It’s interesting the way FX markets are reacting to data and other events, a sign that the rules of old are fading. The resilience of the Aussie is the strongest case in point. The AUD has become increasingly detached from the fortunes of commodity prices and the ebb and flow of the global economic crisis. The same can be seen in the likes of the Canadian dollar and also the Kiwi, although slightly less prominently. As for the single currency, it is having increasing difficulty detaching itself from the bigger risks in the eurozone, as the multi-year lows on many of the euro crosses testify. The most worrying development of the past 24 hours remains the rise in short-dated yields in Spain, a problem that, for other countries, has proven to be a sign that self-sufficiency in funding has come to an end.
Australia’s scope for further rate cuts. The fall in quarterly inflation numbers seen overnight leaves the door open for further rate cuts from the RBA, with the CPI annual rate falling from 1.6% to 1.2% in the second quarter. The Aussie was notably resilient to the numbers, quickly retracing the initial dip lower. But, as we’ve been talking about for some time, the Aussie is showing increased resilience in general as the focus of FX markets shifts more towards the fiscal balance sheet of nations. This has meant that the Australian dollar has increasingly detached itself from commodity prices and the fortunes of the Chinese economy. This is likely to be a recurring theme in the second half of the year.
More of the same for currency markets. In relatively quiet trading conditions yesterday, such was the palpable pessimism towards the single currency that it still managed to underperform most other major currencies. Against the dollar, the euro slipped to 1.2043, a new 2yr low. In June 2010, the single currency recorded a 4yr low of 1.1877 and given the current mood it would not be surprising to see that level tested before too long. The euro has recorded a new 12yr low against the yen, with EUR/GBP back under 0.78. Meanwhile, European bond yields climbed sharply on Tuesday. With Europe’s politicians suffering from crisis fatigue and unable to bridge their differences while Greece, Spain and Italy burn, and with global central bankers likewise bereft of genuine policy responses to the unstoppable forces of balance sheet deleveraging, the euro will probably continue to slide.
The tipping point in Spain. The price action yesterday in Spain reflected the fact that the country is beyond the point of no return, with the curve flattening aggressively. 5yr bonds are now offering the same return as 10yr bonds. The issue is that the Spanish regions are in a funding crisis and are now making requests (or considering doing so) to the government’s central fund set up earlier in the year. No debt crisis has ever been solved by piling more debt onto an already indebted entity. Furthermore, the plan’s announced last month to start down the road towards a pan-eurozone banking regulator, and to give the ESM the ability to capitalise banks directly, is taking time to put in place, time being the one thing the eurozone is becoming increasingly short of.