Currency Levels and Official Will and Tools

The level of speculation of month-end flows appears to be inversely related to the amount of hard evidence. Nevertheless, the market buzz attributes the euro’s modest recovery today to month-end demand. In order to be anything noteworthy, however, the euro needs to overcome resistance in the $1.2780 area. The gains in late Asia and extended in Europe are stretching the short-term technical readings, warning that the gains are unlikely to be extended very far in North America today. Look for offers in the $1.2720-30 area to cap the euro.

Sterling’s low for the month was set a week ago near $1.5375. It was approached in late Asia (~$1.5396) before stabilizing in Europe. However, the upticks appear half-hearted and a new low on the session seems likely. However, the recovery in euro-sterling looks likely to run out of steam as the GBP0.8230-40 two-week cap is approached.

After nearing JPY86 in anticipation of bolder BOJ action, the dollar’s losses were extended to almost JPY84 in Asia on the disappointment. The JPY84.60-80 area should now function as resistance. The euro fell from around JPY109.55 yesterday to almost JPY106 today, but good bids (month-end?) have seen the euro recover to new session highs in Europe. Resistance is seen in the JPY107.50 area.

The heightened risk of BOJ intervention has deflected some of the safe haven demand and speculative flows toward the Swiss franc. The dollar’s low for the year against was set on Jan 11 near CHF1.0130. Today the dollar recorded as low near CHF1.0175. This is likely the low of the day. Resistance is seen in the CHF1.0250-70 area. The euro did slip to new record lows against the Swiss franc (~CHF1.2900) and news to resurface above the CHF1.30 area to help stabilize the tone.

Look at what has happened this month. The Federal Reserve has taken steps to avoid a passive tightening of policy by preventing a contraction in its balance sheet. Judging from Bernanke’s speech at Jackson Hole last week, the Federal Reserve has adopted what traditionally would be called an “easing bias” and although the precise trigger may be being debated, many expect that continued poor US economic data will prompt the Fed to take additional measures. Japanese officials are providing additional monetary and fiscal support. The BOJ yesterday expanded a special lending facility by JPY10 trillion (~$117 bln) and the government indicated it will draw down its budget reserves by almost JPY1 trillion to boost jobs and investment. Later this week, the ECB is expected to indicate that its special liquidity provisions will be extended into next year. The Bank of England has hinted that more quantitative easing is possible.

Many pundits are arguing that the central banks are running out of measures and are powerless in the face of the global de-leveraging. Such cynicism however confuses two issues: tools and will. The tools seem to exist. For example, if countries were willing to sacrifice their ratings, more fiscal stimulus could be provided. This applies to Japan as much as the US and Europe. We would agree that the probability of anything more than initial success of unilateral BOJ intervention is low, there are still other measures Japanese officials could do to weaken the yen. Talk of cutting the overnight rate to 0 from 10 bp is hardly inspiring, but why can’t Japan adopt negative interest rates, i.e., penalize depositors, like Switzerland and Germany have done in the past? The point is that there are numerous measures that governments and central banks can take, but the main obstacle is political will, which includes the perceptions of the cost-benefit of deploying such tools.

Economic reports today have included somewhat better than expected Japanese industrial output (0.3% vs consensus of -0.2%) and retail sales (0.7% vs consensus 0.5%). However, the strength is not expected to last. The manufacturing PMI fell to 50.1 in August from 52.8 in July, which is the third consecutive monthly decline. There a numerous media reports discussing how the strength of the yen is going to force manufacturers to re-locate abroad. MOF data suggests that since the late 1990s, the foreign sales by affiliates of Japanese companies have exceeded exports from Japan. Also note that Japan’s auto purchase scheme expires next month and is not expected to be renewed. However, the year-end expiry of the appliance purchase scheme may be extended, according to local press reports.

Australia also reported stronger than expected data (though it is not aiding the Australian dollar today). Retail sales rose 0.7% in July, nearly twice the consensus and building approvals rose 2.3% rather than decline by 0.7% as the consensus forecast. And the current account deficit narrowed sharply in Q2 from A$16.45 bln to A$5.64 bln. The c/a figure warns that Q2 GDP, due out tomorrow, may be stronger than the 0.9% expected. The net-export function added 0.4% to GDP, the government’s stats bureau estimated today. The trade balance swung into surplus of $A6.5 bln in Q2 from a $A3.2 bln deficit in Q1.