The King and I and the one up and two down of FX!

“et cetera, et cetera, et cetera” - The King and I

Overnight Bank of England Governor Mervyn King warned that “advanced nations are condemning themselves to feeble recoveries by failing to get to grips with their crippled banking systems”. He also condemned the rising belief that the best way that the world's central banks can withdraw from their holdings of sovereign debt is to cancel the debt. He suggested that such a practice would be “dangerous” and that the easy money of recent years will not last forever; despite the suggestion that the BoE stands ready to inject more liquidity if needed.

The tone of yesterday’s markets turned distinctly risk negative. Whether this was caused by the disappointing Q3 earnings reports in the US (though not overwhelmingly so), or the relative performance of President Obama in the last of the three US presidential candidate debates, or even the comfortable win for Spanish Prime Minister Rajoy in the Galicia regional election causing concern about a delay in a Spanish aid request, remains moot. Today, however, the tone is more likely to be set by economic data.

Where now for risk?
The overall attitude to risk was further muddied by the AUD, a traditionally binary indicator of risk, where the base effects of the introduction of a carbon tax put some pressure on the upside of prices. While Treasurer Swan proclaimed that the CPI data confirms that inflation is contained, the uptick in the annual rate has put sufficient doubt over the timing of the impending rate cut in Australia (priced in for the next meeting on November 6 before the data is released) to give the AUD a bounce.

As the data progressed throughout the morning though the reality of the current global economic environment began to return. Fears and concerns over a hard landing in China continue to be moderated, or at least delayed, as the recent stabilisation appears to be holding. The HSBC China manufacturing PMI bounce in October added to the confidence and as the focus moved back to Europe and the Flash PMIs. The European Central Bank has clearly bought time for Europe to get its house in order but the reality of the situation is that the economic backdrop will remain weak for a very long time as the Eurozone fiscal house of cards is rebuilt from the foundations up.

“Eurozone is in a decade of adjustment” - ECB’s Praet

One up…
For me there are a number of themes that are starting to develop, all of which I have portrayed in this blog over recent weeks. Currencies that I favour remain limited (perhaps not so curious in a world of such broad and complex economic difficulties) but for me GBP still stands out as holding strong value in the medium term. Currencies that I dislike, however, are perhaps more abundant but the standouts for me remain EUR and JPY.

 …two down
The troubles of the EUR are very well publicised and my views have oft been espoused on this page. Likewise the concerns over an overvalued JPY internally and externally are clear. The relative value arguments and core fundamental concerns of the JPY have been there for a very long time but there are some significant reasons why this time ‘should’ be different. In economic terms the return to recession in H2 as well as the return to deflation, has increased the urgency for policy action. The political pressure has risen accordingly. Now that the ECB’s Outright Monetary Transactions programme has stabilised markets to a certain degree (hopefully arresting the flood of safe haven flows into, and perhaps more significantly, back into Japan) there are valid reasons as to why this time could be a different story for the JPY.

Patience is a virtue
While I have strong views about the currency markets at this juncture, timing, as is often the case, is key. With the Federal Reserve meeting tonight (no policy action expected, but the statement will be key), UK Q3 GDP data tomorrow and the build up to the US presidential election on November 6 will likely all be sufficiently defining and volatility inducing to warn against getting too heavily positioned ahead of time. In this respect I would caution against getting too heavily exposed over the next couple of weeks as the markets get comfortable with the events.