Busch: Fantastic FX 4

1. The ECB meets this week. The markets continue to abuse the Euro against most major currenciesas concerns over European banks remain strong. As an indication of the uncertainty, the Swiss central bank has excluded Irish government debt from a list of assets considered eligible as collateral for its repo deals. Also, the ECB has stated they are concerned over the Irish government’s ability to force losses on the collateral it accepts for loans to commercial banks. These stories along with others (Belgium) have spooked the European sovereign debt markets and have forced spreads to German bonds and CDS to move to all-time highs. More stories came out today (EZ official saying Portugal should use EFSF) and spreads moved out to all time highs.

For the first time in 2011, the bond markets will have to digest auctions from Portugal, Italy and Spain and Portugal this week.


The markets are not anticipating any change to ECB policy this week.

Outside of Germany, euro zone growth is slow and not likely to accelerate. The official overnight rate is at 1.0% and the ECB is not expected to announce any increase in bond purchases.

The ECB has engaged in buying sovereign debt of euro zone governments in an attempt to stabilize these bond markets. However, they have sterilized the funds and therefore no boost to economic growth. For the euro, this means no end in sight for negative newsflow on growth and sovereign debt. The range has been 1.2950-1.3500 for the last six weeks. The US dollar index has broken out above 80.85 and I expect the euro range to be broken to the downside as well. DXY to 81.45 and Euro to 1.2600 on this run. If you are not a momentum trader, wait for a pull back to gain entry.

2. US Jobs data not so hot. Yes, this story will be beaten to death by the time the markets open on Monday. However, the discussion won’t end. On Tuesday, the NFIB small business optimism index comes out and is expected to increase 1 to 94.3. We watch this for gauging if small to medium sized firms will hire. However, the NFIB already released their survey for December and it showed little change. The good news is that the percent of businesses reporting hard to fill job openings increased 4 points to 13 percent, the best reading in 24 months. Plans to create jobs gained 2 points to 6, the highest level in 27 months. So while the NFP numbers were disappointing, these should indicate coming job expansion. Small business is critical for new job creation as these firms created over 70% of new jobs during the last expansion. For currencies, this means we should see US bond yields stay firm and the US dollar to remain bid.

3. The currency war grows.

Brazil, South Korea and Chile are all struggling to slow the ascent of their currencies. All are taking action to deal with the issue, but all are dealing with inflation issues. Brazil gets most of the attention, so let’s focus on the other two. South Korea is set to announce price-stabilization measures on January 13th as the government aims to keep CPI at 3%. Like China, South Korea has a food inflation problem and fresh food prices soared 21.3% yoy in 2010. The central bank warned of spill-over effects from China’s rising inflation risks. South Korea has currency controls that cap domestic banks’ and non-bank financial institution’s currency forwards and derivatives. (Brazil also reduced size of banks bets in FX this week.) The currency is stable at 1122, but is still near its all time highs.

Chile shocked the currency markets by shifting their policy from a laissez-faire policy to an intervention policy. The central bank said that it will buy $12 billion in the FX markets to offset the US dollar’s decline as the Chilean peso was the best performing Latin currency in 2010. It was only last month that central bank President Jose De Gregorio expressed doubts that such a plan would work. The US dollar spiked from 465 to 497 in four days since the policy was announced. The plan is to buy $50 million a day from January 5th to February 9th. This week, the story stays in the newsflow as South Korea’s and Chile’s central banks meet to decide on monetary policy. This is a battle over the US Federal Reserve’s QE2 program and smaller countries attempts to maintain their competitive export positions.

4. Appetite for Dim Sum. Last week, the World Bank announcedthat it was joining Caterpillar , McDonalds and the Asian Development Bank in issuing a “dim sum” bond into Hong Kong’s offshore renminbi market. They are tapping into strong investor demand for renminbi denominated assets. As an example, McDonald’s dim sum serving was over subscribed and sold out in 2 hours. The changes to the capital account allowing for RMB cross-border trade settlement and allowing RMB bond proceeds to be used outside China for trade and finance has helped to create this market.

However, it is a small market with only $6 billion in 2010 new issues, but is expected to grow quickly. Unlike Brazil or South Korea or Chile, China has a tight control on their capital account and therefore can control the fluctuations in their currency better. Therefore, this program is seen to widen the use of the currency and start the process towards increased convertibility for use in the global financial markets. For the markets, the use of the Chinese currency someday as a reserve currency will depend on full convertibility. The yuan is expected to gain 3-5% in 2011 and its further appreciation continues to fuel demand for investment products.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.