Many countries and economies around the globe are facing record budget deficits and there is much debate as to whether it is better to expand or contract these deficits. On the one hand, reducing deficits improves balance sheets and makes debt easier to service, but on the other hand it brings fear of the dreaded “double-dip” recession.
Here in the US, the obvious tactic is to expand balance sheets as deficit reduction would potentially induce deflation, which could cause another run on the banks which are mired in this housing mess. However, abroad the central bank focus is more on combating inflation, and other banks are nearly as exposed to bad housing bets as are US banks.
While global banks do have their own issues, the general thought is that is that as economies promote fiscal responsibility, monetary policy needs to be more accommodative to attempt to prevent a slide back into double-dip territory.
And that’s what is happening in both the Euro and Pound as deficit reduction plans are starting to come together. So the market is starting to realize that accommodative policy will be necessary.
Job gains in Australia were better than expected, and initial jobless claims here in the US were slightly worse than expected. All of this is adding up to mild risk-aversion in the market as the Euro is now trading at a 1.25 handle.
In the forex market:
Aussie (AUD): Employment gains “Down Under” exceeded expectations prompting speculation that yet another RBA rate hike may be coming soon. The economy gained 33.7K jobs vs. an expectation of 22.5K. The threat of a potential China slowdown has been weighing on the Aussie, as has been general risk-aversion which is what is happening this morning.
Loonie (CAD): The Loonie is hanging in there but is lower as oil prices are off this morning. Speculation is still high that a rate hike may be coming in June, if the global market can dodge major risk events until then.
Kiwi (NZD): The Kiwi is also being weighed down by risk aversion even though a report showed that manufacturing activity expanded at the fastest pace in 5 years. Retail sales figures are due out tomorrow and are expected to show the fastest gains in nearly 9 months.
Euro (EUR): Yep, the Euro is lower again today, as the market is starting to catch on to the fact that austerity measures around the region may require more accommodative monetary policy to make up for the reduction in supply and demand. And while there is concern over the size of the bailout, let’s not forget that it’s not like all of this money is required at once, but rather it was established to help the countries in trouble get better borrowing rates and provide an emergency backstop. Investors are concerned that austerity measures won’t work… but only time will tell. For the record, the unemployment rate in Greece is only slightly higher than here in the US.
Pound (GBP): The new coalition government formed is wasting no time putting forth plans for budget deficit reduction with the blessings of BOE Governor King. As with the Euro, reductions in fiscal policy may require increases in accommodative monetary policy. Frankly, a weaker Pound helps UK exports which help bring capital to the region. They key is going to be reducing without inducing recession. They have their work cut out for them.
Dollar (USD): The Dollar is higher on risk aversion as initial jobless claims came in slightly worse than expected. Fed Chairman Bernanke is due to speak at 2:30 EST so be wary of any market volatility. Tomorrow we get retail sales figures and confidence numbers which could show a shift in sentiment regarding the US economy.
Yen (JPY): There is Yen strength this morning on risk aversion and a current account reading shows surpluses widening as demand for Japanese exports has increased. This bodes well for the economy though concerns about huge deficits still weigh heavily on rates.
There is more than one way to skin a cat, as the saying goes and the global market place is putting that saying to the test. While the US believes expanding deficits is the way to go in combating its economic woes, countries on the other side of the Atlantic are taking the opposite approach.
While the US is the world’s largest economy and is unique, it goes to show that there are different ways to accomplish the same thing. At the end of the day, accommodative monetary policy is going to be needed out of the “big 3”—EU, UK, US- so the race to the bottom is back en vogue again.
As I have outlined earlier in the week, a weaker Pound and Euro is not necessarily a bad thing for those countries. As long as the structural issues are kept intact and there are no defaults, then we can expect to see weakness from the contracting economies.
Meanwhile, the commodity currencies keep chugging along in much better shape economically, yet held hostage to the whims of risk themes.
To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!
To follow these events live with a free, real-time practice account, click here! Don’t miss out on the world’s fastest growing market!
none