G10 Currencies
EUR: On to the next act of the Greek debt crisis: the rating agency Standard & Poor’s has lowered Greece’s rating by three notches. At CCC the risks are now considered to be “substantial” and the securities are “extremely speculative”. A lower rating than that is difficult to achieve as there are only two more notches between CCC and D (default). Moreover the rating agency has made it clear once again that an involvement of bond holders into the aid package would result in a downgrade to D. But that is exactly the proposal brought forward by the German Finance Minister Wolfgang Schauble. He is hoping for an extension of maturities.
As justified as his demand might be from a political point of view: it is pretty explosive. It would not just cause uncertainty on the financial markets as the bond holders were told that they would not have to assume responsibility for Greece until 2013. That alone would not be anything unusual. Investors had to get used to the fact over the past 1 ? years that the crisis in Greece was deteriorating and that an investment in Greek bonds was a mistake due to falling prices. The very determined attitude of the ECB is what makes the involvement of the private sector so explosive.
The new president of the Bundesbank Jens Weidmann once again underlined this attitude. It is difficult to tell that Weidmann, advisor to Chancellor Angela Merkel until a few months ago, was involved in politics until quite recently. His point of view is very clear: the ECB rejects any involvement of the bond holders. Not because it would be unacceptable as such but as it is unacceptable in the current situation. His calculation is very simple: if the maturity of the bonds were extended that would put further pressure on the Greek banking system. The Greek bonds held by the ECB would be worth even less. So the ECB would be paying the bill in the end. Weidmann is very open about the fact that he considers the purchase of bonds on the part of the central bank to have been a mistake. But he thinks that it is now up to the governments to ensure the liquidity of the Greek banks, and if they want to ensure that they have to make sure that the bonds which the ECB has accepted as collateral are not worthless.
“Should we see a credit event or should the bonds be rated as defaults the central banks can no longer accept these bonds as collateral. This would be against our mandate” said Weidmann. If it came to that the ECB would accept a Greek insolvency. According to Weidmann that is the only way of preventing the euro from suffering.
USD: The fact that the euro has not come under heavier pressure against the USD and has been able to recover slightly since Monday morning (low at 1.4295) is due to the debt crisis “made in the USA”. The Democrat administration is still unable to agree on an increase of the legal debt limit with the Republicans. At present the limit is USD 14.3 trillion and was reached in Mid-May. Due to “extraordinary measures”, i.e. a clever way of booking costs, the US has remained solvent. According to the government an agreement has to be reached by 2nd August or the collapse will be reached. The Republicans do not think that the savings efforts of the Obama administration are far reaching enough so far.
There are now reports that large American banks are getting ready to sell large amounts of Treasuries should the emergency arise in August. We consider reports of this nature to have little substance. First of all it would make little sense for an investor expecting the insolvency of the US to wait until August to sell the Treasuries and secondly they would certainly not announce the sale. So far the yields of US Treasuries have not been showing any signs of selling pressure (see chart).
Even if the report is probably untrue it illustrates the level of uncertainty. In the end the politicians in the US will agree on an increase of the debt limit but until that is the case the dollar is likely to remain under pressure. The threat of a US default is more important than the fact that the pressure created by the Republicans is going to lead to a more rapid reduction of the US deficit.
As a result EUR-USD is likely to remain stuck between the two debt crises. US retail sales are particularly likely to attract attention on the data side today. We expect to see an ex-auto value slightly above consensus (+0.2% mom). We would have to see a major surprise though for the US dollar to receive any notable support.
JPY: As expected the BoJ’s rate decision last night was a non-event. Neither key rates nor other central bank programmes were changed. That means that the central bank continues to do everything it can to support the economy even if its view of the economic situation is slightly more optimistic. On the data side of things industrial production for April was revised slightly upwards last night and is now recording a slight growth of 1.6% mom. This was however preceded by a 15% collapse the previous month. The yen has been hardly affected by all of this over the past few days and USD-JPY continues to trade around the 80 mark.
Emerging Market Currencies
CNY: Activity data for May released today gave a boost to markets that had been concerned about a sharp slowdown in China. CPI data however shows that China still has an inflation battle to be waged. Industrial production slowed by less than expected and fixed asset investment growth actually picked up. Meanwhile, CPI inflation deteriorated further. The data was positive for CNY, Asian FX generally and global risk appetite. CPI rose by 5.5% year-on-year in May, in line with expectations and up from 5.3% year-on-year in April. The increase was broad based, with non-food inflation rising by 2.9% year-on-year, up from 2.7% year-on-year in April, while food inflation rose to 11.7% year-on-year from 11.5%. Industrial production grew by 13.3% year-on-year, only down slightly from 13.4% year-on-year in April. This is consistent with leading indicators of output such as the already released PMI. Fixed asset investment rose by 25.8% year-to-date year-on-year, a slight increase on the month prior and again exceeding expectations. The market responded to the data with a sharp improvement in risk sentiment and strengthened expectations of CNY gains. Shanghai stocks rose sharply after the data, while USD-CNY 1m NDFs fell and the risk and growth sensitive AUD-USD rose. We think today’s data should give policymakers the confidence to proceed with further monetary tightening. The last interest rate hike was in early April and the pace of tightening has slowed since the average 25bp rate hike every 1.8 months set between October and April. As such, we should expect another 25bp interest rate hike by end June. That is positive for the CNY.
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