special reports

$ Strength in a Sea of Turmoil 
€ Decidedly Dour Euro
¥ Feeling the Pain
₤ An Economic Slump Darkened By Death
₣ Data Shines Swissie Dulls

Strength in a Sea of Turmoil 

Economics didn’t matter this week. To be sure modestly better than expected housing data did help the greenback at the beginning of the week, however, neither the putrid LEI number which printed –0.6% vs. –0.5% expected nor the lackluster Durable Goods report which hobbled in at –0.3% vs. 0.4% expected hurt the dollar as it gained better than a 100 basis points against all of the majors. The source of its strength was the escalating conflict with North Korea which continued to move along with preparation to fire an intermediate range missile across the sea of Japan, eliciting very harsh rhetoric from Japan which sent its navy ships streaming towards the destination. With diplomacy apparently getting nowhere despite unified calls to stand down by US, China and Russia, traders flocked to the safety of the largest and most liquid unit in the market, pushing the dollar higher until its was finally able to take out the 1.2500 barrier in New York trading on Friday.

Meanwhile, intelligence reports say fuel tanks have been seen around a missile at the North's launch site on its northeastern coast, but officials say it's difficult to determine from satellite photos if the rocket is being fueled. Pyongyang has said it is willing to talk to the United States about its missile concerns, repeating its long-held desire for direct meetings with US. Washington, however, has refused, insisting it will only meet the North amid six-nation talks aimed at ridding Pyongyang of its nuclear weapons program. The longer the delay however, the less impact this story will exert on the FX market, as most participants will conclude that North Koreans are bluffing and will move on.

Decidedly Dour Euro

For the second week in a row news from the Euro-zone was not kind to the euro. Euro-zone Trade Balance deficit widened marginally more than expected while Industrial New Orders dove off the charts printing at –0.2% versus 2.00%. On Thursday we wrote, “April saw a sharp rise in the euro against both the dollar and the yen and suggests that the rising exchange rates impacted the growth of the Euro-zone’s crucial export sector. Since the majority of EZ industrial exports take place with Asia rather than US, the near record value of the EUR/JPY cannot be considered welcome news at ECB headquarters in Frankfurt. The high value of EUR/JPY was one possible reason for ECB’ s reluctance to hike rates earlier in the year and may well be the cause of further hesitation to tighten monetary policy if the economic data shows further deterioration in growth.” We continue to believe that this factor may be even more important than the EUR/USD rate in determining the ECB proclivity to raising. Hawkish commentary from monetary officials notwithstanding, the Central bank may slow down the pace of expected rate hikes if EUR/JPY hovers in the 145.00-147.00 zone, especially if economic data continues to disappoint. The EZ recovery may be far more fragile than the market believes and in that case the ECB will not want risk the possibility of exacerbating the situation.

Next week the European calendar holds little promise for euro bulls as the IFO survey is expected to finally print negative on a month over month basis. Unlike the ZEW, the IFO has refused to buckle under the weight of higher oil prices, higher interest rates and higher exchange rates, registering decade high readings. However, many forecasters believe time has come for the survey to reflect the present concerns in the region’s economy.  Whether a decline in the survey leads to further euro losses remains to be seen. Having already corrected against the dollar by more than 400 points the downside in the pair may be limited, but for now the same can be said of the upside. 

Feeling the Pain

On Friday we wrote, “With the Fukui matter unsettled, following rumors yesterday that the BOJ Governor may resign and the North Korean missile still apparently  on the launch pad, the FX market continues to view long yen positions to be rife with risk.  Although Governor Fukui, testifying before Parliament,  stated that he would like to remain at his post, there is still an open possibility that he may be forced from his position due to appearance rather than the act of impropriety. In short, the yen remains under pressure from a variety of external factors that have nothing to do with the sound underlying economic fundamentals. However, until those issues are resolved, yen longs may continue to feel pain.”

