29.05.07

Broadly unchanged levels since yesterday. The soft housing numbers from US has dented the USD sentiment. GBP looks firm on back of robust growth figures , the economy expanded 0.7% in the third quarter, taking the growth to 2.9% , higher than expected. The monetary policy and minutes from BoE have added to the GBP bullish tone.

The dollar will be put back into the grinder on Tuesday with the Conference Board's consumer confidence survey for May. Taking their direction from the University of Michigan's report for the same month, economists expect tomorrow's confidence number to improve slightly to cross the wires at 105.0. Given the tame predictions, the indicator may not be the rally call that encourages bulls to drive the currency through resistance levels in its many pairings; but it certainly has meaning for its long-term strength. The consumer has single-handedly carried growth and inflation through the worst housing slump in 15 years, wavering factory activity and dried up business investment. Therefore, the potential energy this indicator holds for the markets is considerable - even if it does not translate into immediate price action. On the other hand, considering the aspects more pertinent to the American consumer this month, there is a real risk that the survey diverges considerably from expectations. Clearly in favor of the modest pickup the official consensus is calling for is the strong performance of the stock market. The Dow Jones Industrial Average has closed at numerous record highs over the past few weeks and the media has not missed one of them. Perhaps turning a little murkier, the labor market is expected to be a net contributor as well. Initial jobless claims over the past few weeks have marked four-month lows; though the lighter payroll numbers and deceleration in wage growth over the past few months should dampen the positive response. In clear contradiction to optimists will be the steady degradation of the housing market and record gasoline prices.
Opening Levels

EUR 1.3433
JPY 121.39
GBP 1.9834
CHF 1.2287
AUD 0.8181
CAD 1.0815
NZD 0.7261
EUR/GBP 0.6772
EUR/JPY 163.09

28.05.07

USD lost ground yesterday against major pairs. The deciding factor was the April Existing Home Sales report from the National Association of Realtors. When the gauge hit the wires below expectations with a 2.6 percent drop in purchases over the period, the economic calendar officially lost its hold over the currency. Momentum had built through yesterday’s New Home Sales report for the same month, which reported the biggest jump in sales volume in 14 years.

Elsewhere, oil prices edged lower after Nigerian oil workers' called off strike.Trading at 64.90 USD.

EUR 1.3456
JPY 121.64
GBP 1.9842
CHF 1.2268
AUD 0.8191
CAD 1.0793
NZD 0.7263
EUR/GBP 0.6781
EUR/JPY 163.69

25.05.07 open

Slight appreciation of USD on back of strong housing market numbers
The much awaited German IFO report came in line with expectations saving the EUR/USD from a thrashing in line with strong housing numbers from the USD market. The prospect of another rate hike by Euroland has kept the currency steady. CHF employment numbers came strong. The numbers point to Eurolands economic resilience.
Elsewhere, US housing numbers came strong, with domestic homebuyers making the single biggest purchase this month since 1993.
EUR 1.343
JPY 121.39
GBP 1.9849
CHF 1.2271
AUD 0.818
CAD 1.0859
NZD 0.7245
EUR/GBP 0.6768
EUR/JPY 162.97

24.05.07 Commentary

The BOE minutes showed a unanimous agreement in raising interest rates further. We could see rates at 5.75% before August, and this could fuel the sterling to new highs and back up above $2, on the back of carry trades, where sterling is a hot favourite. The BOJ still holds rate at 0.5% and attracts a lot of borrowers who look to invest in high yielding sterling assets.

Elsewhere,Munich-based Ifo Institute's index of business sentiment will climb to 108.8 in May, the highest since records for a reunified Germany began in 1991, according to a Bloomberg News survey of 37 economists. This couldbe a major boost for EUR, and would set the terms for further rate hike in the Euroland.

24.05.07 Open

Mainly stable market, except GBP posted some gains against USD on back of BOE minutes released yesterday where members voted for a unanimous rate hike.

