UK monthly retail figures vindicate MPC rate decision

Today’s UK retail sales data for the month of February suggest that the MPC was correct to keep the BoE interest rate fixed at 0.5%. The figure showed a 0.8% contraction in sales volumes, causing alarm bells to ring with regard to the UK economic recovery.

With consumer confidence at an all-time low (according to data compiled by Nationwide) and consumer prices at lofty heights, the poor sales figure is easily explained. Higher central interest rates would mean higher borrowing costs for the UK’s already heavily indebted consumer. So despite the shocking UK inflation data released on Tuesday, the MPC really cannot afford to tighten policy when the UK recovery is on a knife-edge. This may well convince those investors betting on a May BoE rate rise to adjust their positions.

What has this meant for sterling? Well, it has fallen across the board. A figure like this makes a rate rise for May all the less likely, particularly with yesterday’s MPC minutes displaying no significant increase in hawkish rhetoric. Furthermore it paints a gloomier picture of the UK economy moving forward, which was also brought into sharper focus yesterday as Osborne announced a downward-revision of the UK’s GDP projection for the year in during the annual Budget.

In addition to today’s sales figures, another factor adding to sterling’s decline has been some negative comments from Moody’s directed at the UK economy. The credit agency stated that the UK’s AAA rating could be cut if the government’s austerity measures threaten growth prospects. It seems a little cruel for the market to have responded so harshly to the comments given the rating cuts that have hit the eurozone left right and centre in recent months. Then again the pound does not enjoy the luxury of consistent demand from Far and Middle Eastern sovereigns looking to diversify their reserves.

Looking forward to next week, sterling has little on the horizon that looks likely to transform its appeal. We may have to wait until after the ECB rate rise (almost certainly on 7th April) for the pound’s potential to gain recognition. It will then be the BoE next in line.

Richard Driver

Analyst – Caxton FX


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MPC Minutes dishearten investors but high hopes for change were misplaced

After a long time out of the spotlight, the UK again took prominence today as the minutes from the MPC’s March meeting were released this morning. In addition, we saw Chancellor George Osborne announce the UK’s 2011 budget earlier today. The former caught the eye but the latter left the market unperturbed.

Central bank interest rates are the real market-mover at present and an insight into policymakers’ views will always attract attention. The minutes revealed that Andrew Sentance’s hawkish camp failed to coax a fourth MPC member to join their campaign to increase interest rates. Had they succeeded in this, the outlook for a BoE rate rise as early as May would have been greatly improved, particularly in light of yesterday’s appalling UK inflation figures (4.4%!).

On release of the news, sterling dropped sharply across the board, and investors may well have been disappointed by the lack of any real increase in hawkish language adopted within the minutes. Indeed if anything, the tone reflected additional uncertainty following recent global developments, which will likely cloud the UK’s economic outlook.

Osborne’s budget announcement today contained a wide range of interesting material; the headline was probably Osborne’s downward revision of the UK’s growth forecast for 2011 to 1.7% (from 2.1% - itself an already downwardly revised estimate) but sterling has survived this hit relatively unscathed.

Sterling has actually lost little ground to the euro today as some bad news from the eurozone irritated the markets. It has been announced that the EU Summit this weekend will not be reaching a final decision on the ever-troublesome bailout fund. Given that the markets had grown in enthusiasm after initial progress at a preliminary summit, and that they would get a definitive answer this Friday, the delay of the decision until June seems to have frustrated euro-investors. Concerns have also mounted with regard to the Portuguese Parliament’s vote on its government’s austerity measures, which if rejected will almost certainly see its PM resign, and could well be the catalyst for a Portuguese bailout.

At present, sterling remains in limbo around €1.15 with another trigger needed to define direction.

Richard Driver
Analyst – Caxton FX


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UK Headline inflation hits 4.4%: Where does the MPC draw the line?

This morning’s data revealed that UK inflation rose to 4.4% in February, a jump of 0.4% on the month, to the highest level since November 2008. In exceeding expectations, the increase in inflation has renewed the possibility of the BoE shifting interest rates, which has helped lift sterling but the market response has still been cautious.

