Forex Investment and Currency Trading

USDJPY has breached trend line resistance levels, but this move has been helped by a sharp decline in
EURUSD. The lower EURUSD has not only been driven by EUR specific factors such as Portugal’s downgrade by Fitch, but also by USD supportive effects coming on the back of China reporting its first trade deficit since 2004 (reported yesterday). China has focused its economic rebound on domestic demand which has been particularly supported by infrastructure investment. The shift away from export driven towards domestic demand driven growth suggests China’s currency reserve growth is running at a slower pace. The slower currency reserve growth will reduce the supply of USD’s on fx markets. Since January central bank reserve managers have sharply reduced the reallocation of incoming currency reserves which has additionally worked in favour of the USD. The anticipated decline of China/Asian currency reserve growth will not only support the USD – it will over time also develop a liquidity decreasing effect which will work against global bond markets that have in the past decade benefited significantly from currency reserve managers buying into Western bond markets (recall 2003/07). During this time global currency reserves growth accelerated leading to what Greenspan called the ‘’glut in Asian savings’. Sovereign bond yields of currency reserve countries declined well below nominal GDP. Now as reserve growth shrinks we have to expect the opposite effect, which we believe will mainly work in support of USDJPY. The decline of currency reserve growth will reduce official demand for Western sovereign bonds which will then be in need of replacing the lag in official by private investment flows. Cross borderwise, traders expect private Japanese investors to replace official Asian investors, which will take USDJPY up.

EURUSD has finally broken lower as investors start understanding that any European aid for Greece will only
come at German conditionality. However, some suggest not confusing matters. Some market agents are under the impression that German conditionality would be born out of a dogmatic political viewpoint occupied by the German government. If this was the case then the German position would be adjustable. But, the harsh German position is due internal Constitutional requirements and these are not adjustable. For now, European economic data releases remain irrelevant. Germany no longer equals EMU, impressively illustrated by the release of EMU industrial production data. While the market was betting for a strong number (inspired by a strong German reading) the release showed surprising weakness due to imploding activity in peripheral counties. Fitch’s downgrade of Portugal is significant. Bear in mind that bank net claims against Greece are only USD23bn), while the net claim against Portugal are USD196bln and against Spain are USD800bn). In other words, banks have contributed significantly to the funding of peripheral countries, but in the case of Portugal and Spain the funding was inadequately covered by domestic deposits or other bank liability.