IB FX View
It’s hard to believe that yesterday was the washout it was. The Dow finished with a six-handle for the first time in 12 years and the incessant bad news obeyed definition. On Tuesday, there is a strange air of optimism. Not only are U.S. stocks rebounding, but the Australian central bank’s refusal to add to seven months of policy reductions has thrown an altogether new question into the mix. Is this the bottom? The World Bank in a speech to Australians pronounced that the worst was behind us. The Aussie dollar grew wings in response to this morning’s inaction while the bulls will have to wait until tomorrow to see if the Australian economy was unique among developed nations in that it failed to contract at the end of 2008. Today the Aussie dollar buys 64.30 U.S. cents, up from yesterday’s 62.94.
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Perhaps it’s the local summer sun that attracts investors to the appeal of Australia just now. Data released coincidently showed a surprising jump in retail sales for the month – up 0.2% instead of the 0.5% contraction that economists predicted. The trade deficit also shrank. The government report showing GDP to be released overnight Wednesday will likely show a 0.2% growth versus the previous quarter, which shows an unusual resilience against the global downturn, despite the fact that Australia is an extremely open economy. Some 60% of what Australia sells overseas is commodity related and a fresh government report predicts a 17% drop through the first half of 2010.
So despite today’s boost for the Australian dollar, it’s very hard to look at the surrounding economies of its major trading partners and go with the view that its safe to emerge with a “blimey mate, it missed us!”
The fact that the RBA held rates at 3.25% today breathed life into other high yielding currencies and commodity currencies. For the last six months it’s become apparent that yield cushions are currency detractors and that the necessary journey to zero was the only way to go. But the fact that the RBA left some yield on the tree here, coupled with the notion that somehow Australia can weather the storm in isolation has provoked a desire to hold the Aussie dollar. The prospect of recovery and optimism rubbed off immediately on the Canadian dollar, the other commodity-rich currency. It roared on the notion that the Bank of Canada might also hold rates steady at 1%. But instead, the Governor sounded more dovish than ever as he slashed rates in half and drew bees to the honey pot by discussing quantitative easing.
The Canadian dollar fell to $1.2915 as investors looked despairingly at the price chart where the magnetic pull of $1.30 continues to lure investors over the edge. It can only be a matter of hours or days before the weight of sentiment surrounding the greenback pulls investors over the edge.
The notable point today is that yield differential came back to the fore between the Canadian and Australian dollars. Today it’s a valid currency driver and whether it’s just a passing phase remains to be seen. But today we can’t ignore it.
The same can be noted of the tug of war between the euro and the pound. For the longest time the ECB has stuck to its rigid dogma and failed to ease monetary policy, while the Bank of England has turned up red-faced and admitted quite how bad things are. The market has looked at this in two ways. First, by admission the U.K. is in a sorry state and so investors have sold the pound. The ECB’s steadfast refusal to adopt more aggressive monetary action has deflected currency investors from the reality of a slumping Eurozone. Only over time does this become exposed. The second way of looking at it is to cast the Bank of England’s response in a similar light to the actions of the Fed. Recognizing and dealing with the problem ultimately will create more favorable domestic conditions and is rewarded by currency investors.
Yet the euro/sterling relationship has traders once again leaning towards the relative yield argument. It’s less than guaranteed that the ECB will eat away at its 2% stance when it meets Thursday, while investors are increasingly banking on the British to do their duty and cut from 1%. Such a move is also being surrounded today with speculation that the Bank of England will announce that it has been granted powers to purchase government gilts in order to alleviate the longer term cost of borrowing. Such a view factoring in relative yields has weighed on sterling recently with investors favoring the euro and pushing the pound to around 90 pence.
Ultimately, yes we are approaching a brave new world. But we haven’t yet finished with the old one in which currencies are rewarded for paring monetary policy to the bone.
Andrew Wilkinson
Senior Market Analyst ibanalyst@interactivebrokers.com
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