U.S. policymakers may finally catch a break as the Chinese Central Bank is likely to let the yuan appreciate at a faster rate. Reports from today have shown China’s trade surplus for June to be at $26.9 billion. This has beaten economists’ expectations of $24 billion. This incredible surge is largely due to firms that were seeking to fill orders before July 1st when value-added tax rebates were taken away or reduced on certain goods in the attempt to curb the surplus. Nevertheless, the overall surplus in the first 6 months this year is 83% more than last year’s in the same period. And this has given the Chinese Central Bank a reason to be worried.
The amount of capital influx brought in by exports has spurred the fastest pace of inflation in more than 2 years. Previous attempts to decrease the trade surplus have seemingly failed. China has imposed cuts in tax rebates and new tariffs on various products to stifle exports. But, along with U.S. pressure to do more, present and imminent inflation may be the decisive factor that will push the CCB to revalue the yuan.
According to Hong Liang at Goldman Sachs in Hong Kong, the level of the trade surplus is unprecedented for China and any other major economy in the world. She states that the undervalued yuan is the root of the problem. Some analysts agree that the current rate of appreciation of the yuan is not enough to curb the surplus. On the other hand, Xue Hua, an analyst with China Merchants Securities in Shenzhen, states that the recent yuan appreciation and attempted curbs on the surplus will gradually take hold. CCB action may not even be needed.
Yet strong hints from the Chinese Central Bank have analysts speculating an increase in yuan appreciation. China Securities Journal cited Central Bank Assistant Governor Yi Gang stating that exchange-rate flexibility will increase. Today the CCB fixed the daily reference rate at 7.5845. Ramon Maronilla at State Street Global Advisors predicts that the strong inflation pressures will lead to further policy tightening by the end of the year.
Despite some mixed expectations by analysts, it seems likely that the CCB will let to yuan appreciate more freely on a floating exchange rate. To avoid the dangers of inflation, which could hurt consumers the most, action must be taken to decrease the enormous influx of capital from the trade surplus. Otherwise the consumer demand will not be able to keep up with rising prices.
July 10, 2007 No Comments
You might have been expecting Patrick to talk about this one (he loves Canada), but he’s a little busy with China right. So you got me. The Bank of Canada raised its benchmark interest rate this morning to 4.50%, and the forex market…well the forex market basically yawned. The USD/CAD pair did retract somewhat from the 30-year low hit yesterday, but the growth did not amount to much. The loonie is still in a position of strength, and some currency analysts are even talking about parity in the USD/CAD.
Much of the recent growth in the Canadian dollar can be attributed to the international bull market for commodities. Commodities make up just about half of Canada’s exports. The price of oil just came down from its 10-month high, but it is still above $70/bbl. That is especially significant because there is an amazing 85% correlation between the price of oil and the value of the loonie with relation to the greenback. The prices of copper and gold are also on the ascent, and that is going to provide further support for the loonie.
But the story of the Canadian dollar cannot be explained only by commodity prices. Wages are up a phenomenal 3.5% this year. Core inflation, subtracting energy and food prices, was at 2.2% in May, an improvement over the 2.5% level in April, but still above the 2% target set by the central bank. This allows the bank some leeway to raise interest rates again this year. The appreciation of the Canadian dollar hurts exporters to some degree (and the world’s ninth-largest economy is still primarily driven by exports), but policy makers in Ottawa believe that a stronger currency might do more good than harm.
Basically, the bank is not going to let USD/CAD approach 1.000. The central bank will intervene in the forex market before that happens. But with the pair trading at a little above 1.05 now, do not be surprised to see levels of 1.04 soon. Some currency traders and analysts have already priced in two more rate hikes by next March. And they might not be far off, considering the following statement accompanied the interest rate announcement this morning: “some modest further increase in the overnight rate may be required to bring inflation back to target over the medium term.â€Â For right now, I would bet on the Canadian dollar and be careful when I am on a submarine (dolphins apparently like to watch).