Why? Mervyn King has already warned that inflation will rise towards 5.0% this year, which has taken the edge of an otherwise shocking increase. The figure also failed to realise rumours circulating of an even larger. Perhaps more importantly though, the data is just one of a series of important UK announcements this week, including the MPC’s minutes and UK monthly retail figures. Investors are likely to want a clearer picture of Britain’s economic conditions before taking up positions.

King has set his stall out in past announcements: he has recognised inflation is alarmingly high but asserts that it’s down to temporary factors which will begin to subside within a year. Moreover, King maintains that the dangers posed by a premature rate cut (which could risk pushing the UK back into recession), outweigh those posed by the current levels of inflation.

The market has fully priced in an August BoE rate rise but some are now leaning to a rate rise as early as May. We find this hard to believe even in light of today’s data, though if tomorrow’s minutes reveal an unlikely hawkish recruitment within the MPC, this argument will be far stronger. A rate rise in June remains our view. The pressure really is mounting on the MPC to slow down inflation - they are at risk of losing their credibility - particularly as the ECB are almost certain to embarrass the BoE by raising rates in a fortnight (inflation in the eurozone is only running at 2.4%!).

Following today’s data, sterling is currently trading at a fourteen month high against the dollar (near $1.64), though this has more to do with dollar weakness than with sterling-positive news. Despite a good day, the pound is still struggling against the euro at lows around €1.15. Looking forward, the risks for sterling are actually skewed somewhat to the downside; tomorrow’s UK budget release is unlikely to inspire the markets and the euro may make some more ECB rate hike-related gains - though these may be limited now that such a move has been largely priced in. Investors may also use sterling’s recent gains as an opportunity to take some profit.

What the pound needs is for Thursday’s UK retail sales data to be positive in order to reignite some confidence in the UK’s recovery, which in turn may convince a couple more MPC members that our economy can withstand monetary tightening. However, this seems somewhat unlikely given the forecasted 0.4% monthly contraction.

Richard Driver
Analyst – Caxton FX


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Long-term yen outlook and what it means for the Antipodeans

Over the past fortnight we have seen the yen initially benefit from strong repatriation flows, which will be needed to rebuild tsunami-torn parts of the country. We then saw an unprecedented move from G7 central banks to intervene and stem the yen’s sharp appreciation (yen hit a post-war high vs the US dollar), which indeed it did. Intervening in the market has historically been unsuccessful in permanently redirecting a currencies momentum, but with the global coordination of this intervention, things will likely be different on this occasion. After all, Japan is the world’s third largest economy and the global recovery is fragile; if Japan suffers, we all suffer.

The yen has little going for it at present. Its growth prospects are poor, which means that its interest rates are extremely low, and the Bank of Japan showed last week that it will print money to boost the economy when necessary. The intervention confirms what we already knew- the BoJ will not allow the yen to appreciate any further. With uncertainty surrounding the effects of the national disaster on the Japanese economy, investors are likely to look elsewhere for safety, such as the ever-appealing Swiss franc or gold. Sterling has had an excellent 2011 against the yen and we do not see this trend reversing, even if market sentiment towards the UK economy is mixed to say the very least.

So what about the kiwi and aussie dollars? The kiwi is in a similar boat to the yen. With an underperforming economy and a recent rate cut, those brave enough to invest in riskier currencies are turning to more promising prospects such as the euro. We therefore see a continuation of the Kiwi’s underperformance for the foreseeable.

On the other hand, the Australian economy is by no means performing poorly, but there is a sense that the aussie may struggle to build upon the gains made in the past couple of years. The aussie has benefitted from aggressive monetary tightening, but this process has slowed and the likelihood is that we will see just one rate hike this year (less than the BoE and the ECB’s expectations for example). Combine this with prevailing risk adverse sentiment and the hit to Japan (Australia’s second largest export market) and we do not see the aussie dollar enjoying too much more appreciation this year.

