G10 Currencies
EUR: The rumour mill had been busy recently. In particular rumours were abounding that the IMF would end the Greece aid. Even serious economic newspapers had announced this as a fact. They now look like fools. A joint statement on the part of the troika (IMF, EU Commission and ECB) was phrased in the usual diplomatic tone and full of praise for the Greek saving efforts promising the payment of the overdue tranche at the end of the consultations. What else could have happened? The IMF had let the recipients of aid payments get away with so much in recent years. Let us remind you of two examples:
• The stand-by agreement with Hungary had barely been signed when the Hungarian central bank reduced key rates by 50bp – despite the fact that in the agreements with the fund it had agreed not to do so. The IMF ignored it.
• At each new review of the aid programme for Ukraine the IMF demanded flexible exchange rates of the government in Kiev. But it was simply ignored. Rather than enforcing the required measures the IMF gave in and watered down its demands.
The logic behind this approach is clear: since the beginning of the financial market crisis the IMF’s main target is no longer a long term stable economic policy of the aid recipinet. In that case it would have to take strict action if its conditions are not met – based on the pedagogical principle of “tough love” as the conditionality has been reduced to the absolute minimum (contrary to the times of the LatAm aid programmes). Instead the IMF’s most important target seems to be the prevention or containment of financial markets crises and in that context the Fund has to be able to turn a blind eye sometimes.
Does that mean that the Greece crisis is off the agenda again for the time being? After all the enlargement of the aid package should now go ahead without any problems. After all the EU had long since made it clear that it did not oppose such a step. But: The sword of Damocles of a “restructuring” is still hanging over Greece if some donor countries within the Eurozone continue to insist on involving the bond investors. Even if the European politicians want to prevent a default of Greece: it remains a tight-rope walk. The rating agency Standard & Poor’s has made it clear once again that “voluntary” restructuring can also lead to a default-rating. That means: there is still a danger that with the “voluntary” involvement of investors the EU unintentionally causes a default of Greece. So it is too early to sound the all clear. As a result we consider the rise of EUR-USD risk reversals (our preferred debt crisis indicator) as a good opportunity to sell the latter cheaply. The bond markets seem to share this scepticism. Risk premiums for Greeks bonds did not fall notably on Friday.
USD: Following the publication of the labour market report on Friday FX markets did not really know what to do with the dollar. The US data in the run-up to the publication had been negative as well. So what was new about the information?
And after all: What is the appropriate reaction to bad US news at present? Sell the greenback as the US is about to turn into Japan, with long term low growth rates, fiscal problems and a permanent zero rate policy? Or buy the dollar as a poor US economy means increased uncertainty with the dollar constituting a safe haven? Following some toing an froing FX markets settled for the former. The lesson we learn from this delay is: reactions to US data are not always as clear-cut as they used to be.
JPY: In view of the disappointingly bad US labour market report and the resulting dollar weakness USD-JPY was able to come dangerously close to the 80.00 mark. Those who remember the interventions in March are likely to consider the area below that as a danger zone. The fundamental reasons that led to the coordinated intervention on the part of the G7 central banks still persist: Japan has slid into recession. The effects of the natural disaster, above all the power cuts, continue to paralyse the country. It remains unclear when the recovery will start and how quick it will be.
On the other hand some time has passed since March. The BoJ and MOF never were terribly keen on defending certain exchange rate marks but preferred a policy of leaning against the wind which simply reduces the speed of certain exchange rate moves. So it is quite possible that the danger zone, which will cause Japanese officials to consider interventions is now much lower. If USD-JPY was to slowly ease below the 80.00 mark that would not look dramatic on the chart. But should this create sufficient momentum for USD-JPY to move downwards quickly that would become increasingly dangerous. This is not the right time for long term USD-JPY shorts. It remains to be seen whether the market gets carried away below the 80.00 mark.
Emerging Market Currencies
TRY: In addition to the current account deficit the central bank (CBRT) now has another problem on its hands: inflation. It rose to a staggering 7.17% yoy, while a rise to just above 5% from 4.26% the previous month had been expected. The central bank’s inflation target is 5.5% and the chances of this being reached are low. In particular if one considers that the CBRT has so far been sticking to its historically low key rate level of 6.25% giving little indication change of course. We assume that the central bank will sound more hawkish next month slowly preparing markets for a rate reversal. As a result the lira’s recovery process against the USD might soon continue.
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