Another week, another set of cycle highs in risky assets

Tom Tong21/Feb/2011Currency Updates

Whatever the macroeconomic or geopolitical risks, stocks and commodities worldwide continue to set fresh highs weekly. While it is true that macroeconomic news in developed countries have consistently beaten expectations over the last few months, this was mostly due to the unfounded fears of a double dip that gripped analysts during the last quarter of 2010. We believe this rally is being powered by the lack of appeal in more conservative asset classes, as cash returns in much of the G10 are below 1% and longer term riskless bonds offer yields barely above 3%. Therefore, we have no reason to expect any dramatic correction in the markets until policy stimulus is reduced.

Meanwhile, FX markets remain trendless, while volatilities continue to hit new post-Lehman lows in a clear sign of market complacency. Post-crisis correlations between FX and other asset classes continue to break down; perhaps one of the most surprising of these breakdowns has been that the dollar is failing to rally in response to geopolitical headline risk, as illustrated by last week’s euro rally in the face of spreading unrest in the Middle East and new Israel-Iranian tensions.


Sterling trading continues to be dominated by the news surrounding UK inflation and the Bank of England response to this. February inflation increased to 4% YoY, although core inflation came in just a touch under expectations at 2.9% YoY. The Bank of England inflation report communicated relatively little information about whether the balance of opinion in the MPC is shifting towards a first hike. This will have to wait for the publication of the MPC minutes of the last policy setting meeting, to be published next week, as well as a number of speeches by MPC members. Further clouding the outlook last week was some weaker than expected news about the state of the labour market in the UK, which perhaps hint at our long-expected weakening of the macroeconomic newsflow due to the significant fiscal tightening about to hit the economy.

Rate and FX markets diverged somewhat in their appreciation of the week news.  Expectations for coming hikes ended the week more or less where they had started. Sterling, however, rallied nearly 0.5% vs. the euro and about 1.5% against the dollar.


Eurozone growth for the last quarter of 2010 was reported slightly under expectations at 1.2% q/q SAAR. While exceptionally bad weather may have played a part in the slightly disappointing news, we will not know for certain until a more detailed breakdown of the German numbers is released. In any event, FX markets are more concerned with the comprehensive policy package that is in the works regarding the weaker peripheral sovereigns. Little news dribbled out on this front last week, and it seems as though European leaders will wait until the very end of their self-imposed deadline of late March to release the final details. In the absence of new information, peripheral spreads generally drifted wider, with Portugal showing particular weakness. The common currency, however, generally shrugged this weakness off to end the week about 1% higher against the dollar but almost unchanged in trade-weighted terms.


US macroeconomic news turned more mixed last week. Retail sales came in somewhat below expectations, indicating that momentum in domestic demand may be waning somewhat from the fairly strong levels seen in the fourth quarter GDP release. Nevertheless, second-tier sentiment indices released last week came out stronger than expected. The minutes of the latest Fed meeting were also released, and they pointed to very little change in the board’s appreciation of the risk to the outlook. The new highs in equities and commodities were generally bearish for the dollar, which ended the week down about 0.5% in trade-weighted terms.

Other G10

GDP growth in Japan in the last quarter of 2010 came in negative as expected, as domestic demand shrunk on the expiration of incentives for big-ticket purchases. However, analysts widely expect the Japanese economy to rebound on the coming quarters driven by exports to the rest of Asia, and the BoJ actually upgraded somewhat its view of Japan’s economy and inflation expectations. The Japanese yen strengthened against the greenback, driven both by lower US yields and generalized dollar weakness.

All three dollar bloc currencies rallied against the dollar, driven on by gains in risky assets and, particularly, commodity markets. Not surprisingly, the most commodity-intensive economy of the three, Australia, saw its currency gain the most, up over 1% to a new record. CAD and NZD lagged somewhat, up less than 0.5% each against the greenback

The Norwegian kroner strongly outperformed the Swedish Krona last week. The higher price of Brent oil, driven up by Middle East unrest, and a strong mainland GDP report out of Norway were the main drivers. In spite of a fairly hawkish Riksbank statement and a hike in the level of rates to 1.50%, the Norwegian kroner rose nearly 2% against the SEK and about the same amount against the euro. We think that this week marks a significant break in the trend of SEK outperformance against NOK, and are bullish the NOKSEK cross rate.


Written by Tom Tong

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