EUR 1.345
JPY 121.57
GBP 1.9856
CHF 1.2278
AUD 0.8227
CAD 1.0832
NZD 0.7282
EUR/GBP 0.6773
EUR/JPY 163.52

FX update 22.05.07

Yen falls to a new low on carry trades, and speculation that Japanese bonuses would be ploughed in overseas higher yielding assets. trading at 121.66. There is a resistance at 122. Markets are predicting a further fall to 123 levels.
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Slight correction in NZD but rally to stay because of huge carry trade with nzd rates at 7.75%, the highest afer Iceland in AAA rated economies, and JPY at 0.5%. The NZD has appreciated 27% against JPY this year, and has been one of the best performing currencies.
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Norwegian Krone to Extend Gains on Outlook for Rates, Says RBS
By Lukanyo Mnyanda
May 22 (Bloomberg) -- Norway's krone may extend gains versus the euro on speculation quickening inflation will force the central bank to quicken the pace of interest-rate increases, according to strategists at Royal Bank of Scotland Plc.
The krone, which reached a two-week high today, will benefit as the economy heads for a fourth year of ``booming growth'' and rising oil prices stoke demand for Norway's assets, strategists Mikael Nilsson and Paul Robson wrote in a note to clients.
Norway's currency, the fifth-best performer against the euro and the dollar this year, may rise a further 5.7 percent to trade at 7.7 per euro by the end of 2008, Nilsson said in a telephone today. It traded at 8.135 at 4:28 p.m. in Oslo.
``Norges Bank will need to hike rates more than is currently priced in,'' Nilsson said in the interview from his London office. ``There's more upside for the krone.''
Norway's economy has benefited as high oil and gas prices spurred oil producers such as Statoil ASA and Norsk Hydro ASA, Norway's largest companies, to boost investment. The economy may receive a further boost from government plans announced May 15 to raise spending.
The central bank said March 15 it plans to lift the deposit rate to 5 percent by year-end, and 5.25 percent by early 2008. The bank may be ``stuck behind the curve'' and may have to lift rates at a faster pace, which will enhance the appeal to foreigners of holding assets denominated in krone, the RBS strategists wrote.
``Higher rates will move the krone from a medium to a high yielder,'' Nilsson and Robson wrote. That ``will be supportive given the market continues to devour yield.''
The gap in yield, or spread, between the Norwegian 10-year bond and the similar-maturity German bunds was recently at 56 basis points. The gap will probably widen further, making Norwegian assets more attractive for investors searching for high yielding assets.
The yield on Norway 4.5 percent bond due May 2017 has risen 11 basis points in the past month. The yield, which moves inversely to the price, is set to rise for a third month. Quickening inflation and higher interest rates erode the fixed returns offered by bonds.
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22.05.07 open

No change from yesterday.
EUR 1.3456
JPY 121.66
GB 1.9746
CHF 1.229
AUD 0.8212
CAD 1.0868
NZD 0.7263
EUR/GBP 0.6813
EUR/JPY 163.73

