FX: Hurry Up and Wait

The US dollar is mixed. Against the dollar-bloc, it is soft, but against the other major currencies, it is consolidating in narrow ranges near the middle of yesterday’s ranges. Of the capital markets, the foreign exchange market seems the more wary of being disappointed this week. Risk assets, like equities, commodities and peripheral European bonds continue to trade higher. The MSCI Asia-Pacific Index was up over 1% today to bring its 5-day rise to about 5.6%. The Dow Jones Stoxx 600 gapped higher yesterday is consolidating today in the upper end of the range, near 4-month highs. Spanish shares are outperforming gaining a little more than 1% to bring the 5-day gain to 16.6%. 

The moves seem defensive after last week’s comments give rise to perceived odds of a “Big Bertha” moment (derived from German artillery in WWI rather than “bazooka” which appears to be derived from the US Army). We worry that ECB President Draghi overplayed his hand. Reports indicate that his comments were not the result of negotiations and consultations and that his remarks surprised many on the governing council. 

That is to say, he did not secure his flanks. This reinforces our sense that he trying to deliver a fait accompli, forcing others to join him or risk destabilizing the markets…again. Moreover, we do not think a refi rate cut, some relaxation of collateral, and/or a resumption of bond purchases (under SMP) will do more than allow officials much breathing space. Key decisions will be coming to a head next month. 

If anything today’s data both strengthens the need to ease conditions, but at the same time shows that the problem is larger than monetary policy itself. Evidence continues to mount that the German economy, the locomotive for the region, is stalling. Today it reported the fourth consecutive monthly rise in unemployment queues and the third consecutive decline in retail sales. The first estimate of Q2 GDP is due out Aug 14 and a near flat reading is expected. France’s household consumption practically stagnated in June, rising 0.1%, for a 0.2% year-over-year rate. 

The worst news came from Italy. The unemployment rate jumped to 10.8% from the 10.1% initially reported in May that was revised up to 10.6%. Moreover, the EU-harmonized CPI measure came in at 3.7% year-over-year for July. Last week, Germany reported its harmonized measures stood at 2.0%. The flash EMU CPI out today puts the region at 2.4%. This illustrates the underlying problem, Italy, but also other euro zone countries are still losing competitiveness to Germany. 

The Swiss National Bank reported reserve figures today for Q2. The fact that the euro’s share rose to 60% from 51% at the end of Q1 took the market by surprise. In recent weeks there has been widespread market talk of the SNB or the BIS, on its suspected behalf, selling euros. There had been some suspicion that it was also partly behind the general resilience of sterling. Sterling’s share of Swiss reserves actually fell to 3% from 5%. The US dollar’s share fell to 22% from 28%. 

Of note, in addition to the euro, the “other” category was the only other one to show an increase (from 3% to 4%). For the SNB “other” includes Australian dollars, Swedish krona, Singapore dollars and Korean won. Although the SNB is known for its conservatism, most central banks do not appear to use emerging market currencies in reserves, especially outside their region. The SNB also holds 10% of its reserves in equities and this appears to be a stable allocation. Few central banks hold equities in reserves. Lastly, note the SNB cut the duration of its fixed income portfolio from 4.0 years to 2.8 years. 

Canada reports May GDP figures, but as we have argued  the Canadian dollar appears more influenced by general risk appetite and the price of oil (especially recently, where the 60-day correlation is near the highest since 1993--the extent of the Bloomberg time series).  The US dollar is testing parity against the Canadian dollar for the first time since mid-May.   Provided the risk appetite holds, the next support target for the greenback comes in near CAD0.9950.  

The US reports a series of data today, but most important will come from Q3 as Q2 is largely history and today's data will not impact potential revisions.   This means that the Chicago and Milwaukee purchasing manager surveys are more important for the price action. 

Ahead of tomorrow's conclusion of the FOMC meeting and especially Thursday's ECB meeting, look for short-term participants to faded moves.