Another risk rally - does it have legs this time?

FX Update: Another risk rally - does it have legs this time?

RBA
The RBA left rates unchanged as expected, and this makes the second consecutive meeting in which the bank has decided not to move higher on rates. A key phrase at the end of the statement suggesting that rates are appropriate for the "near term" was removed, as the bank is clearly raising its concern level on the world economy and European sovereign debt and EU banks. On inflation: Governor Stevens predicted that "underlying inflation appears likely to be in the upper half of the target zone over the next year". On the domestic economy, Mr. Stevens suggested that households are "displaying a degree of caution", but also believed that business investment will increase in the year ahead. Other comments on the domestic economy were largely benign. (Click here for the full text of the RBA's statement.)

Overall, the statement looks neutral to dovish, with the removal of the "near term" language clearly intended to maximize the bank's flexibility in the coming months, as the governor and his colleagues must be noting the sharp turn to the worse in North America and the general malaise expressed by the tremendous bond market rally and equity market sell-off. There was no sign that the market took the statement this way, considering the stiff rally in AUD - particularly AUDUSD and AUDJPY in the wake of the RBA's statement. But if we look over at the Australian STIRs, we can see that the new statement has seen absolutely no adjustment higher in rate expectations. According to the Credit Suisse year forward expectations index, the RBA is not expected to move in the coming year - with the actual index having crept just below zero over the last week. To find an explanation of the move higher in AUD, we must rather look over to the strong recovery in risk appetite that saw Asian equities very sharply higher in today's trade. Considering the lack of enthusiasm in the interest rate market, the AUD could wobble in the days ahead if the move in risk appetite fades. Also supporting some of the enthusiasm for the Aussie was a very strong trade surplus for May.

Chart: AUDUSD
An impressive snap-back rally in AUDUSD off the 0.8310 area lows today despite no change in the interest rate spreads. This is remarkable and makes us a bit cynical on the prospects for the rally holding for very long, though the reversal does look technically compelling so far. If the 0.8550/0.8600 area is not able to hold the pair, then it may have a go at the obviously critical 55-day moving average again (red line).

China
Bloomberg leads with an article today about China's property market, which noted economist Kenneth Rogoff says is starting to "collapse". (See the article here). The article notes that prices theoretically continue to rise, though recent measures from the regime have helped to choke off the rate of sales, which fell 25% month-to-month in May. While the Shanghai composite was clearly not reading this article and closed strongly, it is nevertheless interesting to ponder what this would mean for the Chinese economy (and the AUD as well, if we are to look at G-10 FX fallout from this), as Chinese banks would inevitably be hit very hard by any negative development in property, as Mr. Rogoff explains. Other analysts are far more sanguine on the property market, though Jim Chanos, the legendary short-seller and seeker of all that is troubled, suggests that the Chinese property market is like a Dubai times a thousand.

The Chinese property market is very difficult to observe and analyze from outside China, but it is clear that sales are stagnating. The extremely low carrying costs for owning real estate in China (no property taxes, for example) make it very difficult to gauge the development for prices - making the system slow to mark prices to market as sellers try to wait out any signs of a new negative trend in prices. As well, the building and overbuilding of apartments has been a significant source of graft for corrupt local officials, who apparently often gain ownership of units through allowing projects to proceed in their area and reap vast wealth from this practice. They will do anything in their power to keep the speculative wheels turning.

It will be difficult for us outside observers to perceive what is going on until the market is beating a full, perhaps even panicky, retreat. In the meantime, we ne need a proxy for a barometer on China's economic health besides the Chinese equity markets. Perhaps yuan forwards and sovereign CDS prices are the way to go there. Considering the manner in which the Chinese policy response to the global financial crisis by early 2009 encouraged crass speculation, the “follow the incentives trail” for corrupt local officials in allowing a building boom to proceed unchecked, and the fear of the well-to-do and wealthy classes of China who are always looking for a safe place to stow and grow their capital in a an economy beset with strict property , not to mention a good dose of speculative fervor aggravated as well by wealthy Hong Kong Chinese, and you have the makings of a very ugly situation at some point down the road. China will not escape from this unscathed.

