Yen Traders Not Spooked by Swine Flu Fear…Yet

04/28/2009 9:58 am EST

Focus: FOREX

Yen remains firm on risk aversion as investors around the globe are concerned with the outbreak of swine flu in Mexico and the global spread. Nevertheless, losses in stocks are limited so far, and so is the gain in yen. Major European indices are just around 1% down, while the Dow is drawing support from the 8,000 psychological level. Yen is gaining most against the Aussie, Kiwi, and euro so far. Dollar, on the other hand, continues to recover in general.

Nevertheless, there seems to be another round of euro selling in crosses in the early US session. EUR/USD's dive to below the 1.31 level is believed to be trigged by weakness in EUR/CAD, which is set to take on the 1.5773 support level and resume its recent fall. As mentioned before, the common currency remains under pressure against commodity currencies like CAD, AUD, and NZD, plus the yen as well.

The economic calendar was rather light today. Germany's important price index dropped -0.4% m/m in March, deeper than the expectation of -0.1%. On a y/y basis, the index dropped -7.1%, also larger than the expectation of -6.5%. Gfk consumer confidence unexpectedly rose from 2.4 to 2.5 in May.

Deflation Likely to Be Temporary, But Price Level Should Remain Low for Extended Time

Recently released CPI data showed that inflationary pressure has moderated sharply, especially in developed countries. The market has been under vigorous debates about whether the current recession will end up with prolonged deflation or hyperinflation due to aggressive quantitative/credit easing policies by governments worldwide.

Since mid-March, inflation expectations were heated up after the Fed announced its asset purchase program, which was followed by the BOE and some other banks as the market worried that the money-printing game will cause currencies to depreciate, causing inflation.

However, these expectations faded as investors started to talk about a deflation gain after the US reported its first negative (since 1955) annual CPI reading in March. Adding to the bearish environment was that inflation data from Australia, the euro zone. Canada, etc, also showed significant declines.

Our belief is that while inflation rates will continue to trend lower in coming months and more countries will report negative readings, deflation will only be temporary. It's because easy monetary policies, as well as the ballooning public debts to GDP will prevent it from happening.

Although the most common definition of deflation is "negative year-over-year inflation rate," in order to confirm that an economy has entered deflation, there should be generalized and persistent decline in price levels. However, the recent fall in inflation was driven mostly by energy and food prices, which contributed around 30% of headline CPI.

While core CPI in many countries have also dropped, this may also be due to commodity prices. We have discovered that in recent years, despite the fact that core inflation is defined to exclude food and energy prices, the correlation between oil price and core inflation in developed countries has increased significantly. In this sense, it's normal to see further contraction in core CPI in the coming months due to the high base effect of oil prices in 2008.

Yet, it's also unlikely for inflation to emerge as a real problem in the coming one or two years because capacity utilization remains at a low level and has yet to find a bottom. For the effect of QE to take place, it will also take several years. Therefore, we believe that world CPI could trade below the 2-3% target for most of the time in 2010 and during the period that governments will continue rolling out stimulus measures so as to restore inflation rates to their desired levels.

NEXT: Reviews of Recent Inflation Data |pagebreak|

Reviews of Recent Inflation Data

US: March CPI contracted -0.4% y/y in March, the first negative reading since 1955, as energy prices were down 23.1% from a year ago. On monthly basis, the gauge plunged -0.1%, led by a -3% decline in energy prices. Excluding food and energy, core CPI held steady at +1.8% y/y and +0.2% m/m as spurred by an increase in excise taxes on cigarettes. If the tax increase was also excluded, core CPI only rose by +0.07%. While worries about deflation loomed after the disappointing readings, we need some more data points to confirm the price outlook in the US. In fact, the core CPI increase in 1Q09 was +1.5%, higher than +0.6% in the previous quarter as driven by surges in new vehicle and apparel prices together with the tobacco tax increase. This showed that the actual outlook in the US is "mixed" for the time being, rather than "deflationary" as described by some commentators on the Street.

Euro zone: Growth in consumer prices slowed to +0.6% y/y in March from +1.2% in the previous month as driven by an 8.1% y/y decline in energy prices and a -4.3% decline in transport prices. Growth in other categories such as housing, goods, and beverages also moderated significantly. Core CPI also eased to +1.5% y/y in March from +1.7% a month ago, mainly driving a slowdown in services inflation (high base effect caused by early Easter in 2008). Inflationary pressure will probably ease further in the coming months (may turn negative in by 1H09) as unemployment is soaring, which will reduce household wealth and eventually reflect in lower consumption.

UK: Headline CPI eased to +2.9% in March from +3.2% in the previous month as led by declining energy prices and a slowdown in food, alcohol, and tobacco inflation. Core CPI remained firm, rising to +1.7%, from +1.5% in February, as the service sector stayed strong. However, the RPI reading turned negative in March, sliding -0.4% y/y, and was the first negative reading since 1960s due to lower housing prices and mortgage rates. Compared with its closest counterparts, CPI in the UK is relatively high, and this is probably due to strong service prices as well as higher import prices as a result of the pound's depreciation.

Japan: Japan's headline CPI contracted -0.1% y/y in February, the first time since September 2007, as the sharp fall in commodity prices and strong appreciation in Japanese yen damped the overall price level. Core CPI came out flat during the month, but further downward pressure is seen.

Switzerland: Apart from the US and Japan, deflationary pressure is also emerging in Switzerland. The nation's CPI contracted -0.4% y/y in March, with the largest decline coming from petroleum product prices. Given the high base effect, energy prices are expected to exert downward pressure on CPI all the way until 2H09 at the earliest. The SNB will likely continue its quantitative easing policy and currency intervention to prevent Swiss franc appreciation.

Australia: CPI eased significantly to +2.5% in 1Q09, down from +3.7% and +5% in 4Q08 and 3Q08, respectively. On a quarterly basis, the gauge surprised to the downside, with just a +0.1% increase due to the ongoing decline in energy prices, mortgage rates, and transportation prices. According to the minutes from the RBA's April meeting, "Inflation over the medium term was expected to continue to decline." Also, "There had been further downward revisions to the staff forecasts for growth and inflation. GDP was expected to fall in 2009 but increase again in 2010. The revised outlook for growth, and the associated reduced level of capacity utilization, would entail stronger downward pressure on medium-term inflation than previously forecast."

New Zealand: The CPI rose 3% y/y in 1Q09, with 50% of the increase contributed by food and electricity prices. On a quarterly basis, the gauge came in at +0.3%, slightly below the RBNZ projection of +0.4%. In March, the RBNZ slashed its policy rate to 3% and stated that "Further house price falls and increased precautionary saving by households are driving a weakness in spending. Inflation pressure is abating rapidly as a result."

Canada: The headline inflation rate moderated to +1.2% y/y in March, down from +1.4% a month ago. However, the result has already been better than a flat reading as anticipated by the market, as well as +1.1% in January. A sharp fall in gasoline price was the largest contributor to the slowdown, but the decline was offset by higher food and shelter prices. Earlier this week, the Bank of Canada cut interest rates by 25 bps to 0.25% and announced a downward revision on their inflation outlook. The BOC forecast core inflation to "Diminish through 2009, gradually returning to the 2% target in the third quarter of 2011 as aggregate supply and demand return to balance. Total CPI inflation is expected to trough at -0.8% in the third quarter of 2009 and return to target in the third quarter of 2011."

By Staff

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