AUDUSD and parity – why the tease?

AUDUSD is trading at parity again despite a fairly solid technical break yesterday. This is impressive considering a very Aussie-negative news item out overnight that the market seems to want to ignore in favor of knee-jerk trading on correlation with equity markets. What’s up Down Under?

Moody’s doesn’t like Australia’s banks
In the supposed poster child of economies and “high yielding” (we take what we can get in this era of widespread ZIRP) currencies, we have Moody’s out extending its negative watch on Australia’s banks. The source of the negative watch? Mortgage backed securities – particularly insurers of these securities. Does that sound familiar? Does that echo what caused the downfall of the US financial system? Should we worry about this blossoming into a crisis when Australia has seen a far more aggravated rise in its housing prices than the US ever saw in its housing bubble?. Absolutely, on all three accounts. Let’s watch what happens when Aussie housing prices wilt by 10-15%. Considering this news, it is absolutely spectacular that AUDUSD Is trading near parity as the world’s FX traders (or is it the world’s auto-trading HFT algorithms doing most of the trades based on historical correlations?) seem only infatuated with the latest price of copper and major world equity markets. There is an economy and a financial system Down Under as well, you know.

Chart: AUDUSD
AUDUSD trades near parity still despite a technical break lower yesterday that did a poor job of holding as parity seems to be exercising a kind of magnetism. Equity prices burst to new highs overnight and that is certainly a reason behind the Aussie’s resilience, but we had a sharp sell-off in copper prices and interest rate spreads have been moving against the currency’s favor for some time now.

UK BoE Inflation Report
It is clear from the BoE inflation report that King and company are being dragged and kicking in the direction of raising rates some time later this year. The report forecast that inflation would actually continue to increase through the rest of 2011 before falling back to the 2.0% target by the middle of next year. King was very insistent that he was against “pre-announcing” rate increases and made every effort to knock down expectations for the scale of interest rate increases to come. He was partially successful, as the market priced out about 12 bps of year forward expectations and the pound was sharply weaker today, retracing much of yesterday’s rally on the high CPI data. There may be more downside potential for GBP here, purely judged from the magnitude of today’s move in interest rate spreads relative to the previous several days. As we mentioned yesterday, most BoE members are reluctant to reach after the interest rate lever with so much austerity in the pipeline and the risk of economic weakness foremost in their minds.

Odds and ends
German bunds rocketed higher today, depressing German yields at the longer end of the curve and throwing up a hurdle for further gains in EURJPY after its recent rally. This was the largest drop in yields for some time and bears watching. The move in the US 10-year was less pronounced, but we’ll focus on the 3.50% level in yields there to see if treasuries trade back in the old range and thus buttress the view that we’ve maxed out in yields for now. This will be most interesting for the lowest yielders like JPY and CHF, with the USD more interested in the direction of risk appetite.

The Swiss franc experienced a spasm today as the Swiss government announced plans for bolstering tourism with a variety of subsidies in an effort counter the effects of the very strong Swiss franc. The measures seemed very modes in magnitude and the market justifiably quickly got over this news, as the most interesting thing for CHF right now is the rally in fixed income as EURCHF teeters around the key 1.3070 level, which was the old high. Falling rates would make the franc look more attractive than it has recently, when the focus has been so intense on inflation/CB rates heading higher.

UK Confidence fell again and came out far lower than expectations with a move to 47 according to the Nationwide poll, that’s close to the recent low from October of last year and not far from the lows in the low 40’s during the worst of the global financial crisis.

Looking ahead
The big focus later in the day will be on the FOMC minutes, with the market especially keen to discern any tectonic shift in dissenting views (whether the Fisher/Plosser contingent is gaining any adherents) and further signs that QE2 will be the last of the QE’s (since the question of whether it will run to completion seems fairly firmly established by now). Also, any mention of currency (extremely doubtful) or inflation worries (more of a possibility) could be interesting for any out there who thing that QE2 might gain enough opponents to at least begin to price in the prediction that it will end ahead of schedule. It is worth noting that the market is pricing in almost two full rate hikes within the next 12 months while the Fed still has four months of outright QE to “accomplish”.

Watch the US data out shortly – the PPI data is likely to remain very high and suggests continued margin pressures, though equity traders only seem interested in Fed and the POMO rather than reality, so guessing any kind of reaction is futile. CPI data tomorrow, however, could begin to see the inflation demon cropping up on traders’ radar as it has in the rest of the world. Insanity in equity markets has reached such white knuckle levels that it’s becoming unbearable, but at this point – what’s the difference between insanity raised to the eighth power and insanity raised to the tenth power? Please, you mathematicians out there, that was a rhetorical question.

Be very careful out there.

Economic Data Highlights

• UK Jan. Nationwide Consumer Confidence out at 47 vs. 50 expected and 54 in Dec.
• Australia Jan. New Motor Vehicle Sales out at -1.9% MoM and -2.8% YoY vs. -3.2% YoY in Dec.
• UK Jan. Jobless Claims Change out at +2.4K vs. -3.0k expected and -3.4k in Dec.
• UK Dec. Average Weekly Earnings ex Bonus rose 2.3% 3M/YoY as expected and vs. +2.3% in Nov.

Upcoming Economic Calendar Highlights (all times GMT)

• Canada Jan. Leading Indicators (1330)
• Canada Dec. International Securities Transactions (1330)
• Canada Dec. Manufacturing Sales (1330)
• US Jan. Housing Starts and Building Permits (1330)
• US Jan. PPI (1330)
• US Jan. Industrial Production and Capacity Utilization (1415)
• US Weekly DoE Crude Oil and Product Inventories (1530)
• US FOMC releases Minutes of FOMC meeting (1900)
• New Zealand Jan. Business PMI (2130)
• New Zealand Q4 Producer Prices (2145)
• Australia RBA’s Lowe to Speak (22210)
• New Zealand Feb. ANZ Consumer Confidence (0200)