July 10, 2007 No Comments
Despite the fastest increase in value of the Chinese yuan, U.S. lawmakers remain unsatisfied claiming that the currency remains undervalued and as a result is hurting the U.S. economy. The yuan appreciated 1.5 percent in the last quarter. Prices for food, rent, and transportation have increased the most in 27 months in the Chinese economy. Investment Banks Goldman Sachs and JP Morgan Chase are both predicting that the Chinese government will let its currency strengthen at least 7.5 percent in the next year.
The yuan, against the dollar, closed today at 7.6031. This value is up 8.9 percent since July 2005 when China ended the currency peg against the U.S. dollar. But U.S. lawmakers are still not content with the level of the currency valuation. Despite lifting the currency peg, the Chinese bank still only allows the yuan to trade on a maximum 0.5 percent range on either side of a daily rate it sets. Essentially, the yuan is thought to be pegged against a basket of currencies.
U.S. policymakers believe that the yuan is undervalued and is thereby hurting the U.S. economy. They state that the incredibly high Chinese trade surplus, especially against the U.S., is slowing U.S. job growth. U.S. companies using China as an exporter to the U.S. market are at a disadvantage when the currency exchange is artificially high. Lawmakers are already planning to impose new duties on exports from countries that keep their currencies artificially low. A recent report by the Chinese state-run Xinhua News Agency states that the first-half trade surplus is already at a whopping $110 billion, as compared to the $177.5 billion trade surplus in all of 2006. This gives reason to believe that the increase in the yuan in the past year has done little to stem exports.
Mixed feelings on the current Chinese inflation make it hard to predict what fiscal policies the Chinese government will implement next. Some economists are indicating that a stronger yuan will be needed to combat persistent inflation. Otherwise the Chinese economy will be harmed. On the other hand, May’s inflation reading of 3.4 percent may not be enough for action by the Central Bank. According to Stephen Jen, global head of currency research at Morgan Stanley in London, in the past, policy makers have not really reacted before inflation reached 8 percent. Yet as food prices increased by 8.3% in May from a year ago, there are some worries that prices from the agriculture sector will spill over into other goods.
On the other side of the yuan undervaluation debate, a May article in the Economist argued that the currency is in fact not undervalued (see full article). According to the article, the purchasing-power parity (PPP) cannot be used as a benchmark for comparing currency pairs of countries with highly differing income levels, such as the U.S. and China. After using highly conventional statistical methods to look at the currency pairs, the conclusion was drawn that it is in fact very hard to prove that the yuan is undervalued. Even more importantly, the article made the case that China’s high trade-surplus is not in fact hurting the U.S. economy. Just looking at the current U.S. unemployment rate at 4.5 percent, it has been the lowest in years and does not indicate a weakening U.S. economy. Of course there will always be losers in international trade, but the gains far outweigh the costs.
July 9, 2007 No Comments
European Central Bank President Jean Claude-Trichet spoke to a group of students and economists recently on the overwhelming success of the euro. Europe as a whole is definitely going through a boom period right now with unemployment in the continent at a 25-year low and steady growth. Much of that success, Trichet claims, should be credited to the unified economic and monetary policy. I want to spend some time this morning talking about that assertion and how the euro has been good (and bad) for Europe.
Now the economic virtues of the European Union are numerous, but I want to just focus on the currency today. One of the advantages of the euro is that weak economies get to piggyback on strong ones. And by strong ones, I mean Germany. For the last 60 or so years, Germany has been the engine that drives European growth, and its currency, the Deutschemark, has been Europe’s most stable. What the euro does is it allows countries like Italy, which had a notoriously bad currency, to benefit from the international confidence in German stability. Germany’s reputation basically grants a halo effect to the rest of Europe. This is essential for the central and eastern European countries because as emerging markets, their currencies might otherwise be subjected to dangerous volatility levels.
Another benefit is the political independence of the European Central Bank. Before European monetary policy became aligned, the central banks of many countries were headed by the finance ministers in those countries. But finance ministers are politically appointed, and so the economic and monetary decisions were often dependent on political gain or loss. The independence of the ECB from European governments has allowed for more stability in monetary policy. This is an especially important front to pay attention to as French President Nicolas Sarkozy continues to push for more input from finance ministers. Let’s hope that ECB can withstand this misguided effort.
