After participating in the dollar selloff following the FOMC announcement emerging market currencies started to weaken against the US dollar again yesterday. No great surprise there, as the greenback re-asserted its dominance against the majors as well. There were quite significant retracements across the board, which reinforces my view that what we saw on Wednesday evening was a positioning clear-out exacerbated by poor liquidity. It’s really something to watch the Brazilian real at the moment, just a few years ago we wondered if parity with the US dollar was possible, and here we are now trading above 3.30. The questions isn’t ‘how can things turn bad so quickly?’ It’s more like.. ‘how can we fail to acknowledge what is wrong for so long?’ It took the markets a long time to penalise Dilma for failing to persist with reforms, it makes me wonder where the other blatant errors are, that the market continues to ignore. Time will tell…
There isn’t much on the data front today that’s noteworthy, apart from possibly inflation data in Canada and Brazil. But talking about inflation, I was stunned to read a comment from the Bank of England’s chief economist suggesting that rate cuts are as likely as rate hikes at this stage. What is he seeing I’m not!!? Clearly his reaction function is so far away from what I would hope it is that this sort of comment is possible. And indeed that appears to be the case with his concern being low inflation. Low inflation.. really? I recall just a few years ago when inflation was so far above their mandate but they kept rates low because they saw through the number and focussed on weak growth. Here we are now with the economy getting stronger and stronger, labour markets tighter and tighter, a one off energy price fall causing low inflation readings, and now… we might need to cut rates because of… low inflation? What good is a supposedly independent central bank when there is such a clear asymmetry in the reaction function?
The Nigerian central banks reserves continue to fall, with some estimates suggesting that just $28bn or roughly four months’ worth of imports remain. With elections just days away and no meaningful policies until after the changeover, we’re looking at June or July before any new budget is implemented. It is increasingly obvious that the naira, even though it has apparently stabilised in the last few weeks, is simply untenable at current levels. While the 1 year forwards look extreme pricing in a further 30% depreciation from here, common sense suggests depreciation in the double figure percentage area for sure. No matter the outcome we are likely to be entering a period of a few months where this pseudo-stability of the naira will vanish. Strap on your seatbelts…
Next week the currency market focus might well move away from the US dollar again to the euro. The ECB is likely to limit the amount of Greek treasury bills that Greek banks can buy as one of the red lines in the Eurozone is that central banks cannot fund sovereign governments. The Greek banks are getting close to doing just that. There are a series of member state meetings in the next few days where this issue will be discussed, we all know the participants and the sides they’re on, it’s just a case of waiting to see the outcome.
While I continue to see the euro weakening versus the US dollar, we are now sufficiently close to the UK general elections, and BoE officials are so willing to talk about rate cuts, that I see a risk that the pound sterling could be weaker than the euro over the next couple of months. I would therefore not be surprised if we see a significant move higher in EUR/GBP in the near term with consequent declines in the GBP/USD as well, given our view of EUR/USD. As always we will watch the trends and update you about the level of our convictions. Have a great weekend.
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