22.05.07 open

GBP 1.9702
JPY 121.54
EUR 1.3452
AUD 0.8202
NZD 0.7236
CHF 1.2307
CAD 1.0857
EUR/GBP 0.6827
EUR/JPY 163.51

21.05.07

EUR 1.3515
JPY 121.25
GBP 1.974
CHF 1.2275
AUD 0.8231
CAD 1.0888
NZD 0.7306
EUR/GBP 0.6845
EUR/JPY 163.9

Yuan Rises to Highest Since July 2005 on Wider Trading Band

May 21 (Bloomberg) -- The yuan was little changed after the central bank said its decision to allow wider daily swings in the currency wasn't aimed at increasing the pace of gains.
The increase in the trading band to 0.5 percent from 0.3 percent ``doesn't mean the yuan will fluctuate by a lot or appreciate by a large magnitude,'' the People's Bank of China said in a statement in Beijing May 18. The decision suggests ``more goodwill'' rather than a promise to let the yuan rise by the maximum, said Philippe Gernez, regional head of currencies and derivatives at Natexis.
The yuan is trading at the highest since a dollar link was scrapped in July 2005 before Vice Premier Wu Yi meets U.S. Treasury Secretary Henry Paulson in Washington May 22-24. U.S. Senator Charles Schumer said China still faces ``strong'' legislation unless there is ``significant progress.'' A stronger yuan would increase export prices and lower import costs.
``China wants to show goodwill that it's letting the yuan appreciate faster, but will it fully utilize the band? I doubt it,'' said Singapore-based Gernez the French asset management and investment bank. ``I would expect the yuan to continue strengthening, but China wants to do it gradually.''
The Chinese currency gained as much as 0.09 percent to 7.6615 against the dollar before trading at 7.6641 at 11 a.m. in Shanghai. China has allowed the yuan to rise 8 percent since the central bank ended the fixed exchange rate to the dollar. It may rise 3 percent this year, Gernez said.
Nothing Will Happen
China's central bank also raised interest rates for a fourth time in the past year and ordered banks to put aside more money as reserves to help cool growth in the world's fastest-growing major economy and prevent the stock market from overheating.
``Widening the band is to further improve the yuan's mechanism,'' the People's Bank of China said in a statement in Beijing on May 18 after the market closed.
A stronger yuan may appease U.S. lawmakers who say China's currency policy and the U.S. trade deficit are costing American jobs. The U.S. on March 30 levied duties on imports of coated paper from China to compensate for Chinese subsidies to exporters.
``To widen the band is well and good, but if they don't use the band, nothing will happen,'' Schumer, a New York Democrat and member of the Senate Finance Committee, said after China's decision on May 18.
The yuan never moved the maximum permitted under the previous limit. It moved 0.13 percent from the daily reference rate on April 16, the most this year, according to Bloomberg data.
``This is a useful step toward greater flexibility and an eventual float of the currency,'' Brookly McLaughlin, a Treasury spokeswoman, said in an interview in Potsdam, Germany, on May 18. ``It's important now that Chinese authorities use the wider band and allow greater currency movement within each day and over time.''
Evolution not Revolution
The performance on the first trading day after China widened the yuan's band isn't surprising, said Adrian Foster, director of capital markets at Dresdner Kleinwort in Beijing.
``The history of policy changes coming out of China is more evolution than revolution,'' he said. ``I certainly wouldn't expect them to suddenly move it by half a percent, taking full advantage of the band.''
China's trade surplus, which ballooned 74 percent last year to a record $177.5 billion, drove foreign-exchange reserves to an all-time high of $1.2 trillion, making it difficult for the government to slow growth. The economy expanded 11.1 percent in the three months to March 31, exceeding 10 percent for a fifth quarter.
