Forex Investment and Currency Trading

It seems the point at which both risk appetite and monetary policy expectations pull the FX market in the same direction is getting a little closer, albeit at a very gradual pace. Risk appetite has yet to materially recover from the blow dealt by the lack of detail in the US Financial Stabilisation Plan. The agreement of a $789bn fiscal stimulus package in the US sparked an equity rally into the US close, but equity market performance in Asia has been weak. Interestingly Australia’s Senate failed to pass the government’s stimulus package. It seems local issues dominated and lawmakers do not feel the same sense of urgency as elsewhere.

In terms of policy convergence within the G10, an exceptionally dovish Quarterly Inflation Report from the Bank of England (inflation substantially undershoots the 2% target on a 75bp Bank Rate trough) and a larger than expected rate cut from the Riksbank accompanied by a downgrade of the Swedish economic outlook have prompted significant rallies in front-end interest rate futures across Europe.
The USD positive trend of intra G10 interest rate spread compression has been reinforced although the apparent reluctance of the ECB to cut more aggressively is limiting the drop in Euro-area over US interest rate expectations. Market sense is that the conditions for a strong USD rally – falling stocks and favourable rate spreads moves – are close to dropping into pace.

Data flow over the last 24hrs is interesting. Overnight China has reported a surge in loan growth as banks step up credit provision in response to government “encouragement”. At present China’s imports are falling more rapidly than its exports. A big part of this is a drop in oil import costs but
nevertheless the recent expansion of China’s trade surplus represents a drain of demand from the rest of the world. This should hopefully reverse as government stimuli kick in. Relatively strong growth in China has mixed implications for the USD. On the positive side strong Chinese demand should assist in re-balancing by supporting US exports. Notable within yesterday’s US trade deficit for December was a narrowing of the US-China trade gap. On the USD negative side Chinese demand could again start to push up commodity prices and foster a general return to risk seeking behaviour. The latter impact is somewhat in the market already given the recent rise in the now ubiquitous Baltic Dry
Freight index.

Today’s highlights are Euro-area December industrial production and US retail sales for January. The on-going contraction evident in the weekly chain store sales data flags significant downside risks while the economist consensus looks for a relatively modest 0.8% m/m decline.