FX Update: G20 reaction doesn’t fit?

The market is running with the idea that something significant happened over the weekend with the new G-20 communiqué – but is the reaction in line with the actual statement and its implications?

G-20 communiqué slams the USD
The market has reacted rather strongly to the new G-20 statement – an indication, perhaps, that very little to nothing was expected to happen over the weekend. Instead, we get a very lengthy and relatively firm statement from the G-20 that the world needs to move toward “market-determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies.” The statement also focuses on both sides of the competitive devaluation problem: which shows the leaders who drafted the statement that the interest here is not only in pointing the finger at China, but also at the major economies and their need to be “vigilant against excess volatility and disorderly movements in exchange rates” to help “mitigate the risk of excessive volatility in capital flows facing some emerging countries”.

The statement asks the IMF to perform an oversight role, though one that is far more circumscribed than the rather dramatic idea from Geithner that it should oversee absolute caps on current account levels. Here is a link to the full text of the communiqué.

All in all, it is a fairly impressive statement that contains a strong recognition of the issues driving currency tensions – but there is a vast chasm that often separates good intentions from actual actions – and one can cynically wonder how quickly perceived self-interest will prove the decisive factor going forward rather than the spirit of cooperation. The reaction to the statement will quickly be dwarfed by the more pressing subject of the coming US mid-term election and next Wednesday’s FOMC meeting outcome, which will more severely test the market’s expectations.

On the surface, it appears that the market has already reacted more than the actual communiqué warrants. Certainly from an interest rate spread point of view, the communiqué has had no real bearing. Rather, the enthusiastic response of risk appetite to the situation is the real driver at the moment, as the market feels that any sign of international cooperation and reduction of trade tensions is a good thing for international capital flows and therefore risk. As we have seen endlessly in the past, this always results in a weaker greenback…

Data this week
Out shortly today we have the US Existing Home Sales for September. We can count on this figure to absolutely nosedive in October on the ongoing foreclosure gate issue, so this data point will not get particular attention.  Also today, Bernanke’s partner in QE crime, Dudley of the NY Fed will be out speaking.

Other data highlights for this week include:

Tuesday:

• Sweden Riksbank Interest rate decision – interest rate spreads and strong risk appetite are very supportive of a stronger SEK at the moment, and the Riksbank will deliver with a rate hike today  - but let’s see how hawkish the forward guidance is from the bank.
• UK Q3 GDP – looking for signs of deceleration now with the Q3 report, but just wait to see what happens in Q4 as austerity measures bite. GBP is weaker on the idea of the government austerity punishing growth while the central bank prints money to ease the pain. The pounds only hope is for strong risk aversion, which would result in pro-risk position squaring.
• US Aug. CaseShiller Home Price Index – US home prices teetering on the edge of falling again – and the foreclosure crisis is going to mean a likely renewed fall for a time as uncertainty reigns and as the crisis could mean a more expensive home buying process
• US Oct. Consumer Confidence – record underemployment and 40+ million Americans on food stamps, with the Tea Party expected to sweep to victory and the longer term unemployed to begin losing their benefits. Will the talk next year be of record homelessness? The situation in the US is extraordinarily dire at the lower end of the income spectrum.

Wednesday:

• Australia Q3 CPI: The Aussie is sharply higher to start the week, partly from the G20 reaction, but also after a strong PPI reading – but Thursday’s CPI reading will have a strong bearing on central bank’s decision making in the near term.
• Norway Norges Bank Deposit Rate decision: Norges Bank going nowhere soon and the new governor Olsen is considered dovish.
• US Sep. Durable Goods Orders – a volatile data series that was quite strong last month – how will this month’s data fare. Expectations are for another positive number.
• US Sep. New Home Sales – have dropped back toward record lows again recently. Less likely to be impacted as much as the Existing Home Sales by the foreclosure crisis due to lack of title problems.

Thursday

• Japan BoJ Target Rate – more QE on the way? As the JPY heads ever stronger ,we have to remember that it is actually the BoJ that is at the vanguard of QE measures at the moment, not the Fed.
• New Zealand RBNZ Cash Target – RBNZ not expected to move at this time as it is on hold for a while mulling the fallout of the Christchurch earthquake and generally soft data, but the market is still pricing in about 50 bps of tightening for the coming year.

Friday

• Japan Sep. CPI, Household Spending, Industrial Production – many signs pointing to a slowing Japanese economy here – one doesn’t envy the BoJ!
• Canada Aug. GDP – market looking for a significant bump after a couple of weak months of data, but this is likely not enough to turn the decelerating trend.
• US Q3 GDP – Q3 GDP expected stronger than Q2, but only by a fraction and look what wonders this growth is doing for the job market… The slack in the economy is still far too large to trigger convincing improvement in the job market.
• US Oct. Chicago PMI – the last of the major regional manufacturing surveys and the one that has stayed the strongest. This comes ahead of Monday’s ISM release.

Looking ahead
USDJPY is not far from the 80 level again today as treasuries are rallying once again – can the BoJ do anything to stop the implications of seemingly ever shrinking two-year interest rate spreads between the US and Japan? That spread is fast nearing its theoretical limit on the downside and it will be interesting to see what the BoJ brings to the table at its Thursday policy announcement.

With equities also rallying to within striking distance of 1200 in the US S&P500 again, it appears the market is trying to get back into Everything Up/USD down mode, but it is hard to imagine that we get a strong extension of this trade until the actual FOMC statement is in the rear view mirror next week since so much is already priced into expectations for this meeting.

Be careful out there.

Economic Data Highlights

• Japan Sep. Adjusted Merchandise Trade Balance out at ¥588B vs. ¥496B expected and ¥570B in Aug.
• Australia Q3 Producer Price Index rose +1.3% QoQ and 2.2% YoY vs. +0.5%/1.4% expected, respectively
• China Sep. Leading Index out at 101.81 vs. 101.84 in Aug.
• UK Sep. BBA Loans for House Purchase out at 31.1k vs. 31k expected and vs. 31.8k in Aug.
• EuroZone Aug. Industrial New Orders out at +5.3% MoM and +24.4% YoY vs. +2.2%/+19.3% expected, respectively
• US Sep. Chicago Fed National Activity Index out at -0.58 vs. -0.30 expected and -0.49 in Aug.

Upcoming Economic Calendar Highlights

• US Sep. Existing Home Sales (1400)
• US Oct. Dallas Fed Manufacturing Activity (1430)
• US Fed’s Bullard to Speak (1730)
• UK BoE’s King to Speak (1900)
• US Fed’s Dudley to Speak (2030)
• Japan Sep. Corporate Service Price Index (2350)
• Australia Q3 NAB Business Confidence (0030)