The European Central Bank is unhappy with the tightening credit conditions, and could act in December or in January to counter this trend with new easing measures, says Simon Smith of FxPro. Such a move could weaken the euro. However, any measure such as a new LTRO or a rate cut is far from perfect.
In the interview below, Smith also talks about which currencies could ride on a potential US default, the falling chances of QE tapering and more.
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.
In case the US defaults, which currencies could strengthen?
In the run up to and during the government shutdown, it’s been noticeable how the yen has been trading more as a safe haven. It’s also been more volatile than the other majors, even the Aussie. This is also reflected historical volatility, the Aussie moving below the yen on more short-term (2-month) measures. So the primary candidates are the yen and the Swissie, with the euro following behind, by virtue of the fact that it is the second most liquid currency after the dollar. The Swissie is capped by the floor on EURCHF, but I don’t see this as being under threat.
Assuming a swift resolution of the crisis in the US, how high are the chances for QE tapering in Bernanke’s time? Will the current policy be passed to Yellen as is?
This now looks more likely than not. Any resolution is going to be temporary. You can’t make long-term sensible decisions for the US economy and finances under such pressure, so we’re going to have further weeks of negotiations and uncertainty, potentially on both the budget and also debt ceiling. This is likely to impede investment and spending, more so than the actual government shut-down itself. It’s difficult to see the Fed tapering against this back-drop. As the September minutes showed, they are leaning towards that direction, but will be concerned about the fall-out of such a move against such an uncertain backdrop.
US oil production continues rising. Can this serve as a long term boost for the US dollar?
Yes, it will certainly be a supportive factor. Over the past two years, the trade deficit on oil that the US runs (because it has to import oil) has halved. This means that we are seeing a solid structural (rather than cyclical) improvement in the trade deficit the US runs.
The ECB has mentioned it is open to more monetary action. With tighter credit conditions and falling inflation, could the ECB introduce a new LTRO or a rate cut as soon as its next meeting in November?
For choice, I think December or January is looking more likely. The ECB’s balance sheet is contracting because banks are re-paying 3 year loans early because they don’t need the extra credit. The ECB sees this as an issue because it puts upward pressure on money market rates and tightens monetary conditions and (all else equal) puts upward pressure on the currency. The solution is not as simple as just offering more long-term loans, because why would banks take the money at a time when they are re-paying loans. The ECB has to think round this issue and I am not sure they there yet. They would have to offer loans on better terms than the ones being repaid. But then you are in a situation of the ECB solving a credit crisis by offering ever cheaper lending to trouble (and not so troubled) banks. It’s a strange world. On the face of it, cutting rates from the current 0.25% is the easier route, but the impact may be limited by the continued paying down of loans, putting upward pressure on market rates.
China reported a surprising drop in exports. Is it a canary in the global economy’s coalmine?
I don’t think so. It never pays to read too much into one month’s data, especially for China. It’s the growth in credit, especially beyond the banking sector, that remains the “canary in the coalmine”. It’s less visible that the economic data, but is the bigger threat because it’s the result of China’s efforts to counteract the impact of the global financial crisis a few years ago.
Further reading: NO Taper Wrap Up – All the Information