No one ought to be surprised at yesterday’s commanding performance by the world’s major reserve currency. With most of Europe falling into recession and some of Asia’s major economies losing momentum rapidly, it is little wonder that investors and traders are turning back towards the dollar at a time when the American economy is actually improving (see below). The greenback registered gains of more than 1% on the day against a number of major currencies, including the euro, the Scandies, the Swissie and the Aussie. Commodity prices also suffered badly – gold has lost nearly 4% since the start of the week, while oil was off 1.5%. Equities fell hard, the DAX down 3.3%, while the bond yields of troubled European sovereigns were once again much higher; the Italian 10yr yield up 30bp at 6.58% at one stage. Apart from the dollar, safe-havens like treasuries, bunds and gilts performed well.
America’s surprising buoyancy. America’s improving economic fortunes are providing a stark contrast to the dreadful prospects looming for Europe’s economies. Over recent months, US economic releases have consistently surprised on the upside. The Citigroup US economic surprise index has risen steadily and impressively to a current reading of 78, up from a low six months ago of -115. However in Europe, the economic surprise index for the Eurozone is currently at -13, although three months ago it was down under -100. For Fed policy-makers, who are deliberating ahead of tomorrow’s FOMC meeting, there is very little pressure for additional monetary policy action. The labour market appears to be strengthening (albeit slowly), the consumer is spending (cautiously), and both industrial production and capital spending are growing. Bank credit is also expanding at a decent clip, up 10% at an annualised pace in the third quarter, led by strong demand from the corporate side. In recent days, some Fed officials have expressed particular encouragement with this news, as it suggests that American businesses are minded to expand and that the recovery is becoming more self-sustaining. US banks are in a stronger position to meet this increased loan demand, with net income rising sharply over recent quarters. If the American economy continues to hold up while Europe crumbles, this must be good news for the dollar against the euro.
Cracks already appearing in EU Summit agreement. Already the fault-lines in Friday’s EU concord are emerging. In particular, there has been trenchant criticism of the proposal that Eurozone central banks could fund the IMF, which could then lend to troubled European sovereigns. The Bundesbank is especially annoyed by this plan, with Board member Andreas Dombret claiming that the central bank simply cannot fund other sovereigns – either directly or indirectly – through the IMF. Germany’s central bank is also very concerned about the size of its potential involvement in this proposal (EUR 45bln), and the risk involved. The only way for the Bundesbank to contribute in this way would be through some kind of special indemnity from the German parliament, which would be very controversial and may not be forthcoming. Within central bank circles, the Bundesbank is not alone in terms of its discomfort with this covert IMF-funding idea. New ECB President Draghi suggested last week that the European Central Bank would not fund the IMF as a back door method of rescuing Europe’s damaged sovereigns. America is not so enthused about the IMF’s supposedly new role in Europe, and apparently IMF officials themselves are lukewarm at best. Separately, the president of the German Bundesbank has asked that the constitutional court review the summit agreement because of Brussels’ increased role in German fiscal affairs. And Finland is very unhappy with the idea that unanimous decision-making will be replaced by qualified majority voting, and is threatening to withdraw from the ESM. Just like last time and the time before, more cracks are likely to appear over coming days. It was never going to be easy.
Chinese capital flight. On a superficial level all seems normal, but it is that which lies beneath that is often more revealing. With capital leaving the country over recent weeks, the PBOC has been fighting the tide, lifting the daily yuan reference rate ever so gradually over recent days. Yesterday, the PBOC also announced that policy officials would continue to work towards making the yuan more flexible by reforming the currency and domestic interest rate markets. In spite of this, the currency touched its daily permitted low for the tenth straight session overnight, suggesting that there is underlying demand to sell the currency. With the economy weakening in response to tight credit and falling overseas demand, and some investors pulling money out of the country, suddenly China’s currency is no longer a one-way bet. Right now, it bears close watching, especially at a time when the dollar is strong.
Frustrating end to year for gold. Gold has been left floundering after the USD 1,900 highs marked briefly in both August and September and the data on underlying physical ETF holdings reflects this very vividly. The latest data on known global ETF holdings (from Bloomberg) shows new record highs made towards the end of last week. Indeed, holdings increased nearly 4% through November, even though gold was only 1.8% higher after what was a fairly choppy month of trading. This suggests a certain degree of frustration with the recent price activity on the part of investors. The issue is that, even though there has been increased talk of some sort of break-up of the single currency, gold has not benefitted over the past three months in terms of positive price action. The dollar has been the main reason for this, given that it has increased by more than 5% over the past six weeks. The dollar has simply become the safe-haven of choice in a world of increased economic but also financial uncertainty (bank balance sheets, currency viability). Interestingly, while gold has managed to outperform silver, it has underperformed most industrial metals since the start of November (comparison with S&P industrial metals index), so this move goes a little deeper than just being linked to the global slowdown. The fact remains that gold will manage to put in its 11th consecutive year of annual price increase (in dollar terms) this year, but it’s proven to be a soggy and frustrating end to the year for many gold bulls.