``There will definitely be dollar selling pressure against the yuan as the U.S. isn't ecstatic about the move,'' said Catherine Tan, head of emerging markets at Forecast Singapore Ltd. ``The market may test how far down they can push the dollar-yuan. As far as the U.S. is concerned, the dollar-yuan is stronger by 30 to 40 percent.''
The currency may strengthen to 7.51 in six months, Tan said.

British Pound logs weekly decline

Pound Logs Weekly Decline; Investors Scale Back Rate Forecasts
By Lukanyo Mnyanda
May 19 (Bloomberg) -- The U.K. pound fell for a fourth week against the dollar, its longest losing streak in 15 months, as investors scaled back expectations of rate increases this year.
The pound also declined for a second week against the euro after inflation slowed last month and the central bank said in a quarterly report the outlook for prices was ``unusually uncertain.'' The pound extended declines as a report yesterday showed retail sales unexpectedly fell in April, prompting investors to reduce bets the bank will raise rates.
``In the short term, sterling will come under further pressure,'' said Ian Stannard, a currency strategist at BNP Paribas SA in London. ``Over the coming months, we could see a further scaling back of rate hike expectations.''
Against the dollar, the pound fell 0.4 percent this week and was trading at $1.9730, the lowest since April 11, by 4 p.m. yesterday in London. The pound traded near a two-month low versus the euro, and was recently at 68.37, from 68.26 on May 11.
Retail sales fell 0.1 percent in April, compared to a 0.3 percent gain in March. Economists had forecast a 0.6 percent increase, according to a survey by Bloomberg News.
Slower sales led investors to lower bets the bank will raise interest rates two more times this year, futures prices show, reducing the appeal of assets denominated in pounds.
The implied yield on the September interest-rate futures contract fell 1 basis point to 5.96 percent. The yield on the December contract also declined 1 basis point, to 6 percent. The contracts settle to the three-month London interbank offered rate for the pound, which has averaged 15 basis points more than the central bank's benchmark for the past decade.
`Outlook Dented'
``The short-term outlook has been dented by the retail sales,'' said Steven Barrow, chief currency strategist at Bear Stearns International Ltd. in London. ``It's a setback for the pound.''
Inflation will slow to about 1.8 percent by the middle of 2008, the Bank of England said in a quarterly report this week, after rising to more than 1 percentage point above the bank's 2 percent target in March.
``The big picture is still for steady growth with low inflation once we move through the period of volatility in energy prices,'' Bank of England Governor Mervyn King said on May 16. Inflation is likely to ``settle around the target.''
The central bank increased its benchmark rate to a six-year high of 5.5 percent on May 10. It has raised borrowing costs four times since August to tame inflation which has quickened to a decade-high.
Gains by the pound may be limited because of expectations that Europe's second-largest economy, which last year grew the quickest in two years, will continue creating jobs, which may boost spending and inflation.
Public Sector
A government report due on May 21 may also show the healthiest public sector finances in three months, economists surveyed by Bloomberg predicted.
The report will probably show the public sector had a 1.5 billion-pound ($2.96 billion) surplus in April, the first surplus since January, economists predicted. In March, the public sector needed to borrow 17.2 billion pounds.
``I'm still relatively keen on sterling,'' said Chris Furness, head of currency strategy at 4CAST Ltd. in London. ``We expect the rate differential to move in favor of the pound.''
The yield on the benchmark 10-year gilt rose 5 basis points on the week to 5.14 percent. The price of the 4 percent gilt due September 2016 fell 0.32, or 3.2 pounds per 1,000-pound ($1,972) face amount, to 91.63. Bond yields move inversely to prices.

