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Analyst Interview: Christopher Vecchio on Spain, US Labor Market

Analyst Interview: Christopher Vecchio on Spain, US Labor Market

Christopher Vecchio, CFA, Senior Strategist

- How will the Chinese move to widen the yuan trading bands impact markets?

On Monday, for the first time since 2007, the People’s Bank of China widened the range the Chinese Yuan is allowed to trade in against the US Dollar from 0.5 percent to 1.0 percent. The implications of this decision are considerable in light of the fact that the PBoC keeps a tight lid on any USDCNY currency fluctuations in order to maintain China’s competitive edge in global markets. With that said, this is clearly a move to liberalize economic policy and push China further towards an open market economy, one that will help attract capital flows into the country. The timing of the move is noteworthy in and of itself, now that Chinese growth prospects have fizzled the past few months; at present time, Chinese monetary officials likely feel that there is less downside pressure on USDCNY. In my eyes, from the FX trader perspective, there’s little reason to pay too much attention to this policy shift even though it does mark another milestone on the way to full currency convertibility.

- The debt crisis intensifies around Spain. Will the ECB intervene via the SMP or even another LTRO? Or are the high yields serving as a means of pressure - as the only way to force Spain to act on austerity and reform?

At the April 4 European Central Bank meeting, President Mario Draghi addressed this very issue, saying that “all [the ECB’s] non-standard measures are temporary in nature,” further adding that “in order to support confidence, sustainable growth and employment, the governing council calls on governments to restore sound fiscal positions.” Now, is it in the ECB’s best interest to see periphery yields capped? Of course it is. Is it in their best interest to be the prevailing force behind lower borrowing costs? No. The ECB must force European governments to implement the reforms necessary in solving the current problems and preventing them from reoccurring in the future.

Along these lines, President Draghi has avoided discussing another longer-term refinancing operation (LTRO). The first two rounds resulted in over €1 trillion worth of loans, so liquidity, at least for the foreseeable future, is not a concern. The International Monetary Fund supports this view, with the IMF’s director of capital-markets department stating earlier today that the ECB can’t be “the only game in town.”

The only way that the Euro-zone sticks together through this mess is for a tighter-knit fiscal union. If the answer was for an open liquidity spigot, we’ve seen policymakers already try that via rate cuts and the first two LTROs, and yet we’re still discussing the debt crisis (just a different iteration, from Greek to Spain). This can only be achieved via supranational cooperation among governments. Thus far little progress has been made considering that Spain has symbolically rejected the European Union fiscal treaty by amending its budget deficit target, and that French presidential challenger Francois Hollande (and leading in the polls ahead of the April elections) has stated he would renege on incumbent Nicolas Sarkozy’s participation in the EU fiscal treaty. Until there is a higher degree of fiscal union, I still maintain my bias that the Euro-zone, in its current 17-member format, is finished.

- A rise in US jobless claims joined a disappointing job growth in the Non-Farm Payrolls. Are we seeing a temporary pause in the US job market after a few strong months, or is this a repeat of 2010 and 2011, where a strong start to the year didn't see a follow up later on?

The U.S. economy added 120K jobs in March, exactly half of the revised February figure at 240K. Similarly, the unemployment rate dropped to 8.2 percent from 8.3 percent in March. Many economists and policymakers had been discussing the potential claw back in this month’s jobs report considering that the winter months were unseasonably warm across much of the United States. Why does weather affect NFPs? Warmer conditions are conducive to work outside, in particular construction projects, and work in that sector has surged in recent months.

Where does this leave the U.S. economy? The Federal Reserve’s minutes from their March 13 policy meeting indicated that officials are leaning away from another round of easing due to the progress the U.S. economy has made. In the intermeeting period, Federal Reserve Chairman Ben Bernanke noted that more stimulus could be warranted should the labor market continue to struggle. On the other hand, New York Fed President William Dudley has stated that a moderation in jobs growth was to be expected, given the favorable weather conditions the past few months.

While I think the US economy is on firmer footing in 2012 than 2011 or 2010, I remain hesitant from getting too optimistic, as there are a few of reasons to doubt recent jobs progress. My main issue is that the participation rate has dropped to its lowest rate in three decades; fewer Americans are in the workforce which artificially pushes down the unemployment rate. Until data starts to show that the labor force is expanding (via an increased participation rate), I remain doubtful about how long this so-called “moderate” (in the Fed’s words) labor market recovery can go on for – I would call the labor market’s progress as mediocre at best.

- The New Zealand dollar was the shining star of forex at the beginning of the year, but it lost some of its shine. Is the slowdown in Chinese growth set to push the kiwi lower? Or are there more dominant factors?

The New Zealand Dollar’s recent weakness has a lot to do with the decline in Chinese growth. This has hit the Kiwi two-fold. First, as New Zealand’s second-largest export market (12.5 percent in 2011), a drop in demand for foreign goods by Chinese businesses and consumers has and will hurt New Zealand producers of goods and services. The same negative influence is also reflected in the declining fundamentals of the Australian economy, which is New Zealand’s largest export market (23 percent in 2011). Thus, weakness in both Australia and China can really hurt the New Zealand economy.

What has also hurt the New Zealand Dollar in recent weeks has been the Euro-zone crisis. On February 6, Moody’s Investors Service said that the New Zealand economy was among the “most exposed” to the crisis, further noting that its banking system (along with Australia’s and Korea’s) is “more vulnerable to the first-round impact of a further worsening of the euro area crisis than other systems in Asia Pacific.” Indeed, since mid-March, when the Euro-zone crisis started reheating, New Zealand 5-year CDS have jumped over 24 percent, from 65.98 to 81.90 at the time of writing today. If Euro-zone issues persist alongside softening Asian-Oceanic growth prospects, the New Zealand Dollar will remain under pressure, in particular against the US Dollar.

- The 1.20 floor under EUR/CHF was challenged for the first time. Does this move endanger the credibility of the SNB? Or is it a one time event?

I’ll be the first to admit that I didn’t think the SNB would let the EURCHF trade close to the floor; I figured they would begin to intervene at higher levels so as to prevent a breach of the 1.2000 floor. This hasn’t been the case, and I’ll be the first to admit that I was wrong in this regard. But my theory on what the SNB is doing holds: they’re putting up a defense, albeit a porous one, at the 1.2000 floor. The first breach of the floor showed us that the SNB has buy limit orders in place to prevent market participants from piling into short positions (and/or from stops being hit, triggering further downside pressure) and truly testing the SNB.

Knowing this, I’ve entirely dismissed the notion that we’ll see a move towards 1.1950 or lower before the central bank comes into the market to push the price back up (you’ll hear it referred to as “clearing out the speculative longs”). It’s possible that the EURCHF pokes around in that 1.1990-1.2000 area going forward, but I wouldn’t look lower than that given the buy limit orders in place. I still expect the SNB to raise the floor to 1.2500 or 1.3000 within the coming months.

--- Written by Christopher Vecchio, Currency Analyst for for an interview with

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