While there are still safe havens and more liquid currencies that are favoured in times of severe stress (such as the recent Cypriot crisis), the new dynamics are quite different, says Simon Smith of FxPro. Yen weakness depends more on the new governor than the flight to safety.
In the interview below, Smith also discusses the current situation in Cyprus for the euro, the long way the Fed needs to go, Japan’s “path of least resistance” and the Aussie’s resilience.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
This is a fast moving situation. At present, I don’t see major contagion risks in terms of banks, but clearly the EU’s reputation has been damaged by its initial proposal for a blanket bank deposit levy. The dependence on whether it’s just a short-term impact depends on the Plan B that emerges and at present, that’s not very clear.
I think the risk-on/risk-off dynamic of FX markets is all but dead in the water now. This has been a theme I was writing about 4-5 months ago. Yes there are still safe havens and more liquid currencies and they will always be favoured in times of severe stress. We’ve seen the yen do well so far this week, along with the pound and the dollar-bloc currencies (Aussie, kiwi, loonie), which is a dynamic that would have been very out of sync with most of last year. So the yen is gaining, but it’s now dramatic and the action of the new central bank governor are going to be more key in dictating near-term direction.
With the recent positive signs in the US, can Bernanke hint about a change in policy, or is he expected to remain on the side of caution?
I would think he’s likely to remain cautious until the recovery is assured and the unemployment rate is much nearer their line in the sand of 6.5%. The lack of positive action on the US budgetary front also warrants continued caution on the part of the Federal Reserve. Still, it’s notable how the divergence in data surprises between the US (generally positive) and the Eurozone (negative, although only modestly so) is helping to push EURUSD lower (among other things). I would expect the language of the statement today to remain largely unaltered in terms of its forward guidance.
I’m not sure that weakening the yen is going to be their immediate priority. Firstly, we’ve seen a fairly substantial move already, largely based on expectations of policy actions, rather than actual measures. Secondly, after the latest G7/G20 meetings in February, the message to Japan appeared to be that the move on the yen had gone far enough. Policy measure are more likely to secure the recent depreciation, rather than push the yen lower, largely owing to the high degree of anticipation already in the price. More likely at this point in time is a bringing forward of the pledge made in January to undertake unlimited asset purchases as from next year. This is the path of least resistance, vs. buying overseas bonds.
There was every reason to take the latest labour market numbers with a grain of salt, not least because they were the strongest monthly gain in 13 years. Also, 45k of the 71.5k gain in employment was part-time males, so there could be an issue around the quality of jobs in these numbers. Still, the resilience of the Aussie remains notable, not least because some would see us as being in a ‘risk-off’ environment. But as I’ve said before, I think the market moved beyond this simple analogy some time ago, with currencies in general becoming more sensitive to domestic conditions and less so to the ebb and flow of central bank balance sheets. The Aussie is an example of this and further gains are likely, but I still see the lower end of the 1.05-1.06 area as providing the near-term peak in AUDUSD.
Further reading: The key to an ECB rate cut is the unwinding of the LTRO