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The Central Bank Trade

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Phil McHugh, senior analyst Currencies Direct

The financial crisis which erupted in 2008 is still hanging over the world economy, almost five years on. When the original crisis hit, which shook the global economy into cardiac arrest, governments and central banks had to step in to prevent a full scale meltdown of the financial markets.  Since then we have witnessed an unprecedented array of monetary easing from central banks and a race to the zero bound as they cut interest rates aggressively.  The aim was to get credit flowing again for businesses and consumers but lower interest rates were also aimed at influencing exchange rates and stimulating countries export sectors. While this is fine in theory, in practice easing by one central bank usually prompts action by another and we have seen large swings in most markets on the back of monetary stimulus as each country try’s to pursue domestic policy objectives at the expense of other nations by devaluing exchange rates. We now inhabit markets almost completely controlled by central banks, with the US central bank leading the way in unconventional measures.IMG 6345

Most recently the Federal Reserve sparked a speculative frenzy into risk by announcing QE3 in the form of unlimited $40 billion monthly purchases of mortgage backed securities (MBS), low rates until at least 2015 and the continuation of “Operation Twist” in an effort to stimulate labour market growth.  The Fed has upped the ante on easing in their latest announcement and the move followed the ECB agreeing to fund unlimited purchases of Eurozone debt to protect struggling sovereigns.  We have also seen similar central bank action from across the globe with Switzerland, Turkey, the UK, China and Japan. The sheer length, depth and scale of ongoing monetary easing is astounding and seemingly endless with the Federal Reserve’s latest escapade being dubbed “QEinfinity” in the financial markets.

In the aftermath of the Fed decision we saw a distinct rally into nearly all asset classes as a defined move into risk abounded driving the USD lower across the markets.  The unprecedented action has once again reignited a fierce debate that QE3 will exacerbate currency related conflict as the market jumps out of the risk-haven USD into risk-based assets with the hope of riding higher.   Commodity based currencies and emerging market currencies fear the brunt of this shift into risk with an appreciation on their domestic currencies.  Such appreciation can lead to the introduction of, or at the very least the threat of measures to stem the unwanted appreciation.  IMG 6215

Back in 2010 Brazilian finance minister Guido Mantega coined the phrase “currency wars” in anticipation of QE2 in the US two years ago.  Mantega argued that “besides the direct measures of trade protectionism in the US, we now have quantitative easing, which is an indirect form of protectionism because it debases the dollar by reducing its value and one of the objectives of a weaker dollar is it can lead to greater American exports”. Brazil implemented a number of capital controls to limit the upward momentum of their currency and was joined by Mexico, Peru, Columbia, Taiwan, Korea, Poland, South Africa and Russia.  These counter moves were to be expected, and were actively encouraged by the IMF amid concerns of further USD debasement.

As it transpires the Brazilian real is now much weaker against the USD than back in 2010 and in fact risk oriented emerging market currencies have seen an overall retreat. It could be argued that the emerging markets are winning the currency war as their weakening currency values lead to a competitive advantage and a battle won.  However this would cloud the main reason for the downturn in demand being that the world economy has fallen prey to a coordinated economic slowdown with a cooling China and uncertain Eurozone. In addition the steps taken to curb a stronger currency will have certainly had an impact.IMG 6217-v2

The speculative frenzy that surrounded QE3 has once again raised the chatter of currency wars but it is arguable whether this is valid.Since QE3 we have seen a shift out of USD and it is notable that currencies which have already intervened or threatened to do so have underperformed, whereas those with a lack of intervention history or appetite for intervention have gained.  The Mexican Peso and the Czech Koruna have lost the most ground prompting the governor of the Czech Central Bank to raise the prospect of forex intervention, whereas Mexico’s Central Bank has signalled that it is happy with currency appreciation. The Brazilian real has weakened due to Alexandre Tombini‘s dogged stance on protecting currency appreciation and the Yen has been avoided due to its frequent intervention activity and the anticipation of more. The Indian Rupee has been a popular choice due to reforms from the Indian Government to attract more foreign direct investment (FDI) and is seen as unlikely to intervene to stem any appreciation in the Rupee.  Conversely, the Chinese Renminbi has just hit a 19 year high against the USD, appreciating over 2 per cent in the last month since QE3.  Currencies-Direct

We have a schizophrenic market that is reacting to the central bank stimulus and searching for ever decreasing opportunities.  Ironically central bank action is endeavouring to drive risk in a market full of fear and it is this fear which is pegging back momentum in the currency markets.Markets are jostling as a reaction to the Fed’s easing and swings in and out of currencies as a result.  The scale of QE3 has naturally caused a knee jerk reaction in the markets due to its audacity and open-endedness.  The question is whether the Federal Reserve,the European Central Bank and other central banks maintain this systematic boost of stimulus and will it continue to drive the markets higher in spite of the severe economic headwinds.