Analyst – Caxton FX


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Crunch Time: EU Summit

Next Friday’s EU Summit marks a self-imposed deadline for eurozone leaders to reach an agreement on a “comprehensive package” to deal with the region’s fiscal problems. Progress was made earlier than expected at the preliminary Summit last weekend, and the markets responded positively – perhaps too positively if Trichet’s recent pessimistic comments are anything to go by.

Most significantly, EU leaders reached an agreement to expand the European Financial Stability Fund (EFSF). However, the more realistic tones coming out of the Summit are stressing that “the devil is in the detail” and whilst broad principles were agreed, the financial technicalities involved in actually implementing those principles pose a huge obstacle to concrete commitments.

Certainly, the enlarged bailout fund is a step in the right direction but it is more difficult for the EU member states to agree in what proportions they should contribute. One would assume larger states such as France and Germany would shoulder the burden but their national publics are growing tired of this ‘duty.’ Another issue surrounds the continuation of the ECB’s bond-buying role instead of allowing the EFSF to buy bonds on the secondary market, which Trichet feels particularly aggrieved about. Superseding all of this is the fact that the EFSF is set to expire in 2013, with the European Stability Mechanism to replace it, so agreement on the shape of this longer-term fund is paramount next week.

Coming into this month, the markets were cynical as to progress on EU debt issues. However, with Trichet turning up the heat on EU leaders (indicating borrowing costs would be increased in April with an ECB interest rate hike) we saw greater political commitment last weekend and increased market confidence followed. The euro has strengthened against the US dollar and sterling accordingly, despite several recent peripheral credit downgrades and very high bond yields.

It is possible that agreement on a “comprehensive package” next week will trigger a strong euro rally next week, persuading the markets that the eurozone debt problem can finally be put to rest. More likely though, in this risk adverse environment, is that the markets will greet an agreement positively but remain broadly cautious on the euro. Any gains will be incremental as markets await further proof that the situations in Portugal, Spain and Greece will improve. Sterling is likely to suffer against the single currency if the Summit is successful, at least in the short term, given that the ECB is almost certain to raise interest rates before the BoE. However, the pound should continue to outperform the US dollar, tracking euro strength.

Richard Driver
Analyst – Caxton FX


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Market Volatility Explained

The beginning of 2011 has thrown up a series of major market-moving events and we thought it’d be useful to take a closer look at the extent to which localised unrest and disasters can send shockwaves through the currency markets, and why. After all, how many of you would expect that the Norwegian Kroner will directly benefit from social uprisings in Bahrain? (Norway is a major oil producer, Middle Eastern tensions push oil prices up, Norway profits.)

Whilst the currency markets are more volatile than, for example the equity markets, in calmer times even currency movements can be relatively predictable. When the market spotlight is focused on economic fundamentals, data announcements have a direct impact and exchange rates are more faithful to trends. In early 2011, we saw sentiment governed by interest rate speculation and sterling benefited accordingly whilst the greenback suffered.

However, such factors are of little relevance to investors during times of uncertainty. Most recently the Japanese crisis, but before this the natural disasters in Australia and New Zealand, and unrest throughout the Middle East and North Africa, place traditional economic factors on the backburner. Long-term investors flee to the safety of currencies such as the Swiss franc, the US dollar and the Japanese yen. Short-term investors, or “speculators,” react so quickly to events that their movement is as unpredictable as the freak occurrences on which they base their currency “bets.”

Using the Swiss franc as an example, market volatility surrounding natural disasters is clearly visible in the context of the Japanese earthquake/tsunami/nuclear crisis, and is clearly visible. The “swissie” climbed 6 cents against the Australian dollar from 1.06 to 1.12 in the space of 3 days, having hovered around the 1.06 mark for the preceding three weeks. Investors abandon calculated risks on currencies such as the aussie, euro and sterling, and revert back to safety in such uncertain times leading to sharp appreciation of “safer” currencies such as the Swiss franc.

