The list of people who think the euro will survive is growing. It isn’t clear whether Alan Greenspan is actually one of them, of course, but his comments about the euro ‘breaking down’ made grizzly headlines yesterday afternoon and overnight. And with the equity market yet again unable to build on early strength and manage a meaningful bounce overnight, while the Europeans bicker about the terms of the latest Greek bailout, there are plenty of straws for euro bears to cling to. Yet, here we are again, at EUR/USD 1.44 ahead of IFO, durable goods orders and US house prices.
Our year-end EUR/USD forecast of 1.45 reflects the impasse between sluggish growth, central banks that are almost powerless to act, and a general dislike for both currencies. Our longer-term forecast of a move through 1.50 represents a belief that the euro will survive rather than break up, while the US economy will avoid a return to recession (other than in a some technical way) but won’t grow fast enough to alter a preference for a weak dollar and a super-easy Fed policy bias. Our frustrations is that the lack of appeal of the two main currencies can’t translate into strength for some of those with clearly superior fundamentals but a bias to rally on ‘risk on’ days – like KRW, SEK, NOK. The upshot of that is a tired market that could see volatility drift lower ahead of the September data round.
Meanwhile, those nice people at Moody’s downgraded Japan and warned the US that further fiscal consolidation is needed to avoid them getting a downgrade, too. That will cheer the folks at S&P up. Japan downgrades, which have been happening for years, are a useful reminder that downgrading a major sovereign clearly does not imply, per se, that its currency will fall or its bond yields rise. Indeed, if anything it just reminds us that rating agencies place a lot of importance on debt levels, when in fact, these do not correlate well at all with the probability of sovereign default -at least over the hundred-odd years of rating agency history. The one thing that has changed without a doubt this summer, has been that the first rate hike from either the Fed or the ECB is now much further away in the future than it was, and the yield on 2-year US and European government debt has moved markedly lower. That is unambiguously positive for the yen relative to euro and dollar, and for all that talk of BOJ ‘watching the market’ at some point in the coming weeks we will see Japanese appetite for intervention out to the test again.
The decision by the BoJ/MoF to put 100bn available in reserves for its development arm while easily dismissed by the market should not be for exotic EM markets. It opens a large amount of capital to invest in destination where Japan is building up its presence, much as China has been doing for a while. It is also an indication of the future shift of foreign reserves globally out of US and European fixed income to asset classes with some potential upside. It is a positive for the development of capital markets in developing and exotic economies and a necessary condition for global rebalancing. Nonetheless, the set of decisions taken by the Japanese authorities were disappointing suggesting a leg down is possible.
Today’s key reports – IFO and US durable goods orders – are likely to follow recent trends and display weakness. There’s more hope of a positive surprise form IFO given the resilience of the German, than there is of durables. An empirical study shows that the PMI is a decent lead (it was flat) while the ZEW continues to be an indicator of sentiment in the financial industry and lead nothing. The Richmond fed data were poor yesterday adding to a depressingly long list of soft Fed surveys. The market is waiting for Jackson Hole. Another failure by the S&P to bounce would set it up for another test of the lower end of the range instead.
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Societe Generale
Research & Analytics