Spanish Bailout? Is Risk On Or Off?
Brief Summary:
• This week had been a fairly light in terms of FX market moving data although Wednesday proved a point of inflection. The AUD held narrow ranges against the majors last week, AUDUSD around 1.0250 until it made a comeback Wednesday, breaking 1.0300 to be 1.0313 at time of writing. AUDEUR weakened to be 0. 7876 and AUDGBP was 0.6394 at time of writing.
• Spain continues to postpone its official bailout request from the European Central Bank (ECB). The Euro has strangely found support on rumours a bailout request in imminent. One’s intuition would see a multibillion euro sovereign bailout as a negative economic event, although the market seems to see it as the lesser of two evils, “breakup” or “bailout”. The European Economic Summit begins Thursday and will provide further direction on the debt crisis.
• The Reserve Bank of Australia (RBA) released minutes from its October monetary policy decision on Tuesday. The minutes were typically inconclusive and aligned with the release issued on the day of the decision. Particular mention was made that it was too early to see the full effects of earlier interest rate cuts. This rhetoric leans toward a “wait and see” stance for the next meeting, although interest rate markets continue to price in a high probably of a 25 basis point cut in November.
• China released their trade balance over the weekend. The figure was a surprise positive at 27.7 billion from 20.4 billion expected and the best since June 2012. According to Bloomberg, whilst exports to Europe were 10.7% down on the equivalent month last year, the slack was more than taken up by increased exports to Southeast Asia and the U.S. Additionally, customs data showed imports of iron ore were of the biggest volumes since January 2011, albeit at relatively lower prices. This gave the AUD some support on Monday after the IMF’s World Economic Outlook soured the risk mood last week.
The AUD’s diversion
•We revisit our chart from the lead up to Quantitative Easing 3 announced on the 14th of September and examine how the AUD has tracked since then. The chart shows the S&P 500, a US stock market index and classic bellwether of risk sentiment, versus the AUD, NZD and CAD. The S&P 500 is arguably a prime target of QE3. Recently, the AUD has broken its correlation with the S&P 500, a relationship that at times has been close to perfect.
• The AUD has performed poorly since the announcement, with other risk currencies preferred; the NZD and CAD. Following the announcement, the AUD has had an RBA interest rate cut and uncertainty has risen over Chinese growth. Failing any bad news out of China, one can expect this divergence to correct either with a relative depreciation of other risk currencies, or further appreciation of the AUD.
• The AUD has reacted positively to a better than expected trade balance figure of 27.7 billion, released over the weekend. Furthermore, US manufacturing and employment data has also delivered positive surprises.
• The next tests will come this week with Chinese GDP released on Thursday the 8th, and the HSBC Flash Purchasing Managers’ Index (PMI), a measure of manufacturing activity, on Wednesday 24th. In the U.S., the Philly Fed PMI is released on Friday the 9th; this will give more direction to the strength of the U.S. recovery. Some good figures may give the AUD the support needed to break the bearish cycle of the past three weeks.
• As has been reiterated before, despite a rate cut our benchmark interest rate remains the highest in the developed world, and we maintain our AAA sovereign credit rating held by only a handful of countries.
•Please see below for specific currency commentary.
AUDUSD
• After touching a 3-month low last week of 1.0150 the AUD has strengthened to 1.0313 at time of writing. As stated above, positive Chinese trade balance data and a general increase in risk sentiment has buoyed the AUD.
• The Philly Fed PMI, a measure of manufacturing activity in the US, is released on Friday. The index, where a positive number indicates expansion and a negative contraction, has been negative since April. September’s figure beat expectations at -1.9 from -4.9 expected. This month’s figure is expected to be slightly positive at 1.3, in line with improved US employment data released two weeks ago.
• The biggest upcoming event for the USD remains the 57th Presidential Election on the 6th November. The second presidential debate was held on Wednesday with most commentators awarding Obama the win. A particular theme was that of “China-bashing”, in particular, Governor Romney strongly reiterated his stance of labelling China a currency manipulator. This combative stance seems a strange way to approach China given their significant and crucial trade partnership. Interestingly, no such mention was made of currency manipulation undertaken by the Swiss National Bank, Japanese Central Bank or even the Fed, given QE3.
AUDEUR
• The EUR has continued to strengthen against the AUD on hopes the fragile union will remain united. After touching 0.8000, last week’s high, AUDEUR has weakened to be 0.7876 at time of writing.
• Rumours of an imminent Spanish bailout request have been providing the EUR with short term support over the past few weeks. As stated previously, a Spanish bailout is seen as the lesser of two evils; “breakup” or “bailout”. Moody’s also affirmed Spain’s investment grade rating of Baa3, a downgrade would have lead to Spain being further cut off from funding markets.
• AUDEUR has returned to levels last seen in June 2012, after touching an all time high of 0.8600 during August 2012. Recently, the mood surrounding the fate of the EU has lightened significantly, with several important steps being taken to resolve the crisis. One was the establishment of the European Central Bank’s bond buying program designed to lower borrowing costs and stop contagion, another was the ratification of the European Stability Mechanism (ESM). Additionally, the rhetoric from German officials has slowly become more supportive of a Spanish bailout and more accommodative of Greece. The EU economic summit, beginning Thursday, will provide more direction on future reforms and the steps to a resolution of the crisis.
By Chris Chandler