Of the major currencies it has been the proud pound that has been leading the way so far this year. Following yesterday’s less dovish MPC Minutes and the surprisingly strong employment figures, cable is back through 1.60 once more and EUR/GBP is at a 20mth low of 0.8180. Against the Japanese yen the pound has advanced by almost 10% so far this year. Numerous explanations account for this more buoyant performance: the pound is very competitive, many sovereign wealth funds and high net worth individuals are still spooked by the euro (see below) and regard UK assets (such as London property and gilts) as safe-havens, and the economy appears to have avoided falling back into recession. In addition, other major currencies such as the Japanese yen, the Australian dollar and the Swiss franc are regarded as being very expensive, so it is little wonder that sterling is on the radar of money managers. Looking ahead, these sources of demand are likely to remain evident for some time to come. The message for a while now has been ‘do not underestimate the pound’.
UK QE loses its biggest sponsor. The minutes of April’s Monetary Policy Committee (MPC) meeting revealed that the biggest supporter of QE in the UK lost its main sponsor, Adam Posen. Since October 2010, Posen has been pushing for further QE at nearly every meeting, only falling into line after the agreed increase in October 2011. For the sole member still voting for more QE, David Miles, there was recognition that the decision was “finely balanced”, which could be his way of backing down once the May inflation-forecasting round gets underway. In light of Tuesday’s CPI data however, these decisions are perhaps understandable. Next month the BoE will once again be in the position of needing to explain why inflation has not fallen as much as it anticipated three months previously. Of course, nobody is expecting the Bank to have perfect foresight, but the BoE is gaining a reputation for underestimating inflation and there are only so many occasions on which one can blame one-off and special factors. The rise in core inflation backs this view. It was in March last year that Posen stated that inflation would fall below the 2% target in the second half of this year (Guardian, 27th March 2011). This still may prove to be true but it’s looking far less likely.
Spain goes back to its roots. Yesterday’s news out of Spain has served as a timely reminder that the country is, at heart, a credit bubble with a sovereign crisis by-product. Markets have been overly focused on the latter in recent weeks, not surprising given that Spain has laid out budget plans and fallen short of those set out last year. Wednesday’s data on loan delinquency for February (of three months or more) showed a further increase to above 8.00%, which puts this measure not that far off the 8.9% seen in 1993. This is also from a position of 0.70% in late 2006, which itself was a multi-decade low. The fall in Spanish house prices seen in the first quarter of this year - of 3.0% - is also strongly indicative of further delinquency to come. But the question remains just how far do house prices have to correct to return to more normal levels? In nominal terms, house prices are now back to 2005 levels but there is likely quite a way further to run, given that investment in construction was nearly 25% of GDP at the peak of the boom. This has created a huge overhang that still has to be worked through. Remember that Spain’s government was in surplus ahead of the global credit crunch back 2008, although the current account deficit was over 10% of GDP. As we can see elsewhere, bursting bubbles take longer to work their way through than most expect, and this is going to be true just as much for Spain as elsewhere. The real fear from here is the extent to which bank liabilities migrate towards the public sector balance sheet, which would create a dangerous vicious circle given the extent to which the ECB’s LTRO money ended up being re-invested by banks in government debt.
Reserve managers snub their nose at the euro. Consistent with both the observed price action over the past year and the expressed concern of various fiduciaries, it is no surprise to learn that FX reserve managers have adopted a much more circumspect disposition towards the single currency. According to a survey conducted by Central Banking Publications, FX reserve managers have profoundly altered their view on the euro. Over one third of respondents claimed that the sovereign debt crisis had a major bearing on their strategy for managing reserves, with 29% claiming to have reduced their exposure to the euro over the past year. Separately, the IMF has reported that central bank-allocated reserves to the single currency fell from just under 27% at the end of Q2 last year to 25% by year-end, whereas dollar holdings rose by 1.6 percentage points to 62.1%. Most FX reserve managers are also avoiding all but the best-rated sovereigns in Europe. The diminished standing of the euro in the eyes of FX reserve managers has not translated into an improved perception of the dollar (despite the fact that percentage holdings have increased). Rather, reserve managers overwhelmingly are considering increased allocations over the medium term to currencies such as the Canadian dollar and the Aussie. Also, central banks have suddenly become much more favourably disposed towards gold; last year, central banks bought more gold than they had done for forty years! Even equities are starting to feature on the investment landscape of central bankers. More than anything, surveys such as these emphasise the huge long-term damage that Europe’s sovereign debt and banking crisis represents for the single currency.
Yen softens amidst talk of more BoJ easing. Right on cue, BoJ Deputy Governor Nishimura has sent yen bulls scurrying for cover by suggesting that the Japanese central bank will be prepared to implement additional easing should it become necessary. With the next BoJ meeting just over a week away, many have understandably interpreted his remarks as a warning that the central bank is still disposed towards further measures, notwithstanding the bold announcements already made this year including the huge expansion of its asset-purchase program and the establishment of a 1% inflation target. In response, the Japanese yen has given back some of its recent gains, with USD/JPY now at 81.50. Partial relief then for the MoF which no doubt would have been alarmed by the progressive strengthening of the currency so far this month. Complicating attempts to weaken the currency has been the narrowing in yield spreads over recent weeks between Japan on the one hand, and the US and Germany on the other. In addition, the Japanese economy has just started to look a little healthier. More than ever, the BoJ is under incredible political pressure both to support the economy and to weaken the currency. There is almost certainly considerable discomfort within the central bank with respect to the direction of BoJ policy, but right now the politicians are carrying the debate and the independence of the BoJ is being compromised.