The dynamics of central bank interventions is driving the focus away from fundamentals and onto what the central banks do next.  The markets are facing a psychological fight on the credibility of global central banks to continue driving sentiment over and above the underlying ‘real’ economy.   The foreign exchange market is struggling to adjust to this environment as investors try to gauge how to make money in a market driven by the central banks and fear with tightening interest rate differentials and even tighter currency ranges.  Phil-McHugh

In the months ahead we will learn more about the known risks and uncertainties in the market such as the Eurozone crisis, the US election and the approaching US fiscal cliff.  A clear-out of the uncertainties could change the dynamics by fuelling momentum into currencies and even more into risk.  This would certainly raise the tensions on a continuation of central bank action and increase friction between competing currencies.

Phil McHugh is a senior analyst at leading European FX specialists, Currencies Direct.

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Sterling rises above $1.37 for first time since 2018; UK inflation rises

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Sterling rises above $1.37 for first time since 2018; UK inflation rises 1

By Elizabeth Howcroft

LONDON (Reuters) – A combination of heightened risk appetite in global markets and UK-specific optimism lifted the pound on Wednesday, as it strengthened to its highest in nearly three years against the dollar and five-month highs against the euro.

The dollar weakened against major currencies for the third straight session, helped by U.S. Treasury Secretary nominee Janet Yellen’s urging lawmakers to “act big” on spending and worry about debt later.

The pound rose above $1.37, hitting $1.3720 — its highest since May 2018 — at 1045 GMT. By 1136 GMT it had eased some gains and changed hands at $1.3687, up 0.4% on the day and up 0.2% so far this year.

Versus the euro, the pound hit a five-month high of 88.38 pence per euro, before easing to 88.51 at 1137 GMT, up around 0.5% on the day.

The pound’s recent strengthening can be attributed in part to relief among investors that the impact of Brexit has not caused the chaos some feared, as well as a lessening of negative rates expectations, said Neil Jones, head of FX sales at Mizuho.

“Going into early 2021, there was a bearish sentiment building into the pound on the Brexit deal, in terms of maybe it had a limited reach, and then secondly an expectation of negative rates and so to some extent the market has been cutting down on sterling shorts because neither of those things have been quite so apparent as they were,” he said.

Bank of England Governor Andrew Bailey said last week that there were “lots of issues” with cutting interest rates below zero – a comment which caused sterling to jump.

The UK’s progress in rolling out vaccines is also seen as a positive for investors, Jones said.

Currently, the United Kingdom has vaccinated 4.27 million people with a first dose of the vaccine, among the best in the world per head of population.

“Further progress in vaccinations (a pick-up in the daily rate) by the time the BoE MPC meeting takes place on 4th February may prove enough to hold off on any additional monetary easing,” wrote Derek Halpenny, head of research for global markets at MUFG.

Inflation data for December showed that prices in the UK picked up by more than expected in December, to a 0.6% annual rate.0.6

Inflation has been below the Bank of England’s 2% target since mid-2019 and the COVID-19 pandemic pushed it close to zero as the economy tanked.

(Graphic: CFTC: https://fingfx.thomsonreuters.com/gfx/mkt/oakpeyayxpr/CFTC.png)

(Reporting by Elizabeth Howcroft, editing by Larry King)

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Euro sinks amid broader risk rally against dollar

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Euro sinks amid broader risk rally against dollar 2

By Ritvik Carvalho

LONDON (Reuters) – The euro struggled to join a broader risk rally against the dollar on Wednesday as analysts said the risk of extended lockdowns in Europe to combat the spread of COVID-19 and the continent’s lag in a vaccine rollout were weighing on the currency.

Down 0.1% against the dollar at $1.2117 by 1130 GMT, Europe’s shared currency had only the safe-haven Swiss franc and Sweden’s crown for company in resisting a broad rally against the greenback by the G-10 group of currencies.

“We’re getting more headlines that the current lockdowns will be extended further, which could mean that the euro zone would be flirting with a double-dip recession before long,” said Valentin Marinov, head of G10 FX research at Credit Agricole, noting Europe’s lag in rolling out a coronavirus vaccine compared to the United States and Britain.

