FX Update: UK budget plan boosts sterling

John J. Hardy, FX Consultant, Saxo Bank

FX Update: UK budget plan boosts sterling

Yesterday's move in risk aversion followed through slightly into this morning and is having the usual effects on the currency market, if we look away from the gold market at least, which is an interesting story unto itself. Bonds have rallied enough to bring yields back to below Friday's closing levels - especially interesting for US treasuries, as this falsifies the entire kneejerk reaction of "yuan revaluation means the Chinese will buy fewer treasuries" logic. This has supported the JPY, which is making a bid to push USDJPY back below the 200-day moving average after that pair tried to post a bullish reversal yesterday. The USDJPY has been a mess in recent weeks, with endless fibrillation in a tight range full of critical technical levels, yet no decisive outcomes. Not surprisingly, this has been the case in the US treasury market as well.

Canadian CPI data came in a shade higher than expected, and this kept CAD from crumbling further versus the USD after yesterday's reasonable bullish reversal attempt. The strong German IFO (new high for the cycle unbelievably) failed to support the Euro. The IFO respondents must be focusing on the DAX, which yesterday nearly reached a new post-Lehman high. The heady action in the DAX has in turn been a product of the weak Euro, which is a boon to German exporters. It's surprising that this aspect of the situation has trumped the worries about the European credit system, and the "pick your poison" situation of either having German tax payers pay for a southern Europe bailout, or having German banks take an enormous hit to do the same.

Chart: EURUSD and DAX
Devaluing your way to high confidence! The German IFO came in strong today as survey respondents reveled in the weak Euro and its implications for Germany's vital export industry. The Chart below shows how this has also helped boost the exporter-heavy German DAX relative to the likes of the US benchmark S&P500. This move in the European currency can only be a one-off boon to confidence and is likely to fade as the EUR devaluation slows at some point in coming months

In other news, about half or yesterday's strong move in the yuan yesterday was erased by China today, as it underlines that any new "float" of the currency will remain a very tightly managed one. Also, speaking of trying to manage a currency's level, the SNB's Jordan was out in an interview saying that intervention by the SNB was no longer needed because the threats of deflation are no longer in place. A great excuse! In any case, this has allowed EURCHF to swoop to new record lows into today even as the SNB feebly remarked that it will intervene if it sees the threat of deflation rising again. The speed of the descent on this news is rather slow relative to what Mr. Jordan said. From here on out, we can hopefully look for a EURCHF level that is set by the market - some kind of equilibrium point will likely be reached rather soon. In the USDJPY instance from 2003, the steep part of the sell-off after the MoF abandoned intervention was over after four days, then a new trading lows was established about a month later, followed by an ugly and very slow grind lower for another three or four months as the market got over-positioned. Left to its own devices, we could seea similar behavior for EURCHF, though in the latter's case, we've already seen significant devaluation in fits and starts, so the timeframe may be compressed.

UK Budget
The focus today in the UK is on the new budget presented by Chancellor Osbourne. The budget proposal suggests that the UK can balance its budget by 2015. The austerity measures with this budget are impressive - the VAT will rise back to 20% from 17.5% in January of 2011, capital gains tax will rise to 28% from 18% on higher income taxpayers. On the spending side, the public sector's higher paid employees will see a two-year wage freeze and housing benefits policies and welfare will face cuts. From a sovereign debt/fiscal prudence angle, this looks good for the pound, as it is an impressive attempt to shore up credibility. Indeed, the pound is responding and EURGBP looks like it wants to probe back toward the 0.8200 low. The question going forward will be how much these measures will hamper growth and whether the tax revenues can live up to expectations and if growth projections are realistic.

Looking ahead
So far, yesterday's reversals aren't looking as compelling as they did on the close last night as US equity averages try to make a comeback ahead of the US open  - let's see how the market follows through on yesterday's moves. Normally one would expect a bit of range trading ahead of the FOMC meeting (this Wednesday as we have a two-day meeting this time around), but does any surprise really await us on Wednesday from the FOMC? It would seem that the direction in risk appetite and bond yields are the more important indicators to watch for the moment.

Stay careful out there as always.

Economic Data Highlights

• New Zealand May Credit Card Spending rose 3.4% MoM and 1.9% YoY vs. -1.6% YoY in Apr.
• Japan May Supermarket Sales fell -5.3% vs. -4.9% in Apr.
• Switzerland May Trade Balance out at +0.82B s. 2.06B in Apr.
• Sweden May Unemployment Rate fell to 8.8% vs. 9.4% expected and 9.5% in Apr.
• Germany Jun. IFO Business Climate out at 101.8 vs. 101.2 expected and 101.5 in May
• EuroZone Apr. Current Account was out at -6.9B vs. +1.3B in Mar.
• Canada May Consumer Price Index rose +0.3% MoM and 1.4% YoY vs. +0.2%/+1.3% expected, respectively, and vs. +1.8% YoY in Apr.
• Canada May Core CPI rose +0.3% MoM and +1.8% YoY vs. +0.3%/+1.7% expected, respectively, and vs. 1.9% YoY in Apr.

Upcoming Economic Calendar Highlights

• US May Existing Home Sales (1400)
• US Apr. House Price Index (1400)
• US Jun. Richmond Fed Index (1400)
• EuroZone Jun. Consumer Confidence (1400)
• US Weekly API Crude Oil and Product Inventories (2030)
• US Weekly ABC Consumer Confidence (2100)
• New Zealand Q1 Current Account Balance (2245)