How the G20 Affects Currency Prices

06/30/2010 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

The price action in the currency and equity markets suggests that the G20 meeting provided little surprises. However, price action can sometimes be misleading as the G20 did surprise by placing a target date on deficit reduction and delaying higher capital requirements. This implies that the G20 believes that deficit reduction will crimp global growth, and as a result, they want to delay raising bank capital requirements until there are stronger signs of a global recovery. The dollar traded higher against most of the major currencies, including the euro and Japanese yen, but still managed to weaken against the British pound and Swiss franc. Stocks swung in and out of positive territory (on Monday), only to end the day down slightly. It is the month-, quarter-, and half-year end in most countries this week (and the fiscal year-end in Australia), which means there could be some interesting volatility. Of course, the non-farm payrolls report will contribute to the volatility as job growth is expected to turn negative once again.

Balancing Act at G20

The G20 turned out to be a real balancing act in terms of satisfying needs of countries promoting growth ahead of fiscal austerity and those supporting strong fiscal discipline. Among the three or four pledges to surface from the meeting, the emphasis was clearly on deficit reduction, rather than mandating higher capital requirements for banks. The negotiations provided a commitment that G20 countries halve their deficits in three years and pledge to cap debt loads over the next six years. However, since this was a meeting of compromises, the European interests for harsh fiscal cleansing gave in a bit to the US growth interests by recommending that deficit cutting is conducted at a “growth- friendly” pace. Nevertheless, President Obama affirmed in making good on his commitment to reduce deficits, saying that he will present “very difficult choices” going into next year.

In terms of the banking system, the G20 put off new capital requirements for countries, favoring a “phase-in approach” that would take into account “individual circumstances,” though they recommended that banks keep a “sufficient” level of capital to survive “stresses of a magnitude associated with the recent financial crisis.” Leaders hinted at a bank tax, but simply said that banks should pay for future emergency interventions without government aid. Currencies were not a topic of interest at the G20 aside from the call for “greater exchange rate flexibility in some emerging markets.”

Overall, the G20 meetings were, in essence, quite like their description of the recovery: “Uneven and fragile.” With sharp divides forming between nations, these pledges were, as French President Sarkozy put it, merely “A compromise, a point of equilibrium,” rather than “An instruction from the G-20.” It is expected that the year-end Seoul summit will produce more tangible results in terms of financial regulation.

Spending and Income

The recent reports on income and spending confirm the trend that shows individuals saving more and spending less. Personal income rose by 0.4%, while spending gained at a better-than-expected rate, but still depressed 0.2%. The report showed that the personal savings rate rose to 4%, the highest in eight months and well above the long-term 1.7% average rate. Nevertheless, with income rising to healthy levels, we may eventually see more spending on renewed job-market confidence. We also saw that the Fed’s preferred inflation gauge rose by a subdued 0.2%, indicating that an interest rate hike remains far off into the future. The newest US data will come in the form of consumer confidence and the S&P/Case-Shiller Home Price Index.

EUR: Germany Picks Up Where G20 Left Off

EUR/USD gets off to a rocky start this week as the G20 meeting failed to provide too much for markets to run on. EUR/CHF, on the other hand, plummeted to a new record low as the SNB’s Danthine confirmed that the strong franc was no longer harming the economy and the deflation threat largely disappeared. European policymakers are already picking up where the G20 left off. Even though negotiations failed to reach an accord in terms of a bank tax, Germany has already proposed a bank levy aimed at establishing a fund to be tapped to soften the blow of financial bailouts on taxpayers. The tax could reach as much as 0.04% for the largest of German institutions. Along with the levy, the plan also sees a small tax imposed on derivatives held off the balance sheet. Separately, it was leaked that the Bundesbank has arranged meetings with the largest German banks on June 30 to discuss stress test results. Markets are still on edge in anticipation of the findings, and hopefully, the meeting is one step closer to the results being released to the public. Economic data showed that, on several different levels, price pressures were starting to turn to the downside. In Germany, consumer prices sank to a worse-than-expected 0.9% from last year. In addition, the M3 money supply also worsened, signaling that inflation pressures are nowhere in the pipeline. Expect consumer and economic confidence for tomorrow.

NEXT: What's Ahead for GBP, NZD, and JPY?

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GBP: Sentence Promotes Gradualist Approach

GBP/USD continues its ascent, rallying to the highest level in more than a month. Meanwhile, EUR/GBP plummeted to the lowest levels in about 19 months. Andrew Sentance, the Bank of England policymaker who voted for a rate hike at their most recent meeting, got a chance to explain himself during a recent interview. Sentance said that he prefers a “Gradualist approach to tightening policy,” recognizing the risk that a more aggressive plan could “Knock back private sector confidence.” What was surprising was that even though many reasoned his hawkishness would falter now that the government’s budget plans have been laid out, that does not seem like the case. Instead, Sentance says his views have not changed considering the fact that the budget was not “Far off expectations.” At this point, Sentance is the only MPC member pushing for higher rates, but if he earns some followers, we would receive a clearer signal that BoE policies were about to change. In economic data, the Hometrack survey showed that housing prices rose at the slowest pace in five months, leaving average home prices at GBP 158,900. Tomorrow’s schedule is a bit more substantial, with mortgage approvals, M4 money supply, and net consumer credit.

NZD: Drop in Confidence May Plague RBNZ

While the loonie and aussie have not made or lost much ground, the kiwi suffered a tough day of losses driven by what turned out to be less-than-optimistic economic data. New Zealand’s business confidence was hit hard last month, dropping from an 11-year high. The change in mood is mostly attributed to uncertainty stemming from debt crises abroad and the Reserve Bank of New Zealand’s newly-established tightening cycle. While today’s report does temper chances for another hike at the RBNZ’s next meeting, it changes things only slightly considering the fact that businesses surveyed reported higher expectations to raise prices in coming months. The potential rise in inflation should keep the RBNZ on their toes. On a down note, surveys indicated lower intentions to hire and lower optimism for future sales. New Zealand has building permits on tap for tonight. In Australia, the mood was buoyed as a poll showed that thanks to the recent shakeup in Australian politics, citizens favored the incumbent Labor Party for a win at the upcoming elections. This should calm fears that the Australian government has become unstable. No new economic data was reported from Canada, but we do expect the industrial product and raw material price indexes for tomorrow.

JPY: Retail Sales Paint Bleak Picture of the Consumer

USD/JPY reversed its earlier losses on what turned out to be a truly horrid retail sales report. Japan indicated that May’s sales dropped at the fastest pace in five years, with the annualized figure coming in at the slowest rate since January. Many hoped that the spillover from the surging export sector would have a clearer impact on the consumers’ willingness to spend, as evidenced by relatively optimistic consensus forecasts that were clearly missed by today’s report. With government incentives starting to dry up and a series of harsh austerity measures likely to take hold over the next few months, it is hard to believe that the consumer is prepared to post any comeback. With that in mind, the Japanese government is presented with two major complications. The first is that it may make Kan’s plan to plug the budget gap through harsh rises in consumption taxes more difficult to achieve. And secondly, the drying up domestic demand poses a threat to potentially exacerbate the decline in prices as retailers will be forced to implement sharp discounts in an effort to find buyers. For tonight, we have the jobless rate and household spending reports, both of which are likely to paint a clearer picture as to the health of the consumer.

By Kathy Lien, currency trader and analyst, GFTForex.com

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