“So all of that plays into the story that tomorrow’s ECB meeting, while uneventful in terms of policy announcements, could convey a relatively dovish message to the market. On top of that, President Lagarde could once again jawbone the euro, so the euro is kind of lagging behind.”

Marinov also noted price action in the pound, which hit $1.3720 – a 2-1/2-year high – and 88.38 pence – its highest since May 2020 against the euro – as a contributing factor to euro weakness. [GBP/]

There was also focus on a story by Bloomberg News, which reported the European Central Bank was conducting its bond purchases with specific yield spreads in mind, a strategy that would be reminiscent of yield curve control.

Elsewhere, the risk-sensitive Australian dollar gained 0.4% to $0.7727. The New Zealand dollar, also a commodity currency like the Aussie, gained 0.25% to $0.7133.

DOLLAR WEAKNESS

While the world will be watching Joe Biden’s inauguration as U.S. president at noon in Washington (1700 GMT), traders were more focused on his policies than the ceremony.

U.S. Treasury Secretary nominee Janet Yellen urged lawmakers at her confirmation hearing to “act big” on stimulus spending and said she believes in market-determined exchange rates, without expressing a view on the dollar’s direction.

The index that measures the dollar’s strength against a basket of peers was up almost 0.1% at 90.510. The euro forms nearly 60% of the dollar index by weight.

It also fell 0.1% against the Japanese yen to 103.81 yen per dollar.

While the dollar has perked up in recent weeks on the back of a rise in U.S. Treasury yields, investors still expect the currency to weaken.

“We remain bearish U.S. dollar, and expect the downtrend to resume as U.S. real yields top out,” said Ebrahim Rahbari, FX strategist at CitiFX.

“Continued Fed dovishness remains important for our view, in addition to global recovery, so we’ll watch upcoming Fed-speak closely.”

Positioning data shows investors are overwhelmingly short dollars as they figure that budget and current account deficits will weigh on the greenback.

(Graphic: Dollar positioning: https://fingfx.thomsonreuters.com/gfx/mkt/oakveyombvr/Pasted%20image%201611132945366.png)

UBS Global Wealth Management’s chief investment officer Mark Haefele reiterated a bearish view on the dollar, saying that pro-cyclical currencies such as the euro, commodity-producer currencies, and the pound would benefit “from a broadening economic recovery supported by vaccine rollouts”.

The cryptocurrency Bitcoin fell 4%, trading at $34,468.

(Reporting by Ritvik Carvalho; Editing by Angus MacSwan)

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England soccer star Rashford nets younger buyers for Burberry

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England soccer star Rashford nets younger buyers for Burberry 3

By Sarah Young

LONDON (Reuters) – Burberry stuck to its full-year goals on Wednesday after a media campaign fronted by high-profile English soccer star and social justice advocate Marcus Rashford drew a younger clientele to the British luxury brand.

Higher full-price sales would boost annual margins and Asian demand remained strong, Burberry said, while warning that it could suffer more sales disruption from COVID-19 lockdowns.

Manchester United striker Rashford, 23, has won plaudits for his campaign to help ensure that poorer children do not go hungry with schools closed during the pandemic.

A first coronavirus wave last year cut Burberry’s sales by as much as 45% before a bounce back on strong demand in mainland China and South Korea, which continued in the last few months.

Shares in Burberry were up 5% to 1,825 pence at 0905 GMT, with Citi analysts saying that improved sales quality from fewer markdowns would drive full-year consensus upgrades.

Burberry’s 9% sales decline in its third quarter was worse than the 6% fall in the second, and the company said that 15% of stores were currently closed and 36% operating with restrictions as a result of measures to curb COVID-19’s spread.

“We expect trading will remain susceptible to regional disruptions as we close the financial year,” Burberry said, adding that it was confident of rebounding when the pandemic eases given the brand’s resonance with customers.

In the third quarter, comparable store sales in Europe, the Middle East, India and Africa declined 37%, hit by shops shut in lockdowns and a lack of tourists visiting Europe, but in the same period, it posted sales growth of 11% in Asia Pacific.

Burberry said that Britain’s new relationship with the European Union would cause headwinds, warning of a modest increase in costs to comply with new rules and also the impact of an end to a scheme for VAT refunds for non-EU tourists.

This would make Britain a less attractive destination for luxury shopping when tourism returns after the pandemic, Burberry said, adding that it would try to mitigate the effect.

(Reporting by Sarah Young; Editing by Kate Holton, James Davey and Alexander Smith)

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