China's Flexibility, UK/Japan Fiscal Plans, and Euro Weakness

China remains very much in the center of attention today. The reference rate was set at CNY6.7980, which seemed to validate yesterday’s yuan strength in the spot market. However, as the session progressed the yuan weakened and is back at CNY6.8130 in late dealings. This leaves the yuan about 0.2% higher than where it finished last week.

Although it is difficult to read too much into two-days of price action, it does suggest that what China means by “flexibility” and what its critics mean are two different things. One issue that many are considering is the implication for US Treasuries by the willingness of Chinese officials to accept gradual yuan appreciation. Fitch seemed to play down this connection as did a Financial Times article,. The article noted that during the July 05-July08 period Chinese reserve accumulation was significantly faster than the previous three year period. Lastly, judging from comments by US officials, it seems that the Obama Administration is prepared to declare victory and move on. One unnamed official was quoted on the wires explaining that the lack of details and ambiguity of the PBOC’s statements were “purposeful and necessary” to prevent a new speculative inflows into China, which is what appeared to take place during the July 05-July 08 currency appreciation period. This seemed to reiterate Treasury Secretary Geithner’s assessment that it is “prudent” for China to downplay when and how much the yuan will appreciate. This makes the real significance of China’s move still unclear. It rests on the implementation. The risk is that if the question becomes how fast and how far the yuan appreciates, US policy makers may be disappointed.

The UK’s budget remains a key event on today’s agenda and an austere budget is widely expected. There have been some second thoughts on whether it will include a VAT hike or whether this will be saved for another time. There is also some concern that Prime Minister Osborne may not specify the cuts in public services and a more comprehensive spending review is expected later in the year.

Meanwhile, Japan’s new government unveiled its broad fiscal and growth strategy in general terms. The new government plans on cutting its primary deficit in half by 2015/2016 and balance the budget by 2020/2021. Separately, the government did revise its GDP forecast to 2.6% for the current fiscal year from 1.4%. The rating agencies’ response was lukewarm. S&P said it was better than nothing. Fitch said it lacked details. Moody’s said it was a step in the right direction. It said that while 2.5% GDP is realistic 3% growth is needed to improve the fiscal situation.

The German IFO survey was better than the market expected, but failed to lend the euro much support. The headline reading of the business climate rose to 101.8 from 101.5. The consensus was for slippage to 101.2. The surprise was a function of the assessment of the current climate. That reading rose to 101.1 from 99.4. However, business expectations, the more forward looking component fell to 102.4 form 103.7 (vs consensus of 102.7). There is renewed concern about the funding needs of European banks.

There is also some speculation that with China move behind it, the G20 and some European countries may turn their attention to the German surpluses. In addition, there is some vague talk in the market that US institutions may have euros to be sold as part of a shift of the China play toward a basket. Meanwhile we note that the technical condition of the euro has weakened considerable after the test on the $1.25 level yesterday ($1.2490 high). Yesterday saw the euro make a new high for the move and then sell-off to finish the North American session below Friday’s low. This potentially key reversal day has seen downside follow through today. Initial support is seen in the $1.2230-40 area. A break could signal a move toward $1.21. Separately, the Swiss franc’s relative strength against the euro helped it fare better against the dollar yesterday and today the greenback has been confined to yesterday’s range. A move above CHF1.1150 could spur a move toward CHF1.13.
China's Flexibility, UK/Japan Fiscal Plans, and Euro Weakness China's Flexibility, UK/Japan Fiscal Plans, and Euro Weakness Reviewed by Marc Chandler on June 22, 2010 Rating: 5
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