While the stable monetary policy has been mostly a good thing for Europe, it does have its share of problems. A unified monetary policy eliminates some independence for individual areas. If most of Europe is going through a bust cycle, the bank will lower interest rates. But if Belgium is experiencing growth, this decision will lead to inflation in Belgium.
One great example of this scenario is Germany after re-unification. The government faced a need to invest in what used to be East Germany, and increased investment led to inflationary pressures. The German government needed to raise interest rates to combat this threat. France faced no such threats, but had to raise interest rates as well to maintain the integrity of the fixed Exchange Rate Mechanism (ERM). The French economy experienced a recession, and plans for a unified monetary policy almost fell apart eight then.
This problem is evident today as well. Most western European economies are stable and developed. Growth is consistent, but not especially fast. Unemployment and inflation are usually at manageable levels. But the newer EU countries, those from Eastern Europe, are at a different stage in their economic growth. They are, as a whole, growing faster as developing countries. Ideally, the different parts of Europe would have different monetary policies to accommodate the different conditions, but the euro would make that impossible. Sharing a currency means sharing a monetary policy. So while the euro is mainly a good thing, it might not be a good thing for everyone involved.
July 9, 2007 No Comments
The recent report on U.S. jobs growth came in stronger than expected. The forecast for new jobs in June was 125,000, but instead the report showed 132,000 new workers being added. This is below the 190,000 workers added in May, but it beat expectations nevertheless. Wages also increased as reports showed average hourly earnings to have increased by 3.9 percent in June. Further reports showed the unemployment rate to be held steady at 4.5 percent for the third month.
In response to this news of strong economic performance treasury yields have increased as investors are worried about inflation. During this week, the rate on the 10-year note climbed 15 basis points. This has been the biggest increase since the 16 point increase in the week of June 16, 2006. The economy has been doing better than expected amid the subprime mortgage crisis. This has given bond holders reason to believe that there is potential for increases in inflation, and thereby, have increased demand for higher yields. If inflation does go higher than the target level, then the Fed is likely to increase interest rates to cool to economy.
On the other hand, Janet Yellen, President of the San Francisco Federal Reserve Bank, has indicated that the Fed should not change interest rates. According to Yellen, the best way to achieve faster growth while maintaining a low level of inflation in the current state of the economy is by keeping interest rates steady. Despite a very robust economy, Yellen indicates that inflationary pressures are not strong enough to hurt the goods and labor markets. She is more worried about future problems that are yet to come from the subprime mortgage defaults.
It is difficult to say where the value of the U.S. dollar will stand in the next two months. There are mixed opinions among investors and policymakers as to where interest rates will be held. The next FOMC meeting is not until early August.
July 6, 2007 No Comments
The forex market has become used to dollar strength against the yen. This year, the yen is the worst performing currency against the dollar among all the highly traded currencies. But there are conflicting opinions as to whether that trend is likely to continue into the second half of the year. The majority of currency analysts call for a push upwards in USD/JPY, but there are some influential voices calling for caution for dollar bulls.
The Non-Farm Payrolls Report came out this morning, and the US economy added 132,000 jobs last month, versus the market prediction of 125,000. Job growth in May was revised upwards from 157,000 to 190,000. Wage growth also picked up, and unemployment remained at the 6-month low of 4.5%. Primarily, this data should signal a rebound in consumer spending, and it confirms the anti-inflationary bias for the Fed. At the very least, growth no longer seems to be a concern, and US interest rates are not likely to go down.
During their meeting last week, the Fed said that the low jobless rate created the potential for inflation. They were expecting a moderate pace of growth, with most economists predicting growth in 2.75% in the second half of this year. Seeing as how today’s NFP Report validates this thinking, the Fed’s hawkish stance on inflation is likely to continue.
