Choppy FX Conditions in the Fog of War

The price action in the foreign exchange market is choppy  as short-term participants seem nervous after being whipsawed yesterday.  Sterling fell nearly a cent to new multi-month lows following the BOE's inflation report that confirmed official expectations that price pressures will remain above target and King welcomed the recent depreciation of the point.   Also of note the Australian dollar, which staged a sharp recovery off the year's lows yesterday and has seen follow through buying today, helped perhaps by gains in a consumer confidence measure.  

The was nothing in the rogue G7 sourced comment yesterday that Japanese Finance Minister Aso did not say prior to the G7 statement and before the weekend.  The pace of the yen's depreciation was too fast.  The market reacted to it at the time.  

It is interesting to speculate who is the G7 source.  It may have come from a country who feared the loss of competitiveness from a depreciating yen the most.  Within the G7, this seems an awful lot like France.   Another possible suspect is a country that wanted to make sure Japanese officials understood its displeasure with citing specific bilateral exchange rate targets, which violates the general G7 agreement (and contrary to talk of official manipulation, this Rubicon is rarely crossed these days).  The possible candidate there is the US; perhaps a s a corrective to Treasury's Brainard's comments which appeared to have helped push dollar to new highs against the yen.

Among the difficulties we have with all the attention currency wars are receiving that it distracts investors and policy makers from the real underlying dynamics.  For example, the fear of currency wars is that they lead trade wars.  Yet the opposite appears to be taking place.  In the State of the Union address Obama clearly endorsed a US-EU free-trade agreement.  The goal of which would not be simply reducing tariff barriers, but harmonizing regulations and technical standards as well.    

The EU, incidentally, will soon complete a trade agreement with Canada and will launch negotiations with Japan in a couple of months.  It has reached an agreement with Singapore at the end of 2012.    We also note that talks for a Pacific basin agreement (Trans-Pacific Partnership) are also underway.   

As widely anticipated, Sweden's Riksbank left rates unchanged at 1% at today's meeting.  The tone of the comments was seen through a hawkish lens given the continued reference the high light of household debt.  The market had been leaning toward another rate cut in the coming months and as the market had second thoughts about this, the krona has taken off.   

It has gained a full percent against the euro.  The euro has been sold through the SEK8.50 floor that has held on two tests (early Nov and early Jan).  This is a large move, which seems a bit excessive.  Very little has changed at the Riksbank and the doves Ekholm and Svensson continued to call for cuts (25 and 50 bp respectively).   

Italy saw a rise in yields at today's auction of some 3.45 bln euro of  2015 notes (2.3% from 1.85%) since last month's auction, reflecting the rise in the secondary market that has taken place since the Jan sale.  It also sold some long dated paper (2026 and 2040 bonds).  There are reports suggesting Italy is probing market conditions to bring 30-year paper to market.  While some observers will blame nervousness ahead of the election, we note Italian 10-year bond yields are off 11 bp over the past week and down 3 bp today. 

Although opinion polls are now banned for the Feb 24-25 election, two developments are seen as favoring the center-left's Bersani in the lower chamber.  First, the retirement of the Pope dominates Italian papers and this steals the limelight from Berlusconi.  Second, and perhaps more importantly, the previous governor of Lombardy was found guilty on corruption change.  Lombardy is a key area and especially important for the Senate.

The highlight of the North American session today is the US retail sales report.  It will be the first important reading of the impact of the end of the payrolls savings tax holiday.   In general, economists expect the American consumer to remain fairly resilient.  Excluding autos and gasoline, economists expect retail sales to have risen 0.4%, which is just above the Q4 monthly average.   The yen may be the most sensitive to the resilience of the consumer, if indeed it is borne out, especially if it pushes US yields higher. 

A report that rarely gets attention, business inventories, may be important for thinking about revisions to Q4 GDP.  Recall that recently the increase in construction spending and the smaller trade deficit prompted some economists to revise up their forecasts from the -0.1% initially reported for Q4 GDP.  However, inventories seems to be a larger drag on GDP and that is likely to be seen today's business inventory report.