FX: Is G7 Intervention Enough?

Unprecedented times call for unprecedented measures. For the first time in more than a decade, central banks around the world stepped into the foreign exchange market and jointly intervened to sell the Japanese Yen. The last time they acted together was in September 2000, when the euro fell to a record low. At the time, the Federal Reserve, Bank of England, Bank of Japan and other central banks joined the European Central Bank in buying euros. Since then, they have not shown this kind of solidarity up until today. Over the past few years, currencies have reached extreme levels and individual central banks have intervened but outside of language changes made to the G7 statements, the Group of 7 has not done more than verbally intervene in the currency market. This is why last night’s decision was such a significant one. Japan successfully convinced its G7 partners to jointly intervene in the foreign exchange market to sell the Japanese Yen.

Such an achievement should have driven the Japanese Yen sharply lower against all of the major currencies and it did, but USD/JPY and the other Yen crosses ended the North American trading session well off their highs. This has left many currency traders wondering just how successful intervention will be. Coordinated intervention is the only type of currency intervention that has ever worked but even in 2000, when the G7 collectively bought euros, the EUR/USD did not bottom out until a month later. Furthermore, the G7 statement made it clear that the Fed, BoE, BoC and ECB have only committed to a one day intervention effort. Will that be enough? The size of the intervention has yet to be disclosed and we suspect that the Bank of Japan’s portion could be as large as one trillion Yen. Some analysts estimate that the total amount of intervention could be closer to 2 trillion yen. The Bank of Japan has made it clear that the intervention will be unsterilized which is good because it is more effective than sterilized intervention. When intervention is not sterilized, the money supply is increased.  With the euro trading at such a high level and the Fed practicing easy monetary policy, G7 central banks do not have an active interest in seeing their currencies appreciate significantly. As a result, the BoJ could be on their own from here on forward because the main goal of coordinated intervention was to send a strong message to the market.  Given the degree of speculation going into last night’s conference call, the G7 knew that simply tweaking the words in their statement would not be enough.

The Power of G7 Meetings

The following chart of USD/JPY shows the power of G7 meetings. As you can see, their announcements have frequently marked a top or bottom in the currency pair. Sometimes this happens immediately and other times it takes a while longer. In the case of today’s action, we believe that there could be choppier trading in the days to come and even though a new low could still be made, this is unlikely. Instead, USD/JPY should stabilize above the 79 level and eventually trade back towards it year to date high of 84.

 

USD: HAS THE DOLLAR LOST ITS SAFE HAVEN PROPERTIES?

For the second day in a row, the U.S. dollar traded lower against all of the major currencies except for the Japanese Yen and Swiss Franc as safe haven flows continued to ease out of the greenback.  The U.S. dollar and U.S. economic data this past week took a back seat to the developments in Japan but the one thing that we have seen in day to day volatility is that the greenback is still a safe haven currency. Since the beginning of the year the U.S. dollar has traded sharply lower and because of that many people questioned the dollar’s safe haven status but as we have seen in a few cases this past week, the dollar still rose against the euro, British pound, and commodity currencies when stocks fell steeply. Unfortunately the steep rally in the Japanese Yen, which accounts for the second largest weighting in the “Dollar Index” dragged the entire DXY lower and the index received no help from its rally against the AUD and NZD because those 2 currencies are not included in the Dollar Index. It is true that the Japanese Yen and the Swiss Franc benefitted more from risk aversion than the U.S. dollar but we don’t believe the dollar has lost its safe haven properties. The Swiss Franc is the preferred safe haven, but investors still seek safety in the U.S. dollar. With little market moving U.S. economic data on the calendar next week, how the Yen responds to the intervention should remain a focus. Housing market data, durable goods and the third release of GDP are the only U.S. reports on the calendar. If Japan manages to get their nuclear situation under control, risk appetite could hold steady but if the problems exacerbate, risk aversion could return, making the G7’s efforts futile.

China Raises Reserve Requirement Ratio Again

Meanwhile prior to the Japanese intervention, China raised its reserve requirement ratio for the third time this year and the ninth time since the beginning of last year by 50bp to 20 percent for large banks and 18 percent for medium to small financial institutions. Although recent Chinese economic reports show that the government’s tightening measures are working, the PBoC still felt the need to raise the RRR because inflation remains high. The timing of their hike is certainly questionable and could be related to the Japanese intervention efforts but at the end of the day, Chinese tightening is eliciting a diminishing reaction from the currency market. The reason is because investors are skeptical about China’s ability to tame their roaring economy. Slower Chinese growth is undoubtedly negative for global growth but we have been down this road before and even though there have been signs of slower growth in the Chinese economy, it has not had a significant impact on their demand.