And that spells bad news for the yen. Early morning trading today saw the dollar gain the most in three weeks against the yen. While much of this characteristic of overall greenback strength across the board, it also could signal a resumption of the USD/JPY carry trade after some time of profit-taking. The interest rate differential and the differing pace of consumer demand in the two countries reinforce the carry. The yen is also hurt by rising US yields, as treasuries took a beating with ten-year yields going to 5.18%. Also important to note, the ten-year bonds rose faster than the two-year bonds, suggesting an uptick in expectations of inflation.
But dollar bulls are not without significant opposition in the currency market. As first reported by Bloomberg.com, Federal Reserve Bank of San Francisco President Janet Yellen is somewhat dovish on interest rates. She advocates leaving interest rates unchanged for a long time, as that would best encourage growth and discourage inflation. Yellen warns carry traders specifically, arguing that “‘carry trades’…expose investors to ‘substantial exchange-rate risk’ that they may be underestimating.†The low borrowing costs in Japan have created an untenable situation.
Standard Chartered Plc, a London-based bank, does even further in its analysis of a possible carry trade unwind. Currency analysts at the bank argue that volatility in the dollar-yen exchange rate will decline as the interest rate differential closes up. Standard Chartered claims that by the end of the year, US rates will decline 0.25 percentage points to 5.00% and the overnight lending rate in Japan will increase 0.25 percentage points to 0.75%. These two moves, when coupled together, will kill volatility in the currency pair. The final diagnosis is that the dollar will fall to 122 yen by the end of the year.
When the analysis leads to two divergent positions (as we have now), how can we profit? The good news is that most of the disagreement is over the long-term positions of the two currencies. In the short-term, there is a forex market consensus of dollar strength. As Boris Schlossberg of DailyFX.com points out, retail investors in Japan just keeping hopping aboard the carry trade gravy train. We should see the pair test 125.00 soon, and possibly break the resistance on the back of today’s positive data.
July 6, 2007 No Comments
Those who thought the US economy was slumping (including me) are wrong. Or at least that’s what today’s information tells us. The ISM survey for the month of June reported at 60.7, up from 59.7 in May. The ADP Employer Report counted 150,000 new jobs this month. That is a significant increase from the 100,000 new jobs expected this month.
What does all this mean for currency traders? The job report is important with regard to interest rates. A number under 100,000 would have been increased speculation for an interest rate cut. The Non-Farm Payrolls Report is still scheduled for Friday, but today’s news suggests that growth picked up in the second quarter. Some economists are even suggesting the likelihood of a 3% surge in the economy by the end of the year.
If the Fed does not have to worry about a slowdown in growth, then it can turn all of its attention towards inflation. We have already seen the importance of curbing inflation on the decisions and comments of monetary policymakers. Central banks around the world are maintaining hawkish stands in the face of growing worldwide energy prices. Now that we’ve seen the Fed’s expectations of moderate growth being met, the US dollar should see a rush of support. The greenback has been up today against both the pound and the euro. Carry trades should also pick up (or at least continue) as interest rates all over are destined to remain high.
July 5, 2007 No Comments
With oil prices still hovering around $70/bbl (and with a realistic possibility of $80 oil), world prices are not likely to go down anything soon. Both headline and core inflation are on their way up, and that makes inflation more of a concern for central bankers than growth. What that means for forex traders is continuing hawkishness for monetary policy makers and a steady rise in interest rates all around the world.
The Bank of England led the way today, raising interest rates to 5.75%. The accompanying statement was not as hawkish as some currency analysts were expecting, however. The central bank made the claim that inflation was starting to get under control, with CPI nearing the 2% target level. And new Chancellor of the Exchequer Alistair Darling came out and said that the higher interest rates should prove a burden on new debtors in England, especially those with fixed rate mortgages. Trade union groups as well as the business lobby have protested the rate hikes, citing a possible brake on growth.
But housing prices in Great Britain are still as high as they have even been in years. The financial services industry in London is booming, carrying the economy to its largest growth in three years. M3 money supply in England is growing at a dangerous pace, and the Monetary Policy Committee members recognize the inflationary risk there. Taking into account the rapid growth of credit and broad money, the MPC left open the possibility of future rate hikes this year. In fact, most forex market analysts expect at least one more move upwards in the interest rate, bringing it to 6.00%.
