Currencies trade in tight ranges; US assets continue to outperform the rest of the world
12/Dec/2011 • Currency Updates•
We just closed a relatively quiet trading week, light in market moving data, in which the main focus were the monthly rate decision from the Bank of England and the ECB and a late week bombshell from the European summit. Expectations (including, we regret to admit, our own) had been allowed to build up that the steady drumbeat of negative news out of the Eurozone, both financial and macroeconomic, would finally force at least a change of rhetoric from Mr. Draghi. It was not to be, although there were some signs that the ECB is not altogether ignoring the dangers. Meanwhile, the split between the US economy, which continues to muddle along, and Europe, which we believe is already in recession, continues to widen. As a result, the performance gap between US and European stocks widened further last week. The dollar rose mildly against most currencies, confirming our view that the greenback is regaining its safe haven status thanks to the Euro crisis.
No surprises out of the UK last week, save for Friday’s refusal to go along with the deal hashed out at the Euro summit. We think that the importance of this veto is much overstated, and markets were right to react to it more or less with a shrug. The MPC kept rates and the size of the balance sheet unchanged, but it added a new liquidity facility. Data on manufacturing and employment confirmed our view that the UK is likely in a new recession. It is true that the services sector is holding just above the contraction line, but we expect the European crisis to pull down the external sector enough that the 4Q number will come just below the zero line. The only consolation is that it should be a mild one, given the disappointing recovery that preceded it and the absolute lack of any excesses to purge either in financial markets or the real economy. However, the existential threat to the Euro is making Sterling look good in comparison, and we continue to expect GBP to fall against the dollar but rise against the common currency.
The biggest news of the week was the ECB meeting on Thursday. Given the submissive gestures coming from the new Governments in Italy and Spain, acquiescing to all sorts of wage-lowering austerity measures, some expectations had been built that Draghi would announce a more aggressive role on the part of the ECB. This did not happen. The ECB did cut rates to 1%, as expected, thus correcting belatedly yet another policy blunder. It also announce more generous bank lending facilities, which will be of very limited use now that European banks have been ordered by Euro officials to raise capital or deleverage, again, at the most damaging time in the business cycle. However, the new head of the ECB did not change its position on sovereign funding, and instead regaled the audience with the usual nonsensical grumblings about inflation levels, monetary levels and the like. In our view, the ECBs indulgence to banks, which will not or cannot lend, offers an interesting contrast to its sadistic attitude to sovereigns, which in most of Europe have become the only line of defence against outright economic collapse. We remain convinced that the ECB will eventually be forced to change course, just like it did with its ill-advised policy hikes of 2011 and 2008, but are increasingly concerned about the enormous economic damage that will have been wreaked by the ECBs blunders. We remain convinced that the gap between lofty EUR levels and the deteriorating fundamentals in the Eurozone is unsustainable.
Second tier macroeconomic data brought further confirmation of a subdued economic recovery in the US. Growth is insufficient to make a dent on the structural long term unemployment that has developed since 2008. However, in sharp contrast to the disaster developing across the Atlantic, there are few signs that a relapse into recession is imminent. While we are far from bullish on the US economy, the absence of catastrophic tail leads us to think that the dollar will become increasingly attractive as a safe haven destination and remain bullish on the greenback.