FYI | May 16 2012
By John Kicklighter, Sr. Currency Strategist, FXCM
There is a growing talk of Greece’s imminent exit from the euro-zone. How will this impact the euro in the short- and longer-term? Will central banks work to stabilize the situation?
Though perhaps unintentional, the way that policy officials deal with the threat of a Greek exit from the Euro Zone is to buy a little more time. Pushing back the risk of crisis a few weeks or months has been the regional policy for some time now. Nevertheless, two sizable bailouts, aggressive austerity efforts and a debt restructuring have all fell short of ‘solving’ Greece’s troubles. Unless global economic and market conditions unexpectedly and inexplicably improve, these policy approach has proven it will not work. Therefore, either a wholesale change of the rules (allow larger deficits) or helping to create as orderly an exit as possible are the best options. Both paths would be a significant leap especially after all the resources that went into stringing the situation out. The ECB, European Union and IMF would certainly act to stabilize the situation regardless of whether they decide to buy a little more time or take a drastic turn on policy. In the short-term a Greek exit would represent uncharted territory and the uncertainty of the situation that accompanies such a move would cause the euro a lot of pain. Yet, medium-term, the situation would like improve so long as Spain, Portugal, Ireland, etc don’t start to follow the same path.
With the troubles in the euro-zone, the pressure on the SNB is rising. Does the SNB have a significant role in keeping the euro up? Is the 1.20 floor under EUR/CHF in danger?
The 1.2000 floor that the Swiss National Bank is trying to keep intact is in constant jeopardy. The trouble that the central bank is facing is an elemental one – the sentiment level of the larger financial market falls on the shoulders of the Swiss franc. As a traditional safe haven currency and the preferred regional store of wealth for Europe, SNB President Jordan and crew are attempting to hold back a incredible tide. The situation can certainly oscillate between tolerable and unbearable depending on the assessment of the Euro-area’s financial troubles, but the pressure will be constant unless sentiment suddenly changes (unlikely) or the SNB makes a move. The market knows the SNB’s euro purchases are not unlimited as they say, and the push is not from speculative interest. They could raise the floor to deliver losses to those that sought safety in recent months and discourage future inflows. Alternatively, they could take the drastic step of taxing and/or curbing capital inflow that is not destined for structural investment. Regardless, the central bank and government will probably have to be forced to make the decision either way.
China is showing increasing signs of a slowdown, such as industrial output and electricity usage. Is the 50bp cut in the RRR sufficient to balance the situation? Or is the hard landing scenario high on the cards?
The modest changes to the reserve ratio by the PBoC is not enough to cure China of is financial ills. This is another move by a policy group that is aimed at providing stability for market conditions that are generally calm. If the situation deteriorates, policy officials will be forced to act once again. With China, there is an advantage for policy makers in that they can adjust the timeliness (and some say the accuracy) of data so that panic doesn’t spread so readily. In gauging a soft or hard landing for China, I think it comes down to definition. Negative growth won’t likely be a factor, however it is very likely that their financial juggling act will fall apart. That would mean structural issues for a market system that doesn’t have a relief valve in free movement of capital into and out of the Chinese markets.
Oil is at the lowest levels since December, and the average gasoline price in the US is falling, currently around $3.73 per gallon. Fed officials have occasionally stated acceptable and problematic levels for fuel prices. Now prices are falling. At what level do you think that US consumers will feel it? At what levels will it boost the economy?
Cheaper fuel prices has an impact on the economy even on a marginal level. However, the real impact on the capital markets is the influence over risk appetite trends – and the sentiment of the masses can be sticky. Confidence indicators from the US have been mixed as of late, but I’d rather watch where the money is flowing by following the capital market assets that are growth sensitive. We have seen many ‘risk’-based assets falter as of late, but the stimulus-backed US equity indexes have proven more stubborn than most. As long as they hold back against the current, there is an inherent stability to the market. In this scenario, lower fuel prices are secondary (if not tertiary) in level of importance. If general confidence in the financial system is guiding us lower, both oil prices and sentiment will continue to falter. That said, the lower energy price will be a touching point when that fear abates and policy officials once again discuss economic health versus inflation pressure.
In the current global storm, Canada is doing quite well, enjoying two consecutive months of impressive job gains. Some think of the loonie as a safe haven currency. Can Canada and its dollar remain strong if things worsen? Or will the storm push it down as well?
Nothing really escapes the pull of fear when there is a systemic crisis concern on our hands – they just perform to different attributes. In the 2008 financial crisis, the Canadian dollar played to its commodity-currency roots by stumbling against the liquidity-haven US dollar. That said, a look to AUDCAD shows where it was in that spectrum – a safe haven relative to a persistent high-yielder. This go around, there isn’t much yield to unwind. More importantly, they don’t need to really act aggressively. There is some concern about lending and housing issues domestically, but Canada has the benefit of enjoying the strengths of the US economy as well as a clear investment appeal for those US market participants that want a higher return but stay within the continental borders. The loonie may very well be a safe haven in its own right.
The views expressed are not FNArena's (see our disclaimer).
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