark during an interview with an Italian newspaper. He had said that markets were deluding themselves if they thought that the EU would bail out Greece. The Greek finance minister hastened to assert that Greece did not need any outside help.

Next week, the ECB governing council is holding its first meeting of the year. At the beginning of December, the ECB had embarked on a gradual exit from unconventional measures, stating that, given the improved conditions in financial markets, not all liquidity measures were needed to the same extent as in the past. The expansionary monetary policy stance was still appropriate, however. At the moment, there is no indication that the ECB could change its position in January. We are expecting the assessment to remain basically unchanged.

News from Asia

At the beginning of the week, Japan's prime minister Yukio Hatoyama appointed Naoto Kan as successor to finance minister Hirohisa Fujii, who had resigned for health reasons. Following in the footsteps of his predecessor, the new finance minister started off by making a few strong remarks about the exchange rate, only to back pedal shortly afterwards. Mr Kan had initially said that it would be nice to see the yen weaken, and that he would work with the BoJ to bring the currency to an appropriate level. On these remarks, USD-JPY rose over 93. On Friday, however, Mr Kan was more cautious in his comments: currencies should be determined by markets; the government should only intervene in extreme circumstances. Prime minister Hatoyama and other government members also issued guarded statements.

Despite having toned down his comments later, the new finance minister has made his mark. Whereas his predecessor had tended more towards a strong yen, Mr Kan has shown clearly that he is against an appreciation of the yen and thus more in line with the demands of industry.

The Chinese central bank surprised markets at the beginning of the year by raising interest rates (albeit only slightly) for the first time. The People's Bank of China offered its 3-month treasury bill at a rate of 1.368, as opposed to 1.328 in the previous four months. The PBoC is striving to slow down credit growth, in order to curb inflation risks. An exchange rate policy shift is not on the agenda, however. On New Year's Day, Prime minister Wen Jiabao had announced that the government had no intention of giving in to foreign demands to appreciate the yuan. Now the central bank has stated that it will keep the yuan stable in 2010.

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