Canada Dollar Reaches Highest Level Since 1977 on Interest Rate

Canada Dollar Reaches Highest Level Since 1977 on Interest Rate
By Haris Anwar
May 18 (Bloomberg) -- Canada's dollar climbed to the highest level in almost 30 years on speculation the Bank of Canada will raise borrowing costs in 2007 as the economy benefits from price increases in the nation's commodity exports.
The Canadian dollar had its biggest one-day gain in almost two months and has outperformed 15 of 16 most-active currencies this year as the economy rebounded from a slump in 2006. Producers of gold, copper and natural gas have been the target of foreign acquisitions this year. Interest-rate futures contracts suggest a central bank rate increase before the end of the year.
``A rate hike in July could potentially be a possibility,'' said George Davis, chief technical analyst at RBC Capital Markets in Toronto, a unit of Canada's largest bank by assets. ``The market has started to price in rate increases sooner rather than later, and that's prompting speculative interest in the currency.''
Canada's dollar rose 1 percent to 91.77 U.S. cents at 3:30 p.m. in Toronto, from 90.91 U.S. cents yesterday. Earlier it reached 91.94 U.S. cents, the highest since Oct. 10, 1977. One U.S. dollar buys C$1.0898.
As the currency's gain accelerated, some investors said Canada's dollar will soon reach parity with its U.S. counterpart. That hasn't happened since 1976.
`Parity'
``I'm a very big bull on the Canadian dollar,'' said Michael Woolfolk, senior currency strategist in New York at the Bank of New York. ``Parity is a realistic objective, but that will be really requisite on the Bank of Canada raising interest rates.'' He is forecasting parity in mid-2008.
The yield on the September bankers' acceptances futures contract rose 5 basis points, or 0.05 percentage point, to 4.59 percent on the Montreal Exchange. It has gained 17 basis points this week.
Bankers' acceptances futures have settled at a three-month lending rate averaging 16 basis points above the central bank's rate target since Bloomberg started tracking the difference in 1992.
The currency gained after retail sales rose a more-than- forecast 1.9 percent in March, the second-biggest monthly gain over the past three years, on a surge in new car sales.
Yesterday a report showed the so-called core rate of inflation, which excludes prices for items such as gasoline and fresh fruit, reached 2.5 percent in April from a year earlier, the fastest pace since 2003. The central bank monitors the core rate as a key gauge of trends.
Bank of Canada
Forecasts that the Bank of Canada may raise interest rates as early as its July 10 meeting triggered a sell-off in Canadian bonds, with the yield on the two-year government security gaining 19 basis points, or 0.19 percentage point, to 4.39 percent this week.
The nation's central bank has held borrowing costs at 4.25 percent for the past year.
``There is a possibility that the Bank of Canada will disappoint the market by not raising rates,'' said Firas Askari, head currency trader at BMO Capital Markets in Toronto, who exited his long Canadian dollar bet at C$1.0887. ``The bank will be quite reluctant to move rates at a time when the currency is doing the tightening job.'' A long position is a bet on a currency's gain.
Booming Economy
Canada's dollar reflects a booming economy that is benefiting from higher prices of crude oil and metals like copper and gold. Canada's oil sands in Alberta contain the largest crude deposits outside the Middle East, and the country is the world's No. 2 producer of nickel and zinc. Oil rose 4.1 percent this week.
The boom in commodities, sparked by demand from countries including India and China, has helped the Canadian currency surge more than 46 percent since the start of 2002.
Surging tax revenue has allowed the Canadian government to pare debt and post 10 straight budget surpluses, the lone country among the Group of Eight nations with a balanced budget, helping to bolster investor confidence in the currency. Standard & Poor's affirmed its 'AAA' long-term foreign and local currency sovereign credit ratings on Canada.
The currency's gains prompted manufacturers such as jet- maker Bombardier Inc. to push for lower borrowing costs and tax breaks. More than 200,000 factory jobs have been lost since 2003.
``For our business, it means lower revenue because so much of our sales are denominated in U.S. dollars,'' said William LeGrow, vice president of transportation and energy at West Fraser Timber Co., North America's second-largest producer of softwood lumber. ``Most lumber producers are selling at or around their cash cost.''
A 1-U.S.-cent change in the exchange rate impacts earnings by 39 Canadian cents a share, the company said in its February presentation.