In addition to the surrounding turmoil of North Korea and the Fukui matter, Yen bulls were stymied by unsupportive data. Most importantly the BSI survey of large manufactures printed a shockingly low 1.8 versus 7.0 expected send waves of worry that the Tankan due two week from now on July 3^rd will miss the market’s expectation. On the flip side BOJ minutes suggested that the Japanese monetary authorities are beginning to take seriously the issue of inflation and may be growing considerably uncomfortable with the prolonged adherence to the Zero Rate Interest Policy. This week’s CPI numbers which are expected to rise 0.2% from 0.0% last month should offer further evidence that the ZIRP standard will soon be history. Having rallied in an almost uninterrupted fashion for 700 points, the USD/JPY may be ready for a correction, but as we stated earlier, at present yen’s fate controlled by politics rather than economics.

An Economic Slump Darkened By Death

Last week neither shone or depressed in terms of economics for the British pound.  Starting out with the June Rightmove housing indicator, prices rose almost exactly in line with expectations while beating the previous month’s annual figure, suggesting some lifting of the hesitancy of potential homeowners to finally enter the market while the central bank remains mum.  This proved to be the same reasoning behind a jump in public borrowing and financing  - once again taking advantage of the stable rates and rebounding consumer sentiment.  The only real disappointing economic piece of data for the whole of the week came from June’s CBI industrial trends report, plummeting to a reading of -12 against the expected -6.  The UK is particularly sensitive to the happenings in the manufacturing sector after having just pulled itself out of a recession in March. 

Rather than trading on fundamentals, the real selling point of the week in the sterling came from the untimely death of MPC member David Walton.  Dying on Wednesday following a short illness, the already shaken ranks of the central bank’s policy group have now taken another blow for the probability of a shift in the near future.  In June’s meeting, the presence of perpetual dove Stephen Nickell was noticeably absent, who had since December voted for a rate cut to further stimulate consumer spending, which he had said was still fragile.  Now, perhaps in some karmic sense of irony, Walton’s voice as the lone hawk in the June meeting will be lost from future meetings.  Given these events, we see little chance of the BoE entertaining a rate hike over the summer sessions, and maybe even through the fall.

Making a hard turn back to the scheduled economic slate, a few indicators of market worth will be sprinkled within some revised and other unimportant reads.  Nationwide housing prices will follow up on last week’s Rightmove, the CBI will releases its distributive trade report and GfK will release its consumer sentiment index for the current month.

Data Shines Swissie Dulls

Greenback bulls recently overpowered their Swissie adversaries, as better-than-expected Swiss economic data was not enough to defend against the dollar advance. The move is perhaps especially surprising given that much of the U.S. dollar strength came on the heels of worldwide political turmoil—typically a time of strength for the Swiss Franc. Likewise atypical, gold prices remained almost exactly unchanged on the week despite North Korea’s continued threats against worldwide peace. While market price action left many analysts confused, the fall in the Swiss Franc only supports our claim that the currency could progressively gain status as a more speculative investment. With the recent SNB interest rate hike and predictions of more to come, it seems logical that traders seeking higher returns would turn to the currency.  This is not to say that it will lose support from those seeking greater safety, but a slight shift seems increasingly plausible.

Recent producer and import price inflation data served to boost the likelihood of further monetary tightening. Despite median forecasts of a 0.2% gain, prices added 0.6% in the month of May. The year on year change likewise beat estimates, printing a 2.8% change—well above the previous 1.9% figure. The higher import prices seemingly did little to slow overall trade, however, as the trade surplus improved to its highest since June 2005.  It will be very interesting to see how the bullish data will affect the national currency’s strength in the face of overall U.S. dollar bullishness.

The coming week will also likely see a fair amount of volatility in the USD/CHF, as Swiss Retail Sales, KOF Leading Indicator, and CPI data are all predicted to impress. As if these reports were not enough to shake the currency pair, the U.S. dollar will also see a FOMC interest rate decision, Consumer Confidence results, and PCE deflator inflation data. Needless to say, it should be an exciting week in the foreign currency markets.

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