Forex Investment and Currency Trading

Eurozone German ZEW economic sentiment unexpectedly fell to -41.4 in May, against market forecast for an improvement to -37.0 from -40.7 in April. The expectations of investors and analysts almost came back to the January trough of -41.6, which had been the worst level since January 1993, despite the recent positive news from financial markets. Meanwhile, the assessment of current conditions rose to 38.6 from 33.2, probably reflecting the good news for 1Q German GDP. EUR pared losses after the release as ZEW President Franz said that the ECB might raise rates in the near future if inflation pressures continue. He also added that 2Q German GDP growth rate might be near zero. A rate hike discussion so far has very limited consensus support within the ECB. Nonetheless, the ECB will likely harden its stance somewhat in June, with higher inflation projections for 2008 and, to a smaller extent, for 2009, but likely to shy away from an explicit rate hike warning.
Switzerland April producer & import price eased to 3.6% yoy from 3.9% in March, as the deceleration in import prices (3.6% yoy from 4.6%) more than comfortably offset the slight pick up in domestic PPI (to 3.6% yoy from 3.5%). However, the April headline reading was above expectations for 3.4% yoy. The strong CHF should continue to exert downward pressures on imported inflation, giving way for monetary policy easing towards the end of the year as economic activity softens.

Japan As expected, the BoJ Policy Board left the overnight rate target unchanged at 0.50% by a unanimous vote, and the Bank also left its judgment on the economy (“slowdown due mainly to higher energy and raw materials costs”) unchanged. BoJ Governor Shirakawa’s statements remained well balanced. On the dovish side, he ignored the 1Q GDP growth acceleration and emphasized the ongoing economic slowdown. He reiterated that the BoJ is still focusing on downside risks to the economy, indicating that the Bank is guarding against potential downside risks to private domestic demand, particularly capital spending, resulting from a weakening of the income generating power on the back of terms-of-trade deterioration. On the hawkish side, however, Governor Shirakawa said that inflation risks have also been on the rise, and that the degree of monetary stimulus has not changed much. Thus, the BoJ is likely to remain firmly on hold. The May 20 Nikkei reported that Japan Post Bank (formerly the Postal Savings System) intends to invest at least Y1tn out of its huge postal savings assets (Y181tn at the end of September 2007) in foreign assets, including US and European corporate bonds during FY2008. Normally, most banking accounts are typically foreign currency funded for their foreign bond investment. However, the Japan Post Bank manages huge JPY postal savings, so its foreign bond investment should be accompanied by some JPY selling. As the bank still needs to guarantee principals of formerly deposited postal savings, only a fraction of its assets should be invested in risky assets. As for the Japan Post Insurance (Kampo, formerly the Postal Insurance System), the firm reportedly intends to concentrate in domestic investment for the time
being. However, as Kampo probably finds private-sector life insurers’ asset allocation patterns more rational, the firm should shift toward foreign assets over time. Thus, as the Yucho and Kampo seek higher yields, they will probably be among major JPY sellers, and their asset allocation changes should be moderately negative to the JGB market.

Australia In something of a bombshell, the minutes of the May RBA board meeting revealed the following: “The question … remained whether the setting of monetary policy was sufficiently restrictive to secure low inflation over time. Members spent considerable time discussing the case for a further rise in the cash rate.” We have always characterized the RBA stance as a conditional tightening bias but this wording was more explicit than the market had expected. In its discussion on inflation, board members noted the broad tenor of price increases, with three quarters of the CPI basket increasing at a pace beyond the mid-point of the 2%-3% target range. The RBA revealed that its calculations of around 20% terms of trade gain this year were based on contract price increases of 80% for iron ore, over 200% for coking coal and 125% for thermal coal. Notably the RBA supported the contention about a cheap currency vs terms of trade: “Members thought that the rise of the exchange rate over recent months had been less than might have been expected given the strength of commodity prices.” The minutes also took an optimistic view of financial sector repair in Australia, with limited fallout from the global financial turmoil. After the minutes were out, AUD/USD spiked by more than 0.5%, and yields across the curve are high by about 10bp. Before the minutes, the curve was
pricing in less than a 50-50 chance of a hike later this year, but a hike by around August — the call — is now seeming likely.

New Zealand The IMF annual assessment of NZ garnered a lot of attention largely because the organization recommends NZ keep interest rates on hold during this period of above target inflation, until the state of the economy becomes clearer. The IMF consults with the Government and monetary authorities during these consultations. As of Monday’s close, the NZ credit market was pricing in
almost no chance of a June cut but an 80% chance of a July cut and between one and two 25-bp cuts overall by the September meeting. There was little change in the rates curve after the IMF report, the market perhaps construing that “waiting” means July or shortly thereafter.