Untitled Document

Monday April 20, 2009

The euro is trading at a level not seen since the day before the FOMC announced its quantitative easing plan. Thereafter, the euro gained to just about $1.3750 from $1.2971 as investors resigned the dollar’s fate to dust for fear of debasement. But for now at least, it appears that the Fed and treasury know how to steer the boat they chose to combat the financial disaster. On the other hand the ECB appears torn on what vessel to pick. What’s becoming increasingly apparent is that bickering aside, they clearly need a bigger one. The euro is down all over town against the dollar at $1.2889, against the yen at ¥127.10 and against the Swiss franc at Chf1.5131.


Click on link for updated table throughout the week at http://www.interactivebrokers.com/en/general/education/FX-View.php?ib_entity=llc

Today the German Bundesbank announced a 2.1% and worsening contraction of German GDP in the first quarter neatly clashing with shreds of perceived good news elsewhere around the globe, especially in the apparently fighting fit U.S. banking system. Last week the SNB once again tore a strip off the euro by reaffirming its preparedness to sell its currency. The notion helped the euro immediately, but after the perceived schism amongst ECB council members took hold, the Swiss franc gained heading back towards Chf1.50 as if drawn by magnetic force.

The crux of the ECB problem is that despite Mr. Trichet’s attempt at unity, there are clear divisions first of all over how deeply monetary policy can be cut beneath its present 1.25%. Euro bulls thought the ECB had it licked at its last meeting when it cut its more meaningful discount rate. Second, there is growing dispute over the role of using central bank funds or those of Eurozone governments to spark lending through the purchase of corporate or even government debt in the market. The fear is that not only will this ultimately by inflationary, but also that once the drug is proven to work, it will have to be quickly withdrawn from the system.

The problem as far as we see it from here is that the ECB has been wrong before. Not just a little, but to a large degree. And that’s formed a huge part of our underlying distaste for the euro, which turns out in large part to be a trust issue. They have been badly wrong on inflation. They have been badly wrong on the economy. They have called monetary policy the wrong way altogether within the last year no less. Why should we believe them on the subject of quantitative easing when they can’t get the basis of monetary policy right in the first place?

Turning slightly west now, the British pound has recoiled from a $1.50 reading just a couple of sessions ago to $1.4532 against the dollar this morning. One could say that the pound suffered from ill-gotten gains if indeed the analysts’ collective criticisms of the recent slew of banking results are accurate. Pumped up trading revenues and shrewd accounting maneuvers are hardly a cause for declaring a cessation of the financial collapse.

The pound is suffering on a couple of domestic fronts today. On Wednesday the British government stages its annual budget in which Chancellor of the Exchequer, Alistair Darling will likely reveal a larger need for government debt issuance courtesy of a larger cost of bailing out the financial system than was ever expected. And one weekend press report says that some of that cost may be sunk forever, deep in the bowels of the system’s balance sheets. Still, better lost than lose a bank eh?

The CBI says that the British economy might shrink by more than originally estimated and will decline by 2.9% instead of 2.3% in 2009. Meanwhile the CEBR says that as many as 29,000 financial services jobs might be lost in 2009. More bad news for sterling.

With global bourses in decline to start what will be a week exacerbated by fears over what next week’s bank stress testing may or may not reveal, all eyes are back on the risk aversion trade. Both the Canadian and Australian dollars are weaker against the dollar, which on its trade-weighted index is higher by 0.8% today. The Canadian dollar has the hurdle of its central bank’s prognostication over monetary policy this week and is currently down by 1.5% at 81.00 cents exactly. The Australian dollar will be steered by the release of April’s RBA policy meeting minutes, which might hint at what it will take to drive interest rates lower still.

In deciding on the future the RBA looks at inflationary trends. An earlier release of producer prices will add weight to calls for lower rates given the unexpected 0.3% first quarter reading of input prices faced by producers. The market had expected a 0.6% quarterly increase. Here’s yet more evidence of the loss of energy inflation driving down costs. Later in the week the consumer price reading will be released. In all it could be a rocky week for the Aussie dollar and of interest will be whether the unit will breach 70 U.S. cents from its current 70.37. The Aussie is down from a Friday close at 72.19 cents.

The yen is benefiting from the safety flow today out of the euro and out of stocks. This seems a strange theme given what we know happens to a practically dead economy when the exchange rate is forced higher. Still, investors will push if they see potential profits. Watch for a snapback for the dollar from its current reading of ¥98.30 in the event of a jump higher for stocks.