Basal III accord driving forex trading directions

Forex markets appear poised to extend the upswing in risk appetite, carrying linked currencies higher for a third week, but the drivers of the advance appear vulnerable while an ominous set of US economic data looms ahead.

Major Currencies vs. US Dollar (% change)

06 Sep 2010 – 10 Sep 2010

CHART 1

General Comment:

Sentiment remains the dominant catalyst driving currency markets and risky assets are seemingly poised to advance for a third week, with the MSCI World Stock Index soaring toward Augusts’ swing top after a robust set of Chinese economic data and the unveiling of the Basel III international bank regulatory framework over the weekend.

The East Asian giant reported that Retail Sales topped economists’ forecasts to add 18.4 percent in the year to August and Industrial Production unexpectedly picked up pace, with output growing 13.9 percent over the same period as compared with a 13.4 percent annualized increase in the previous month, stoking optimism about the continuity of the global recovery. Meanwhile, the Basel Committee on Banking Supervision – a multinational group of financial regulators – agreed to a compromised set of new rules aimed at preventing a repeat of the 2008 credit crunch and subsequent recession. Under the new regulatory regime, capital requirements will more than triple to 7% of assets, though the scheme will not be fully implemented until 2019, giving lenders over 8 years to comply with its provisions. The announcement served to remove a layer of uncertainty about the future international regulatory environment while suggesting banks will have ample time to raise cash and become compliant, soothing fears of a sudden retrenchment in lending.

The knee-jerk upswing may not prove sustainable, however, considering a number of glaring vulnerabilities in the drivers behind the advance. Indeed, the same set of Chinese economic releases that included the aforementioned retail sales and industrial production outcomes also showed that new yuan loans rose for the first time in four months in August while the Consumer Price Index ticked up to a 21-month high of 3.5 percent while money supply growth accelerated for the first time since November 2009. This hints that renewed tightening measures may be on the way, an outcome that is likely to prove detrimental to risk appetite.

Turning to Basel III, the long implementation period means that a lot can change about the global economic landscape while the rules are phased-in, raising doubts about just how much uncertainty has really been dispelled and their implications for broad-based economic growth. Furthermore, the likelihood of a substantively harsher outcome than what was unveiled from essentially the same group of central bankers that are seemingly so reluctant to tighten domestic monetary policies was surely minimal, hinting the announcement’s market-moving potential may prove short-lived.

On balance, all eyes now point to U.S. economic data as traders continue to view the health of the world’s largest consumer market as the bellwether for the global recovery at large, with weaker Retail Sales and Industrial Production as well as higher Jobless Claims figures expected ahead and threatening the spectrum of risky assets and correlated currencies.

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