Three Noteworthy Developments

The global capital markets are mostly quiet and the dollar is mixed, but mostly softer.  There are three developments we direct your attention to:  the RBA rate cut, Spain and aid, and the US block of a Chinese acquisition.

The  euro has been confined to about a half cent range in the upper end of yesterday's range.  Resistance is seen in the $1.2940-60 area before last week's high just above $1.30 comes into view.  A softer than expected, but better than August, CIPS construction PMI in the UK has kept sterling range-bound as well.   Offers are being encountered on pushes in the $1.6170 area, but important resistance is not seen until $1.6210-30.  The dollar is testing last week's high just below JPY78.30.  The slog gets more difficult between there and JPY79.00 


The Reserve Bank of Australia delivered 25 bp rate cut that indicative prices suggested was largely anticipated, but where opinion polls showed greater doubts.  The important thing here may not be the lowering of the cash rate to 3.25%, but the dovish comments, which clearly opened the door for additional easing before the end of the year.

There are two considerations. First is domestic inflation.  The Q3 report is due out on Oct 23.  Headline inflation (Q/Q) in Q2 was 1.2% and the trimmed mean was at 2.0%. The second is the global economy. This is not just the Chinese economy, which is of course important for Australia, but also the more general state of the world economy.  Provided price pressures remain subdued and the world economic outlook bleak, a rate cut in early December appears likely, though a move in early Nov (Nov 5) cannot be ruled out.

The Australian dollar briefly traded below $1.03, after testing $1.04 yesterday.   Resistance is seen in the $1.0320-40 area.  Judging from the recent IMM data, the short-term momentum and trend followers were leaning in the wrong direction.  It warns of the possibility of trapped longs that will likely sell into bounces. 

Press reports suggest Spain's Rajoy is done with the flirtation and now wants to consummate the deal and formally request aid.  At the same time, the reports shift the burden of potential delay to Germany.

Germany's position appears two-fold.  First, German Finance Minister Schaeuble has told his euro area counterparts that it is difficult to present a case for new aid to Spain so soon after the 100 bln euros was agreed upon.  Chancellor Merkel has also reportedly indicated a preference for avoid piecemeal votes and instead seeks a larger package that includes a resolution of Cyprus, Greece and Spain.

Second, is the question of what are the funds for.   Germany wants them to be "must haves" not "nice to have".  That is to say, it must be an emergency and one does not exist at the moment.  Consider the Spanish premium over Germany.  At the 2-year sector is its 315 bp now.  At the end of 1993, prior to the real convergence for EMU, it stood at 276 bp.  The current 10-year spread is near 425 bp.  At the end of 1993, it stood at 248 bp.

The short-end, which the ECB's OMT scheme focuses, does not appear at an emergency level or one that reflects a broken monetary transmission mechanism.  Moreover, understanding the interest rate premium now, also requires appreciating that Spanish inflation is running 150 bp on top of Germany, which is twice the inflation differential in 1993

With the various unconventional policies in the US, Europe and Japan, talk of "currency wars" has resurfaced.  Action at the end of last week by the US to block Chinese ownership of a wind farm in Oregon seems to fit well into such a narrative of beggar-thy-neighbor policies.   Yet closer suggests it is not the beginning of a downward spiral as in Smoot-Hawley.

While acknowledging that the timing of the Obama Administration seems political after Romney's criticism of Obama's China policy, it is likely a one-off move.  The same Chinese company has been allowed to purchase two other wind farms (in Massachusetts and Texas).  The concern is not the industry, but the location of the wind farm in Oregon, which is near a US naval base and where cutting edge technology (drones) are used.

There is also the fact that the purchase was completed without US officials being informed.  In fact, according to press reports, this only came to light after the Navy objected several months ago.  The location coupled with the failure to follow proper procedures strongly suggest there is not far-reaching implication for US policy.  Nor is an expression of the "currency wars".