In confirmation of that fact, December short-sterling futures went up to 6.33% shortly after the interest rate decision. The British economy has been resilient thus far to interest rate hikes, and the Great Britain pound should benefit. GBP/USD is up 3% this year and GBP/JPY is up 6%. Fundamentals point to the pound continuing to be a great buy and currency traders should continue to provide bid support for the sterling. Look for the cable to test 2.0500 in the coming days and weeks.
July 5, 2007 No Comments
The Canadian dollar is back on track to regaining its 30-year high position against the U.S. dollar. Recent reports have shown that building permits increased by 21 percent in May. This news comes as a relief in regards to reports earlier this month, which showed stagnating economic growth in April. Instead of lowering interest rates, investors are speculating that the Canadian Central Bank will raise interest rates in order to cool a growing economy. The increase in building permits, valued at C$6.83 billion in May, is a great sign for the Canadian economy. This morning the Canadian dollar traded at 94.57 U.S. cents, and is on its way to regaining its 30-year high of 95.51 from June 29.
Other than higher expected interest rates, increases in the price of crude oil this morning also factored into the Canadian dollar boost. Crude oil increased to $72 per barrel, a 10-month high, due to resurging violence in Nigeria and refinery breakdowns. The Canadian dollar has climbed 11% this year since crude oil traded at a low of $49.90 per barrel on January 18. (See article by Kathy Lien at FXCM for a further discussion on the impact of oil on currency price fluctuations)
Looking across the Atlantic, this morning the euro traded against the yen at an all-time high of 167.28 yen. European Central Bank president Jean-Claude Trichet indicated that interest rates are “accommodativeâ€, which implies a potential hike in rates by the ECB. According to Mario Maratheftis, a currency strategist at Standard Chartered PLC., the fact that the European Central Bank still sees the need for rates to move higher indicates more buying opportunities for the euro. After reaching a high of 167.28 yen, the euro settled at 167.17 as of 2:13 p.m.
The yen may further drop in relation to other major currencies including the euro as investors are gearing to launch more than 1.5 trillion yen of foreign currency trusts. At the lowest interest rate benchmark of 0.5 percent in the industrialized world, Japanese investors are sending their money away into foreign currencies and equities. This trend is likely to continue as the Japanese Central Bank is unlikely to raise interest rates anytime soon.
July 5, 2007 No Comments
The pound reached a new 26-year high against the dollar last night. Still short of the important 2.0200 level, the gain was still impressive and primarily fueled by speculation on interest rates. Among the major forex countries, there are a number of central banks having their meetings this week, but the Bank of England is the only one likely to raise interest rates this time. With regard to GBP/USD, currency traders are being driven by the search for the highest yield. With the Fed not likely to change rates any time soon, the differential is pushing the cable to new highs.
The strength of the pound in the forex market should not surprise most market observers; Terri Belkas of DailyFX.com predicted the new high in the cable last week. The money supply is Great Britain is growing at an astronomical rate. House prices continue to surge, and labor conditions are extremely tight. The recent CPI report is at 2.5%, above the 2.0% level preferred by the BoE. The latter might be the most important factor leading to Thursday’s rate hike, as Monetary Policy Committee member Kate Barker has said that the bank’s credibility is dependent on keeping inflation in check.
The pound was down yesterday against the Japanese yen, the Swiss franc and the euro, but its long-term strength seems secure. Construction PMI printed this morning at 60.1, compared to the expected results of 57.7. The economy seems like it can withstand future rate hikes with the threat of collapse. With oil still above $70/bbl, worldwide inflation is not going to go away. The BoE is the only bank likely raise interest rates this week. And the futures market has even priced in another rate hike later in the year, which would bring the interest rate in Great Britain to 6.00%. It is no wonder, then, that even with new terror threats in London and Glasgow, market observers are predicting even greater highs in the forex market for the pound against the dollar.
July 3, 2007 No Comments
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