Currency Market Mix Up

The currency markets were a bit mixed yesterday, with half the currencies higher versus the US dollar, and half lower. The markets seemed confused, and didn’t hold to ‘normal’ trading patterns. The three best performing currencies versus the US dollar were the Brazilian real (BRL), British pound (GBP), and Japanese yen (JPY). That is an odd group! At the top spot, we have the Brazilian real which is a commodity-based currency with some of the highest yields available; which would lead you to believe that the risk trades were back on. But the Japanese yen was the third best performer, and the yen is a currency that typically moves higher when the markets are nervous and reversing out of carry trade positions. And who in the world would be buying the pound sterling right now? Something just wasn’t right in the currency markets yesterday. The overnight markets started to set things right, pounding the pound sterling lower; but the currency markets still don’t seem to be able to agree on a direction to take the dollar.

The euro (EUR) got a bit of relief from the constant selling pressure of late as European Central Bank President Jean-Claude Trichet said its legally impossible for Greece to leave the Eurozone. Investors had worried that Greece’s debt problems would force the euro to break up. But Trichet kept talking and eventually gave the market another reason to sell the euro. That is what has become the norm, as currency traders have a bias to sell euros and look for any reason to do so. Trichet gave them ammunition to sell when he spoke out against offering low-interest rate loans for which the Greek government has been pressing.

Many are still looking for more trouble for the euro. BNP Paribas issued a report that suggested investors take advantage of any euro strength to sell the currency as it remains ‘extremely vulnerable’. Another research paper issued by Standard Bank suggests the euro will reach $1.25 in the short term. But markets are made by buyers and sellers, and there is always two sides of every trade. The Bank of Tokyo suggested investors should be buying the euro, which has been the weakest performer of the G10 currencies since October. The report, written by a London-based foreign exchange strategist, suggested the euro is 5.8% undervalued versus the Canadian dollar (CAD) at current levels, and will likely rally 5% in the near term. This trade uses the crosses between the euro and loonie; as he also believes the Canadian dollar is slightly overvalued.

The Canadian dollar was off just a bit versus the US dollar as technical traders sold the currency, which they say is forming a ‘shooting star’ formation. The technical traders weigh this pattern as a reversal signal for the Canadian dollar. They agree with the Bank of Tokyo research, which shows that the loonie moved too far too fast and is due for a sell-off. Lower crude oil prices also contributed to the sell off for the Canadian dollar. While the short term doesn’t look positive for the Canadian dollar, a strong economy and rising inflation may force the Bank of Canada to move rates higher before their counterparts at the FOMC. If this occurs, the Canadian dollar should take another run at parity, and could trade through $1.00. This is still one of the better currencies to own, and any sell off should be seen as a buying opportunity.

I did stir it up a bit mentioning the healthcare reform passed by the house yesterday. Chuck warned me against bringing it up, but like a kid, sometimes I have to learn things the hard way. The point I was trying to make was that I am against deficit spending no matter what that spending is for. We have to get a handle on the spending, and the healthcare reform threw another level of spending on top of the existing mountain of red ink. I realize we need healthcare reform, and I also realize that we are already paying for the uninsured through higher premiums for those who have insurance. But where is tort reform in all of this? And how about all of the backdoor deals that were made in order to get this bill through? I better stop there, as I am slipping down the slippery slope again.

So what do the markets think of the US economy and all of the debt we are accumulating? Apparently not as much as they think of Berkshire Hathaway. Yields on two-year notes issued by Warren Buffet’s company are yielding 3.5 basis points less than US treasuries of the same maturity. US Treasuries are traditionally seen as the safest of all investments, and form the base of the yield curve. But in what is a very rare occurrence, bonds issued by quality corporations are trading at lower yields than US Treasuries. Investors apparently feel Procter & Gamble Co., Johnson & Johnson, and Lowe’s Co. all are better credit risks than our Federal Government. I guess it was inevitable, as the US budget deficit swelled and the Treasury department issued record amounts of debt. But if this continues, US Treasuries will lose their ‘save haven’ status and the US dollar’s position as the global reserve currency could also be in jeopardy.

The Swiss franc (CHF) rose to a record high versus the euro as investors continued to move allocations out of euros and into the Swiss franc. The Swiss National Bank tried to calm the appreciation by repeating that it will continue to act decisively to prevent excessive appreciation of the currency if needed. But traders aren’t falling for the jawboning, and seem to be challenging SNB President Phillip Hidebrand to put his money where his mouth is. The franc appreciated to 1.4309 per euro, surpassing its previous record of 1.4315 per euro reached in October 2008. The SNB was active in the currency markets over the past year to try and keep the franc from appreciating too quickly. But recently, they have seemed to back away from intervening, allowing the Swiss franc to appreciate versus the euro and US dollar.

UBS AG, the world’s second largest currency trader, raised its forecast for the Swiss franc versus the euro. The report that was released early this morning quoted SNB Governing Board member Jean Pierre Danthine who said last week that policy makers can’t prevent the currency’s advance indefinitely. Sounds like the SNB may be throwing in the towel, and currency traders are jumping back into the Swiss franc to see just how far the SNB will let it appreciate. As we suggested early in the Greek crisis, the Swiss franc may be a good place to move European allocations until the euro is back on solid ground.

Chinese officials signaled they would keep their currency pegged to the US dollar, in spite of all of the saber rattling coming out of Washington. Senator Schumer and his band of brothers have proposed legislation to punish China for manipulating their currency, but the Chinese officials don’t seem scared. Pressure on China to strengthen the renminbi (CNY) does “no good to anyone,” according to Commerce Minister Chen Deming.

Chris Gaffney
for The Daily Reckoning

The Daily Reckoning