We can be confident that these times of heightened volatility will prove temporary. As events stabilise in states such as Bahrain and Japan the market’s will begin to calm down and factors such as interest rate differentials and growth potential will return to focus, bringing with them more predictable currency investments. However, amid soaring debt levels in eurozone peripheral countries, there may yet be another crisis round the corner unless the EU can reach a firm agreement at their Summit meeting next week.

Richard Driver
Analyst – Caxton FX


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Eurozone crisis still bubbling under the surface

The crisis in Japan is understandably dominating the headlines in the financial markets as the impact on the global economy is contemplated. Aside from this, the state of emergency in Bahrain is also providing reason for the markets to remain in a heightened state of nervousness. The country’s debt rating has been cut to BBB by Moody's and there remains the possibility of an Iranian militarily intervention if the protests escalate.

Although it’s not dictating market direction at present, bubbling under the surface (and surely soon to come back under the spotlight) remains the eurozone debt crisis.

After last weekend’s EU Summit, the markets responded positively to news that EU leaders agreed to expand the European Financial Stability Fund to €440bn euros, which will now have greater capacity to cope with further euro-area bailouts. But Trichet’s comments this week suggest that the markets may have got overexcited about the weekend’s early progress. Trichet dismissed the agreement as “insufficient” and it’s quite clear that in order to reach the “comprehensive package” there are some serious obstacles to be overcome. It remains to be seen whether the agreement can actually pass through the European Parliament and whether the populations of large eurozone countries, such as Germany and Austria, can be convinced to increase their financial commitments.

Portugal’s credit rating was downgraded by Moody’s yesterday, and the euro suffered accordingly. A Portuguese bailout seems on the cards and a Greek default is certainly probable in the coming months. Any perceptions of a new safe-haven currency in the form of the euro – as was seen in City AM this morning - are wholly misguided; the downside risks to the euro in coming months clearly outweigh its upside potential.

Richard Driver
Analyst – Caxton FX

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And its the Swiss Franc coming up on the outside...

Whilst Japan continues to dominate the headlines we have seen the yen and dollar strengthen as the markets chase the solace of safe-haven currencies. However, there is one very well-performing currency that may have crept under your radar- the Swiss franc, A.K.A the Swissie. Due to Switzerland’s economic, political and fiscal stability, the franc represents the third major safe-haven currency. Indeed the swissie has today climbed to its highest point against the US dollar in at least 40 years and is rallying against all its major counterparts, which illustrates its increasing popularity in these times of extreme market uncertainty.
However, just as the Japanese government is determined not to let the yen appreciate too strongly, the Swiss National Bank (SNB) has showed willingness to intervene. The bank intervened last year when it considered the swissie to be overvalued, and it could do the same again if the soaring currency threatens the country’s economic growth, having stated last December that it would “take measures necessary to ensure price stability.”

The Swiss government are concerned about maintaining the strength of its export sector, but a closer look reveals that despite currency appreciation, its trade surplus actually widened last month. In addition, last year’s intervention was broadly unsuccessful (as intervening often is) and cost the SNB $25bn. In light of this, and amid a healthy economy, it seems unlikely that the SNB will act any time soon, though one has to wonder how far they will allow their currency to appreciate. This will surely come to the point if Swiss growth were to slow down and safe-haven appeal remain strong.

Against sterling, the swiss franc has gained 5% over the last month with the rate currently at 1.47. But there is certainly room for further gains with the rate still some way from the 1.44 levels seen at the end of 2010.

In other news, investors looking for higher yields might, ironically, look to Quantitative Easing, racing at Cheltenham Festival on Thursday, people say he has a licence to print money...

Richard Driver
Analyst – Caxton FX
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Japan announces a major round of quantitative easing: how will the yen fare in response?

Reacting to the devastating impact of the earthquake that struck on Friday, the Japanese central bank has announced its intention to pump a record ¥15tn into the economy ($183bn). This follows the reaction of the Reserve Bank of New Zealand to the earthquake that struck Christchurch, which opted to cut rates by 0.50%. With Japanese interest rates currently at next to nothing (<0.10%), the Bank of Japan clearly can’t follow suit, and has therefore opted to loosen monetary policy through flooding the money markets and buying government bonds.

