Ratings-giant Standard & Poor’s reassessment of the fiscal health of Japan was responsible for a slump in the yen on Thursday while an ECB official sent another hawkish signal helping further vilify a recent rally for the euro.
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Japanese yen – The dollar rose by more than one yen as it swooned in the aftermath of the downgrade. The move from AA to AA- might be a small move but sends a bigger signal and changes the dynamic of the relationship between the safe haven pairing. S&P said that the downgrade was on account of worsening debt ratios, which it says still won’t peak for a further 15 years. Japanese officials responded by saying that the government was trying to overhaul social security and reform taxes and defended Prime Minister Kan’s policies. Some even said that they were “misunderstood.” By tossing the scale of Japan’s fiscal challenges under the spotlight, the S&P move shook investors’ willingness to treat it as a safe haven. On account of the size of domestic holdings of government paper, the common perception is that it would be almost impossible to force a run on the yen. The yen played second fiddle to the dollar this morning as it rose to ¥83.21.
Euro – ECB official Lorenzo Bini Smaghi fanned inflation fears of earlier this month when he noted that rising import costs can’t be ignored. The euro surged to $1.3756, an 11-week high, in response to his warning before paring gains. There is a notable difference in tone between the Fed’s aware yet sanguine attitude towards rising commodity prices and the attitude of the European central bank. Against the yen the euro rallied more than 1% to ¥113.92.
U.S. Dollar – In today’s melee, the dollar index is unchanged despite a 1.1% rally against the Japanese unit. The dollar weakened midweek in response to the unexpressive review from the FOMC at the end of its two-day meeting. The recovery continues but remains “insufficient to bring about a significant improvement in labor market conditions.” In conjunction with proposed spending cuts in Tuesday’s Presidential address dealers turned soft on the dollar until the downgrade of Japanese long-term debt. The Fed’s lack of indication that it was willing to end what it calls its exceptionally low period for interest rates also seems to be weighing further on the dollar these days. The FOMC also used the elevated level of unemployment to justify its $600 billion bond-buying program.
British pound – The pound continues its voyage of recovery into the unknown and on Thursday rose to $1.5970 almost wiping out all of the losses suffered following news of a sharp contraction in activity at the end of last year. Investors are split over whether the Bank of England will be forced to raise interest rates in response to what the central bank has already called temporary factors. In a speech on Tuesday, the Governor predicted that inflation would return to below target over the medium term. The euro weakened against the pound to buy 85.93 pence. The pound was unresponsive to a report showing further weakness last month in British home prices.
Aussie dollar – Prime Minister Julia Gillard said she’d draft in an income tax worth A$1.8 billion in order to help pay for a clean-up operation following the Queensland flooding. The announcement weakened the Australian dollar on two fronts. The move could further crimp domestic spending at a time when mortgage interest rates have been rising. Second, the tax will be a new factor for the Reserve Bank to consider when considering whether or not to raise interest rates any further. The Aussie fell by 0.9% against the greenback to stand at 99.06 U.S. cents, but is off an earlier session low at 98.75 cents.
Canadian dollar – The Canadian dollar is marginally lower but continues to tag alongside the recovering U.S. unit. On Thursday the Canadian unit commands $1.0046 U.S. cents.
Andrew Wilkinson is a Senior Market Analyst at Interactive Brokers LLC
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