EUR/USD, Eurozone and ECB Watching ...
[small update added below]
Time is a scarce ressource and so (as I have become painfully aware) is bets on the short EUR/USD :)*. Tomorrow the ECB is set to meet to decide on monetary policy decisions and as we(I) have been talking about here at Alpha.Sources some issues are weighing heavily on the intray of the high lords at the ECB. About a month ago at the time of the last ECB meeting I provided a couple of notes which you might want to revisit in order to catch up on what I have been arguing;
Returning to that intray at the ECB it must surely be red hot at the moment on the back of the remarks made by Cheng Siwei, vice chairman of China's National People's Congress about how China was going to look for elsewhere for yield than the Dollar or, as it were, this is was certaintly the point taken away by the markets as the Dollar has tumbled against just about anything today in quite a violent fashion. Macro Man is (and I have to say rightfully) quite smug and as always very informative in his recent post which talks about today's Dollar knock out.
The dollar fell the most since September against the currencies of its six biggest trading partners after Chinese officials signaled plans to diversify the nation's $1.43 trillion of foreign exchange reserves. The dollar fell against all 16 of the most-active currencies, declining to the weakest versus the Canadian dollar since the end of a fixed exchange rate in 1950, a 26-year low against the pound and a 23-year low versus the Australian dollar. The New York Board of Trade's dollar index dropped to 75.21 today, the lowest since the gauge started in March 1973.
Consequently, the EUR/USD has traded just above 1.47 today before falling a bit this afternoon to just shy of 1.4690. To cut right to the chase, in my opinion the most remarkable characteristic concerning the movements of global liquidity is the prevailing short term definition of yield which essentially is vested in expectations (as well as of cources real divergences) in short term interest differential movements. In this respect, a recent note over at Daily.FX had an interesting and very important obervation even if it is pretty obvious.
Today the markets saw more evidence of that decoupling thesis as Reserve Bank of Australia raised its overnight rate to 6.75% despite the fact that the country is facing a Federal election at the end of the month. Governor Stevens noted that inflation has exceeded the central bank’s target and decided to act expeditiously. suggesting that further hikes may be in the offing. It is precisely this type of stark difference between the easing monetary policy of the Fed and the continued hawkish posture of US’ s major trading partners that has helped to produce the current round of dollar weakness.
As for the Eurozone in particular this is becoming a serious risk in my opinion and it has been so ever since the EUR/USD breached 1.45. And all this talk about reserve diversification just makes it a twist more interesting of course. In this way, the current movments and essentially expectations of divergences in short term interests among global central banks are moving perfectly along the lines of the de-coupling and re-balancing thesis. I don't buy this thesis as I have emphasised again and again but this does not hide the fact that I have been duly surprised by the extent to which this has been going on. Of course, people need to realize I think that de-coupling has an immediate perspective as well as a more long term one. The short term perspective goes something like this (also from Daily.FX) ...
The price action in the dollar is uniformly bearish, as currency traders fear that the problems in housing and finance sectors will drag the US economy into a recession in 2008, while the rest of the world will continue to expand and perhaps even tighten its monetary regimes.
And this is the process which now needs to be watched very closely since it is a proxy for a bet on global economic fundamentals which seems very unsustainable in my opinion. In short, for how long will the current interest differentials remain? Of course, the question of whether the Eurozone can ascend to take the US' seat as the point man of the global economy is not the only worry at the ECB I imagine. Much more pertinent I think is the recent inflation figures which clearly show that the trade-off between growth and inflation is now very much here. Especially in this light tomorrow's ECB meeting will be interesting to since, as I noted in one of my previous notes, we will see whether the ECB is expanding its playbook or sticking to its good old autriche mode. By the latter I mean staying put while citing ongoing market turmoil as well as 'future' incoming data in order to have a more 'solid' ground on which to build its decisions. Fundamentally of course, this is moving just an inch closer to crunch time and words are beginning to become very expensive at the ECB. Vigilance for example and the subsequent hint of a hike in December could end up being a very expensive word indeed, something like '1.50 for the EUR/USD' expensive. More formally, I clearly see a holding operation tomorrow but as I say the forward looking statement should once again be watched closely. I will have more later ... much more, so stay tuned.
*Disclaimer: I know that I have been talking a lot about my bets on the EUR/USD. Please note that it is only a question of 'funny money' as function of me participating in an invesment game (and by all means, I have other oustanding FX positions too). So, rest assured that my analysis remains objective or close to it at least :).
I am sorry that I did not manage to convey more specifically above my views of whether China in fact has the real intention to drop the hammer on the Dollar. Clearly, this is not the case (for now at least); let me for example quote Macro Man who is also linked above ...
Now, there are three basic facts that one should know about Mr. Cheng in interpreting his comments:
1) He has no position at SAFE, and no position of influence over SAFE. In other words, his comments carry no particular policy insight.
2) This is the same chap who tried to talk down Chinese equities in Q1. Needless to say, those that acted on his advice have regretted it.
3) Mr. Cheng is actually the leader of an opposition party. Given what we know about the Chinese Communist Party and their desire to retain power, you can reach your own conclusions about the type of chap that they would allow to run a legal opposition party.
Simply put, Mr. Cheng is talking out of his 括約肌 when he discusses financial markets. But the reaction has been very telling indeed. EUR/USD has traded a percent higher from yesterday's NY close, and USD/JPY is at its lowest level since early September.
And the WSJ economics blog also cites some analysts who, contrary to FX punters, seem to have the cool oversight.