Rising interest rates in emerging Asian economies and the promise of growth rates three-times that expected in the developed world continue to inspire wishful thoughts among risk-loving investors and laying optimistic groundwork for the midweek session. All quiet on the European sovereign debt crisis has euro bulls hard at work hoping that a permanent solution will be forged to stem disruptive surges in government bond yields. President Obama wants lawmakers to cut to the chase and agree on basic matters and wishes he could get them to agree to a five-year spending freeze that would keep $400 billion from blowing up the budget over a decade. Governor King at the Bank of England sounds off over myopic hopes that the Bank could stop inflation. For my part, I hope that after about two feet, we have no more snow in Connecticut this winter but as Governor King warns, it’s all just wishful thinking.
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British pound – Trading in the British pound remains volatile with the timeline of driving forces becoming somewhat confusing. Last night Governor King made his maiden speech for 2011 ahead of minutes published Wednesday from the January 13 MPC meeting. Yesterday a GDP report possibly unavailable in time for that recent MPC meeting showed an unexpected contraction in growth in the last quarter. The pound rose following a change in the voting pattern at the MPC when Martin Weale joined the call from Andrew Sentance for an immediate interest rate increase. The pound jumped to a session peak at $1.5892 having hit a low following the GDP report at $1.5751. Worrying the hawks on the committee is the stubbornly above target pace of price increases currently running at 3.7% and according to official predictions will shortly breach 4% and twice the mandated policy target.
Governor King, speaking in light of the added call for tighter policy and now in knowledge of Britain’s growing pains, described “a period of uncomfortably high inflation” for the domestic economy, but sounded upbeat when adding “the determinants of inflation further ahead remain consistent with inflation falling back quite sharply next year.” This comment is in line with the view expressed by member Adam Posen at the weekend and put the current bout of inflation in the camp of being temporary. King explained further that very large shocks to relative prices were part of a real adjustment process rebalancing the economy. None of this, in his words, would prevent the Bank from returning inflation to target within the medium term. Cognizant of the discontent from consumers over eroding standard of living, the Governor said that to believe that the Bank could or should have acted in order to return prices to target without raising unemployment, or through a reduction in earnings as he called it, was “wishful thinking.” Traders who continue to buy the pound on the back of rising expectations for interest rates might want to get the timeline of events straightened out before such wishful thinking.
U.S. Dollar – Faced with a lack of data on any nation’s economic calendar, the dollar is little changed. The overnight State of the Union address of the President was marginally dollar negative from the perspective that economic growth might be crimped should lawmakers rally around the President and agree to cut spending. On top of a proposed spending freeze on non-defense items over five years’ worth $480 billion over a decade, a further $78 billion defense spending reduction is also possible. The dollar index trades at an unchanged 77.90 as global risk appetite looks the other way with equity prices advancing this morning.
Euro – Gains for the euro have disappeared and for no apparent reason. The vogue rationale for getting long the single currency at the moment is the lack of rationale for selling it. Little progress has been made in finding a set of solutions to dissipate the sovereign debt crisis but currently there is nothing flaring up causing reason to stoke up on bearish bets. At the other extreme, a German import price index for December showed the strongest pace of increase for costs with a 12% annual change. That’s the largest pace of gain since 1981 and set off the alarm bells over inflation set in motion by Trichet and Weber at the ECB over recent weeks. The euro has fallen from an earlier gain at $1.3721 to trade lower on the day at $1.3662.
Aussie dollar – The commodity dollars are starting to make hard work of an earlier head start against the greenback. The Aussie was buoyed this morning by an independent prediction for imminent interest rate increases from the Reserve Bank of Australia. The local dollar gained to as high as 99.98 U.S. cents before paring gains to 99.55 cents propelled by a prediction from Canberra-based Access Economics that the central bank would be forced to move on policy despite the Queensland flooding. The agency cited rising export demand, domestic wage growth and a turn in import prices as reasons to make additional monetary moves. However, earlier in the week the fourth quarter inflation report showed a drop in price pressure relative to the third quarter with consumer prices gaining at the slowest in two years. The report could simply be wishful thinking by the authors given the recent inflation data showed prices were restrained by a rising local currency offsetting import price gains.
Canadian dollar – The Canadian dollar also made heavy going against the dollar after an early morning gain. The loonie earlier rose to $1.0063 U.S. cents but has receded to $1.1.0027.
Japanese yen – The barrier at ¥82.00 is proving problematic for yen bulls and is supporting the dollar. Typically the yen gains when risk aversion is in the air but with regional equity prices enjoying an upswing at present, investors are selling both dollar and yen. What’s possibly fuelling relative demand for the yen within this equation is an overnight report showing a further worsening of the nation’s deflation prospects. A December report showed prices paid by corporate services fell by 1.3% on the year and accelerating a 1.1% year-on-year decline in November.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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