EUR: TRICHET STILL LOOKING TO RAISE RATES

The Euro reached fresh 4-month highs against the Pound, U.S. and Canadian dollars today and strengthened against most of its major counterparts as the rally in risk continued for the second consecutive day. Supporting the Euro’s rally were comments made by European Central Bank president Jean Claude Trichet, indicating that the central bank will likely go through with its plan to raise interest rates at its upcoming policy meeting next month as it tries to control excessive inflation and balance higher growth prospects. Inflation in the Eurozone increased 2.4 percent last month, above the ECB’s limit of 2 percent. Trichet told reporters that he had “nothing to add, nothing to withdraw,” which confirms the bank is still in a mode of “strong vigilance,” the language used by the bank to signal an imminent rate increase. Rate hike expectations signal that the market is currently pricing in 50 to 75 basis points of tightening by the end of 2011. Trichet also reiterated recent calls by the central bank to strengthen new Eurozone debt rules, saying “we think we need greater ambition in governance reform…we are really at a point where it is time for decisions.” Inflation at the producers’ level in Germany, as indicated by the Producer Price Index, beat expectations printing at 0.7 percent in February from the previous month, and up 6.4 percent on the year. Natural gas prices are reported to have risen nearly 13 percent last month from the previous year. The European Central Bank reported that the Eurozone’s Current Account figures beat forecasts, improving significantly in the month of January with a deficit of only 0.7 billion Euros, as compared to December’s deficit of 12.5 billion Euros. The Eurozone’s trade balance figure surprised to the downside, posting a deficit for the third straight month. On the calendar next week for the Eurozone are the ECOFIN meetings, the EU Summit, Consumer Confidence, Purchasing Managers’ Index, and the German IFO report.

CAD: CORE CPI GROWTH HITS RECORD LOW

The Canadian dollar ended the day unchanged against the greenback while the Australian and New Zealand dollars rose strongly. Intervention by G7 central banks helped risk appetite recover and the Aussie and Kiwi were among the biggest beneficiaries. Canada was the only commodity producing country to release any meaningful economic data today and according to the CPI report, inflationary pressures declined in the month of February. Even though oil prices surged above $100 a barrel towards the end of the month, the strength of the CAD helped to mitigate any inflation pressures.  CPI rose 0.3 percent last month with core prices growing by a mere 0.2 percent. On an annualized basis, this drove core CPI growth down to 0.9 percent, the lowest level ever. However this may be a bit distorting because inflation was particularly high February of last year as the Vancouver Winter Olympics drove accommodation prices sharply higher. Yet even without the distortion, inflationary pressures in Canada are muted, giving the central bank little reason to tighten monetary policy. Next week, Canadian retail sales are due for release and based upon the rise in wholesale sales, consumer spending growth is expected to have rebounded after falling 0.2 percent in December. There will be no major economic reports from Australia but New Zealand will be releasing current account and GDP numbers. The New Zealand economy contracted in the third quarter and the Finance Minister has previously warned that growth could remain negative in the fourth quarter, putting the New Zealand economy into a technical recession. The RBNZ on the other hand thinks growth will be closer to zero, but either way, it will be negligible, providing support for the central bank’s recent decision to cut interest rates by 50bp.

GBP: CONSUMER CONFIDENCE AT RECORD LOW

The improvement in risk appetite helped sterling traders overlook a major disappointment in economic data. Consumer confidence plunged 10 points to a record low in the month of February according to Nationwide Building Society. The VAT tax increase combined with high oil prices and lower stock market values gave U.K. consumers little reasons to be optimistic. It will be interesting to see how this played into the Bank of England’s latest monetary policy discussions. The minutes from this month’s monetary policy meeting will be published on next week. Inflation has become such a big problem that the European Central Bank telegraphed plans to raise interest rates next month. Price pressures in the U.K. are even more significant than in the Eurozone and for this reason we believe that another U.K. policymaker could have voted for higher interest rates. Back in February, 3 members voted to tighten monetary policy while 6 members voted to abstain from any changes. This month, the BoE did not alter monetary policy but that does not mean that the committee has not grown more willing to raise interest rates. However inflation would be their only motivation to do so because economic data has actually taken a turn for the worse as we have seen from last night’s consumer confidence report. Retail sales are scheduled for release this week and economists are looking for a pullback in spending. According to the British Retail Consortium, same store sales fell 0.4 percent last month. Excluding the date-related impact of Easter last year, this was the poorest performance since May 2009. Concerns about the economic outlook led consumers to cut back spending on many non-food items including clothing and furniture. Big ticket items have seen a sharp reduction in demand following the January VAT tax increase. If not for inflation, there is no need for the BoE to even consider raising interest rates. The market is currently pricing in one 25bp rate hike from the BoE this year, which represents a significant downgrade from last month when they were looking for up to 75bp of tightening.

USD/JPY: Currency in Play for Next 24 Hours

The USD/JPY will be our currency pair in play for Monday. From the United States, we expect the Chicago Federal Reserve’s Nativity Index data at 8:30 AM NY TIME / 12:30 GMT, followed by Existing Home Sales figures at 10:00 AM NY TIME / 14:00 GMT.

USD/JPY rallied for the second consecutive day today, supported by the coordinated efforts by the G7 countries to sell Yen, and remains within a down-trend for the sixth consecutive day, which we determined using Bollinger Bands. Earlier this week, as a result of last week’s catastrophic earthquake, the pair reached a post World War II high of 76.39 against the dollar, before paring gains back to its current levels. The closest level of support is at the low of 76.39, which will likely be a strong bottom in the pair due to the coordinated policy action. In the unlikely event that the pair drops below this level, the psychologically significant 75.00 level should provide major support. The nearest level of resistance for the pair is at the 50-day simple moving average of 82.33. If the pair rallies past this level, the pair should face strong resistance at the 38.2% Fibonacci Retracement of 83.49, drawn from the March 2010 high of 94.98 to yesterday’s low of 76.39.

Similar Posts:

• Forex Markets Look to Interest Rates for Guidance
• FX: Rose Colored Glasses On, BoC Keeps Rates Unchanged
• Existing Homes Data Fails to Help the Dollar
• Australian Dollar Retreats After Reaching Record vs. Yen
• USD/JPY Breaking Below Support