Despite the fact that on Friday PBOC raised interest rates and reserve requirements as well as widened the yuan/dollar band
[B]- Japanese Yen: G-8 avoids weak yen comments
- Euro: Treads water but news highs on carry
- Pound: Friday?s bounce peters out but money supply growth at double digits
- US Dollar: North America quiet Canada closed[/B]
Euro at Records on the Carry- How Much Longer Will the Swiss Tolerate Weakness?
Despite the fact that on Friday PBOC raised interest rates and reserve requirements as well as widened the yuan/dollar band, global equity markets shrugged off the news and continued their upward trajectory in Monday trade. The Shanghai stock market rose another 1% after an initial sell off as PBOC efforts to dampen speculation through tighter monetary policy turned out to be ineffective. In short risk appetite turned to gluttony as carry trades set new records in EURJPY and EURCHF.
Northern Trust?s Paul Kasriel noted over the week-end that while the measures by the Chinese monetary authorities may appear to be restrictive, they are in fact simply cosmetic in nature. The true culprit in Chinese banking system - reserve growth - continues to expand at double digit rates. With Chinese banking reserves growing far faster than the latest round of restrictions, the Chinese overnight interbabk rate remains at a mere 1.57% creating extremely easy lending conditions. Little wonder then that speculation in Shanghai market runs rampant and spills over into the currency market taking the carry trade to new highs. Furthermore, adding fuel to the fire, this weekends G-8 meeting avoided any mention of a weak yen and USDJPY after a very brief correction on Friday traded right back to 121.30 by early London trade.
Thus, while the euro continues to tread water against the dollar, it has once again reached record levels against the yen and the Swiss franc in overnight trade. While yen may suffer further weakness as Japanese fundamentals offer no support to yen bulls, the Swiss franc may be another matter. At 166.00 the EURCHF exchange rate is clearly overvalued as Swiss growth continues to match and perhaps even beat its much larger European neighbor. Furthermore, the weakness in the franc is beginning to exert significant pressures on Swiss inflation. Today?s release of the Swiss Producer and Import prices showed the largest gain in fourteen years with prices rising 2.6% on a year over year basis.
The Swiss monetary authorities who are notoriously hawkish on the issue of inflation, are not likely to tolerate further weakness in the currency, especially if it leads to a serious acceleration of consumer prices. With the latest Retail Sales rising more that 7% on a year over year basis the SNB is clearly concerned about overheating. Therefore if exchange rates continue to levitate around these levels or perhaps even trade to 167.00 and beyond Swiss monetary officials are likely to hike rates by 50bp rather than just the expected 25bp at the SNB quarterly policy meeting in June.