As traders in the US head into the long weekend, Citi’s currency guru Steven Englander looks at the two big stories that really clubbed markets this week.
Interestingly, although Japan crashed on Thursday, there was no real fundamentals-based story emanating from Japan. There was no one big data miss or comment from someone in charge, leading many folks to simply characterise the crash as being “technical” in nature, and an unsurprising event given the insane surge that the Nikkei has seen in recent months.
Alas, Englander’s two big stories for the week don’t include Japan. Instead they concern the Fed and China.
1. Bernanke ambiguity – The most obvious was Bernanke’s testimony that was widely viewed as opening a more than expected door to a slowing in the pace of Fed balance sheet expansion. The key quote “If we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases. If we do that it would not mean that we are automatically aiming towards a complete wind down. Rather we would be looking beyond that to see how the economy evolves and we could either raise or lower our pace of purchases going forward” leaves it ambiguous as to whether he is opening the door to a near term drop in the pace of QE or indicating that there is no timetable whatsoever on the pullback. Subsequent newspaper reports raised the possibility the FOMC would be discussing tapering in the June meeting. Hawks have been advocating tapering or stopping QE for some meetings, and they are nowhere near having the votes to influence policy any time soon. It also seems that the Fed exit discussions are now focused on how not to avoid having the first taper a signal for an inexorable sequence of taperings. Nevertheless investors are so conditioned on a Fed that keeps on easing that any discussion of a deceleration is coming as a shock. So the first shock yesterday was the fear that the global liquidity deluge may one day come to an end.
2. Definitive China weakness – The second driver was the drop in the China PMI to 49.6, lower than the lowest forecast in the market. This continues a string of weak China data, and reinforces the view that the slowdown is more pronounced than expected. It is still not a collapse, but outcomes are clearly much to the weak side of what was anticipated. The spillover is both to neighbouring Asian trading partners and commodity currencies. The second shock is a confirmation of fears that the China slowdown and downward pressures on commodity currencies are becoming well-embedded.
Englander actually has a third big theme that’s specifically related to currency, and that’s the realisation that commodity-based currencies (like the Aussie dollar) are overvalued, but again, these first two apply to all risk markets.
He goes on to note how this week was “different” than recent weeks in that dips were not bought knee-jerk in markets (although US equities were remarkably resilient, especially yesterday).
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