The two countries’ approaches are alternative ways of achieving the same basic goals - to give consumers ‘a break’ in amid social upheaval and to provide support to fragile economic growth.

The so-called policy of quantitative easing that Japan has announced this morning invariably has the effect of weakening the economy’s national currency. The US Federal Reserve’s ‘QE II’ program has been responsible for the dollar’s woeful underperformance over the past year or so. Money-printing increases supply, thus weakening the currency as demand eases.

Accordingly, the yen declined against 13 of its 16 major counterparts as markets reacted to the news. However, just as the New Zealand Dollar did in the immediate aftermath of its rate cut last week, the yen has rebounded relatively strongly. There is a sense that New Zealand’s economy may eventually benefit from Christchurch’s disaster, with its construction sector in particular expected to enjoy strong growth. The same was thought of the Japanese construction sector but the apparent devastation suffered in the country’s north-eastern region seems set to provide a genuine setback to the Japanese economy in 2011. The country has suffered major damage to its infrastructure- most notably its roads and highways, factories and nuclear plants.

Fundamentally, we can be pretty confident of one thing- the yen will not strengthen this year. The Japanese government has this morning said as much. It threatened intervention to curb any sudden yen appreciation, asserting that it “will take decisive steps if necessary” (indeed the BOJ acted on their threat in September last year, though the impact was fleeting). So anyone hoping for a yen appreciation to mirror the aftermath of Japan’s last major earthquake in 1995 will be disappointed.

Behind the government statement is the concern that Japan is an export-dependent country which relies on weaker exchange rates particularly in times of low-growth. When a government makes this sort of statement, market appetite for the related currency is understandably dampened.

Will the yen decline? Well, the scale of the disaster is continually being revised up, and in light of this morning’s government statement, the yen could be set to weaken despite a thus far robust post-quake performance. In addition, we see risk appetite increasing over the course of 2011 and anticipate that funds held in yen will be redirected to higher-yielding, riskier currencies.

Richard Driver
Analyst – Caxton FX


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Tsunami hits Japan- how have the currency markets responded?

Japan has suffered from one its most powerful earthquakes for a century, unleashing a devastating tsunami across its northern coast. Today’s events follow last month’s earthquake in New Zealand, and January’s flooding in Australia. Japan represents the world’s third largest economy and the effects of this disaster are being felt throughout the global financial world.

The immediate response to the quake saw the Japanese yen fall across the board. This is understandable; it comes only two days after Japan announced that its economy slipped back into contraction last quarter. However, the market’s slightly longer-term response to the quake is somewhat counter-intuitive.

Since its initial dip, the yen has rebounded very strongly against all its counterparts as the markets. Why? The yen is one of the world’s few safe-haven currencies, which investors turn to in times of uncertainty. The earthquake may have occurred in Japan, but the global financial markets are intertwined and the widespread concern that has been triggered has seen the yen appreciate impressively. Market appetite for safety had already been heightened this week amid soaring oil prices, turmoil in the Middle East and North Africa, and eurozone debt concerns – this earthquake merely confirms this recent investor mindset. Accordingly, other safe-haven currencies such as the US dollar and the Swiss Franc have today strengthened against riskier assets such as the euro and sterling.

So will the yen continue to benefit from the earthquake? This will not be clear until the extent of the damage to the Japanese economy is ascertained. If Japan’s last major earthquake in 1995 is anything to go by, then the yen will continue to appreciate impressively. But the yen has heavily underperformed this year and with Japanese interest rates low and growth prospects poor, it will take prolonged risk aversion for this downwards trend to be reversed.

In other Caxton FX-related news, it was excellent to see fellow analyst Duncan Higgins quoted by Reuters today on his UK rate rise forecast.

Richard Driver
Analyst – Caxton FX


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