*Recap*
•The G20 meetings disastrous to produce whatever thing particular
and deferred any market-moving developments until April
•In Germany, the CDU party's gray defeat in Hamburg over the
weekend has provoked a gentle fall back in risk-tolerance
•Three major themes are in play – Emerging Market inflation,
Middle-Eastern politics and lingering peripheral stress in Europe
•Market difficulty on BoE to act in the name of reputation was
resisted although three rate hikes are still priced in
*USD*
A honestly turbulent week with few trends holding up in G20 FX
crosses. News flow and sentiment has been very mixed across the
developed world whereas macro-data from EM countries has tended to
outperform expectations. Last week, several key data releases swayed
market opinion. Retail sales figures (0.3% vs. 0.6% exp.) were
disappointing whereas CPI beat expectations (0.4% vs. 0.3% exp.) which
set the mood for mixed and choppy USD trade.
Fed minutes from their late January meeting were made available
although nothing new was mentioned in the official text. An issue
which may come back as an active them was the news of fresh stress
tests intended to be imposed on US banks prior to additional liquidity
measures being withdrawn. The Fed is seemingly attempting to test
whether US banks can take the strain as capital is returned to
investors thus putting untimely difficulty on bank weigh sheets given
the ongoing recovery.
*EUR*
The sovereign debt crisis lingers on with a particular solution still
only on the horizon. European policy makers expect to present a firm
plot by the end of March 2011. In the meantime, indicators that shed
light on Europe's ability to stabilize its periphery are getting a
lot of attention.
Greek GDP figures (-6.6% y/y, from -5.7% y/y in the previous quarter)
indicated to market participants that the simplicity measures imposed
in Greece (and elsewhere) have drastically unnatural economic
prosperity. This is compared to a 4.52% decline in 2010. On quarterly
basis, Greece shrank 1.4% in Q4 2010. For the Euro, the 'Greek
effect' is minimal because Greece makes up only about 3% of total
European GDP whereas the 'contagion effect' has been very actively
weighing on EUR pairs.
Spain approved a law on bank capital requirements. The law gives
savings banks (Cajas) until September to clarify any plans regarding
additional capita and sets a smallest core cap requirement of 8% for
listed banks and 10% for savings banks. Regardless of what decisions
are made, weaker banks will continue to struggle and could potentially
require further help. Debt is simple to buy but very hard to eradicate
once there is too much of it. The probability of a Spanish institution
requiring central bank intervention at some stage in the next year is
high which is likely to act as a weight for the Euro.
By the end of the week the Euro was broadly higher in most pairs –
the largest gain was against USD (+1.20%) while the largest loss was
against CHF (-1.74%). The EUR/CHF pair was particularly volatile last
week as the SNB stepped in to artificially intervene in the value of
the Swissie. The primary reason was most doubtless excessive CHF
strength.
*GBP*
UK CPI figures were in line with expectations and prevented additional
speculation about an imminent interest rate rise. The headline rate
rose from 3.7% to 4.0%, but wasn't higher than consensus. The fact
that CPIY (CPI without tax effects) has now risen above the BoE's 2%
target is doubtless providing BoE members with a juicy topic of
conversation. Once food and energy effects are excluded, inflation is
much lower but crucial assumptions such as a strengthening GBP and an
abatement of commodity price increases seem quite hopeful.
Despite inflation being on the offensive and potentially rising
further in the UK, it should nevertheless slow to some degree before
the end of the year because of standard-term factors like wage growth,
money growth and spare capacity all having more than enough slack to
absorb the inflationary effects thus capping any potential rise in
inflation.
UK growth was revised lower and inflation was revised higher in the
Quarterly Inflation Report. This was a toxic combination for GBP pairs
although Sterling finished the week broadly higher across the board in
G20 FX – largest gains were against USD (+1.58%) and the largest
loss was against CHF (-1.37%).
Also, retail sales data (1.9% vs. 0.6% exp.) was stronger than
expected despite the downward revision to December's figures. Trying
to discern underlying trends from retail sales data at this time of
year is incredibly hard given the large amount of seasonal effects in
play.
*CHF*
The EUR/CHF pair was particularly volatile last week as the SNB
stepped in to artificially intervene in the value of the Swissie. The
primary reason was most doubtless excessive CHF strength.
*Others*
The Riksbank raised interest rates in line with expectations (+25bp)
as expected last week. The fifth increase in a row ensures inflation
stays within target as economic growth remains robust. The Riksbank
also raised its forecasts for future rates, adage "the repo rate
would need to be raised somewhat quicker in the coming period" to
contain inflation.
A key point for us is that the Riksbank is sticking to its earlier
assessments and its estimates are not far off the mark in terms of
accuracy. This adds to central bank credibility. Forecasts for 2012
and 2013 in terms of both policy rates and GDP performance have been
raised. The central bank said it expected inflationary pressures to
rise as wages increased at a quicker rate and spare capacity in the
economy declined.
Preview: 21st- 27th February 2011-02-22
*Looking ahead*
• Three major themes are in play – Emerging Market inflation,
Middle-Eastern politics and lingering peripheral stress in Europe
Middle East tensions escalated over the weekend with fresh political
unrest growing
• As earnings season winds down (80% of the S&P has reported),
markets focus on a gray data calendar and policy events in Europe
• Highest risk of adverse price moves and elevated volatility is
with the commodity currencies - CAD, AUD, NZD, ZAR, RUB, BRL in USD
and JPY pairs
• Next Wednesday's BoE minutes fully in focus for the voting split
which the street will closely analyse. Revision to shocking Q4 2010
GDP figure is expected.
• In the US, focus is on the housing sector as new and pending home
sales figures are due
• German six states CPI on Friday will also be key ahead of Euro
area flash CPI on March 1 and the next ECB meeting on March 3
• There are no significant Chinese data due during the week, but
Singapore and Malaysian CPI on Wednesday will shape the broader Asian
inflation outlook
Bank of England publishes minutes from its February 10 meeting. The
December 2010 vote was 1-7-1 (Posen, Sentence dissent), and the
January 2011 count 1-6-2 (Posen, Sentence and Weale dissent). This
week's inflation report left any outcome possible for the MPC, and
only the minutes can inform whether additional members have shifted in
favour of hikes.
Middle East tensions escalated over the weekend with fresh political
unrest growing - following on from Egypt, Libya, Bahrain, Yemen and
Iran are now firmly in the media spotlight as protests push for
political change in the region. Economic effects have been limited to
fearful risk-off plays for now without any severe price shocks. The
vital element is crude oil supplies which may be restricted given the
scale of the political unrest as well as the fact that oil is usually
used as a bargaining chip for most matters in the region.
On several occasions over the past few months EM inflation and capital
controls have threatened major currencies through two channels: risk
of a global slowdown due to higher interest rates, which in turn could
break down an unwind of dollar-funded involve trades; and slower
capital inflows or even capital outflows from emerging markets which
could reduce reserve accumulation and recycling into non-dollar
currencies, particularly the euro.
But they do underline the difference in view between the Fed and ECB
about how to handle commod price inflation. The ECB is just a lot more
hawkish. It takes years of inflation above 3% for the BoE to show
signs of worry, a couple of months above 2% and the ECB lays down the
law. This is likely to matter increasingly vacant forward and
illustrates one of the cornerstones of our positive EUR/USD view: Fed
policy will remain loose, the Europeans in general are much more
likely to act. It's not vacant to kick in immediately but this will be
a key theme for FX in 2011.
Foreign official buys of US assets have fallen dramatically since QE
was launched, to net sales of $9bn per month on the TIC data and to
buys of only $13bn per month on the modified Fed custody data.
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