Today is a day that is devoid of economic data so the market has turned its attention toward the European banking conference taking place in Germany. At this conference, Fed Chairman Bernanke defended QE2 and took aim at China and their currency peg.
Not coincidentally, today the Chinese raised the reserve requirements for their banks, trying to tighten monetary policy to ward off inflation. Bernanke has warned that things are going to get worse for countries that keep their currencies artificially low, which is going to harm the global economy overall.
China is doing just about everything it can besides letting its currency strengthen and at some point the dam is going to burst. This is definitely a situation to follow closely next year.
The other major topic of conversation in Frankfurt is the aid to Ireland. I refrain from calling it a bailout at this point as no aid has been requested (yet), as questions remain over what strings will be attached to any such package. Already the talk is starting to heat up that Ireland will lose sovereignty and be forced to accept measures put to them.
One of the most important but least talked about issues is the tax rate in Ireland. This is a particularly touchy subject because essentially Ireland is a tax haven within the Euro zone, and most established economies like Germany don’t like it as many of their re-insurers have domiciled there. By having low corporate taxes, not only does Ireland make itself one of the leaders for business, but they also prevent other countries in the Euro zone from raising taxes too much.
Regardless of how this plays out, the market is feeling confident and the Euro is higher as a result. However this could change quickly as risk aversion appears to be a more prevalent theme this morning, especially going into the weekend.
In the forex market:
Aussie (AUD): The Aussie is lower this morning as it is highly sensitive to economic activity in China. As mentioned above, China is requiring their banks to keep more cash on hand to try to thwart inflation so this could mean fewer exports from Australia to China which would hurt the Australian economy.
Kiwi (NZD): The Kiwi is also lower on Chinese tightening concerns. In addition, there was a major mining disaster which may rival the one that took place recently in Chile, though the facts are still unknown at this time.
Loonie (CAD): The Loonie is lower as oil has retreated to 81.50 on concerns over a Chinese slowdown. The Loonie is near its lowest level against USD for the month. (Click chart to enlarge)
Euro (EUR): The Euro is mostly higher as the market believes a solution to the Irish banking problem is near. However, it will be interesting to see if Ireland allows terms to be dictated to them and give up sovereignty, or if they balk at the requirements put the Euro back in jeopardy. Once this problem is “solved”, it will be interesting to see if the bond vigilantes go after Portugal with the same vigor that drove Irish yields to unsustainable levels. (Click chart to enlarge)
Pound (GBP): The Pound is mostly lower as it stocks in the UK were lower giving back some of yesterday’s gains. The UK has a fairly large exposure to Irish banks so a resolution is also in UK interests. Because the Pound was seen as a “safe haven” for Euro region money flows, it is giving back some gains vs. Euro.
Dollar (USD): Bernanke’s in Germany and defending QE2 while at the same time trying to garner support against China. The Dollar is marginally higher as risk aversion due to the Chinese slowdown has commodities and stocks lower to start the day.
Yen (JPY): The Yen is stronger against all but the Euro as the demand for carry trades is weaker going into the weekend.
Today would be seen a classic risk aversion day if not for Euro strength this morning. The potential threat of a global slowdown due to a Chinese slowdown will be a major theme going forward.
This is setting up to be “inflationary showdown” which I think Bernanke can actually win. QE2 is putting the screws to the Chinese economy and while they have enough cash on hand to maintain artificial conditions, inflation there will be a major problem. How this battle plays out is anyone’s guess but how China reacts will determine the fate of the global economy.
As of right now, China is using the veiled threat of “if we go down, we’re going to take everyone else with us mantra” so now more than ever it is important to have global cooperation. Emerging economies have become the unfortunate side story to this dilemma, as both a weakening Dollar AND Yuan have caused inflation and currency strength.
At this point it is still just “words”, until actions change the nature of the game. So this is still a major risk that needs to be monitored closely.
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