It is interesting to note that the Shanghai Composite supposedly jumped higher on the day due to a an article in Shanghai suggesting that China is ready to invest USD 100 billion in 23 new infrastructure projects. Is this a sign of strength, we ask, or a sign of desperation?

Why the weak USD?
The greenback has been relatively weak of late vs. the European currencies and JPY due not only to the deceleration of recent fundamental data, but also on the focus on the situation with state and local governments all around the US, many of which started a new fiscal year July 1 and face dramatic budgetary pressures that will not only mean austerity, but even the potential for default/debt restructurings in some instances. This situation reinforces the idea that a very negative view on "the rest of the world" is necessary for the greenback to survive and thrive, as the near term future for G-10 FX may turn into an "ugly contest".

Looking ahead
Recall that we are about to enter earnings season for companies' Q2 earnings, which are traditionally kicked off in the US as Dow Jones Industrials component Alcoa reports its results (on July 12 in this case). It is interesting to note the. Will the signs of a sharp deterioration in the improvement of the US economy in last Q2 wear off at all on companies' results? And more importantly, what is the guidance. A good article on the upcoming earnings season, and the very bullish expectations for earnings despite apparent deceleration in the economy's improvement can be found over on Bloomberg.

Meanwhile, just ahead of the US open, AUDUSD is gunning above 0.8500 again despite a relatively neutral to dovish RBA statement and the EURUSD is pushing above the 55-day moving average in today's trade. If risk appetite keeps up a head of steam, the squeeze may last a bit longer in the AUDUSD rally (even if it still just looks like a squeeze so far), but the EURUSD rally or squeeze seems relatively uncorrelated with the risk appetite situation. While it is technically interesting that the pair has moved above a key moving average, it's certainly tough to find anything that will hold the pair higher for any significant length of time and the bears may find value here in the 1.2600 area. The recent rally in short rates in Europe has been given some credit - but there are no real legs in that development, as we discussed last week (what's the maximum potential for movement there - 10 or 20 bps either way, perhaps?). Still, technically-minded traders might at least want to see a close back down well below 1.2490 for signs that the bear is ready to growl again for the pair.

Watch out for the key ISM non-manufacturing data out today. Any relatively unchanged level would likely be celebrated at least briefly, since we have seen such a persistent drumbeat of negative data, though we have no reason to believe that this will be an especially strong number. The May number finally saw the employment component creep above the 50 level for the first time since December of 2007 and this is the component that will likely see the most focus. Also watch the ABC weekly Consumer Confidence number out after the close - this number strangely notched its best reading
 
For the rest of the week, the focus shifts to the Canada Ivey PMI tomorrow, Australia employment data on Thursday, and the BoE and ECB meetings on that day as well. The week wraps up with the Canadian employment report for June, so we should know by the end of the week whether USDCAD can punch back through the 1.0680 area or if it the 200-day moving average can support the pair (currently around 1.0424). It is interesting that the fresh signs of a strong slowdown in the Canadian housing market in the form of today's very weak building permits was met with a wall of CAD buying  - again, risk appetite reigns supreme for the moment for the commodity currencies as the fundamentals may have to wait.

Economic Data Highlights

• New Zealand Q2 NZIER Business Opinion Survey out at 18 vs. 22 in Q1
• Australia May Trade Balance out at +1645M vs. 500M expected (Apr. figure revised up tto 1123M vs. original 134M)
• Australia RBA left rates unchanged at 4.50% as expected
• Switzerland Jun. CPI out at -0.4% MoM and +0.5% YoY vs. -0.1%/+0.9% expected, respectively
• Canada May Building Permits fell -10.8% MoM vs. -2.0% expected

Upcoming Economic Calendar Highlights

• US Jun. ISM Non-manufacturing Index (1400)
• US Weekly ABC Consumer Confidence (2100)
• UK Jun. BRC Shop Price Index (2301)
• Australia Jun. AiG Performance of Construction Index (2330)