CAD hit 29 year high on back of strong retail sales

The Canadian dollar hit a new 29 year high today and came within 30 pips of its 30 year high. As we suggested yesterday, the wholesale sales number was a perfect indicator of today’s surprisingly strong retail sales figure.
Spending in the month of March doubled expectations, rising by 1.9 percent, the second biggest gain in 3 years. Demand for autos was particularly strong, but sales of non-auto retailers also hit the highest level on record in the first quarter. The combination of strong inflation and retail sales raises the chance of an interest rate hike by the Bank of Canada later this year. However things should calm down in the week ahead with only leading indicators due for release. There was no Australian or New Zealand data released overnight although Finance Minister Cullen downplayed the chance for future rate hikes. In the week ahead, the only important releases are New Zealand trade balance and Australian leading indicators.

20.05.07 Open

GBP 1.9749
JPY 121.06
EUR 1.3516
AUD 0.8236
NZD 0.7301
CHF 1.2269
CAD 1.0894
EUR/GBP 0.6842
EUR/JPY 163.57

Central Bank Rates

Central Bank Rates

NZD 7.75%

AUD 6.25%

GBP 5.50%

USD 5.25%

CAD 4.25%

EUR 3.75%

CHF 2.25%

JPY 0.50%

Traders look at consumer spending to guess NZD rates

New Zealand Rates Hinge On The Persistence Of Consumer Spending
How Will The Markets React?
The outlook for monetary policy in New Zealand has undergone drastic changes in the past month. Not a few weeks ago, the central bank was on track to hike rates at least two more times before the end of the year. However, after the Reserve Bank of New Zealand actually lifted its overnight cash rate 25 basis points to a record 7.75 percent, expectations for further moves were curtailed significantly when it stated in its news release that the exchange rate would “exert some downward pressure on medium-term inflation.” This was the first inclusion of dovish rhetoric in the group’s boiler plate statement in some time. Needless to say, the shift shook up the market’s steady rate outlook. While the correction that resulted in interest rate futures and bond yields was sharp and extensive, it didn’t last for long. When rational heads prevailed, the masses realized the two sentences on inflation and high exchange rates were not necessarily the admission of dovish intentions, but rather the first warnings that things may cool. So, analysts and traders turned back to the most reliable tool available to them: the economic calendar. Since the April RBNZ meeting, data has burned up the wires. This is especially true of consumer spending and housing sector inflation – RBNZ Governor Alan Bollard’s well-documented, main concerns for future policy decisions. Housing was certainly steering the economy towards another rate hike as sales for the year through April rose 8.1 percent and price growth hit a record high. Perhaps the more pressing factor into a possible follow to last month’s hike though is consumer spending. Retail sales in the first quarter of the year soared 3.8 percent, the most since records began in 1995. Now, the market turns to its next central piece of data. There is no consensus for Monday’s credit card spending report, though its leading status could point the way for overall consumption since purchases on credit is usually the first thing to go.
Bonds – New Zealand 10-Year Government Bond Futures
Volatility in New Zealand government bonds have been the envy of the debt world recently. The active futures contract on the benchmark 10-year government bond yield has rallied nearly 400 basis points and retraced half of that in the span of two weeks in the lead up to and fallout from the RBNZ’s rate hike. After a brief period of consolidation, yields are back on the move. A bounce on support at 6.040 was triggered by strong economic indicators like house price inflation and retail sales. It’s not a coincident that these are the two areas where the central bank has placed the burden of the necessity of another rate hike. This suggests that Monday’s credit card spending report for April will have a considerable say over yields. If it falters, it could signal the beginning of a bigger trend.FX – NZD/USD
The New Zealand dollar has formed a relatively well-defined channel after rejecting the highs near .7495 on the Reserve Bank of Zealand’s unexpected rate hike to a record high of 7.75 percent. Since then, fundamentals have done little to underpin the pricing of further tightening into the currency, and the release of credit card spending may only add to this sentiment. The April release credit card spending may ease back from March’s figure of 7.5 percent, as consistently high borrowing costs should eventually deter shoppers. However, the New Zealand consumer has proven uncommonly resilient, leaving open the possibility for a pick up. An increase is highly unlikely to spark a solid rally for NZDUSD given the second-tier nature of this particular indicator, but a reading of 7.6 percent or above could be enough to push the pair up to .7330.Equities – NZX 50 Index
New Zealand stocks hit a record high in intraday trading on Friday, with optimism over the national budget, which was announced Thursday, offsetting a sell-off of some of the previous session's biggest gainers. The NZX-50 index ended the day 0.1 percent higher at 4,280.43 led by financial services firm Tower Ltd., the only New Zealand-listed default provider for KiwiSaver - the government's retirement savings plan - rallied 5 percent to NZ$2.42. On the other hand, Fisher & Paykel Healthcare and Fisher & Paykel Appliances, two stocks set to gain from government tax benefits for research and development spending, eased back Friday after surging on Thursday, with F&P Healthcare down 1.9 percent to NZ$3.61 and F&P Appliances 1.6 percent lower at NZ$3.74.

19.05.07 close

GBP 1.9749
JPY 121.06
EUR 1.3516
AUD 0.8236
NZD 0.7301
CHF 1.2269
CAD 1.0894

Chinese Yuan Band Widens: Are we heading for free float ?

Once again, as we have been forecasting for some time now, the People’s Bank of China made a move and widened the Yuan’s trading band. Planned perfectly to coincide with the weekend’s G8 finance minister’s summit and the Strategic Economic Dialogue with US Treasury Secretary Paulson next week, the highly anticipated decision continues to have broad implications beyond currency markets. Foreign exchange effects were immediate as the Japanese yen gained rapidly against the dollar shortly after the release.

So what didChina do?

- China widened the daily trading band against the dollar to 0.5%

The daily trading band, which represents a daily limit for appreciation or deprecation of the Chinese yuan against the US dollar, was widened to 0.5 percent from 0.3 percent effective May 21, 2007. The People’s Bank of China has enacted this measure amidst major pressure from its international trade partners of which US was the most aggressive voice. The main purpose of this change is to allow the yuan to rise against the US dollar faster, but given the small value of the actual band widening, markets should not expect wild fluctuations or rapid appreciation of the Chinese currency. The yuan has never moved the maximum range under the previous daily limit of 0.3 percent, as the biggest move this year against the dollar was a 0.22 percent gain on May 11. Furthermore, the 0.3 percent trading band has been a long standing one, as it was initially enacted in 1994. The People’s Bank of China and the Chinese government have stated previously that they would allow appreciation of the currency, but that it would be a slow process. Thus, we may expect continued widening of the trading band at a later date – compared to an outright revaluation of the yuan – leaving the issue is unlikely to fade from the limelight.


- China will maintain a managed float against a basket of currencies

The People’s Bank of China has said that their exchange management methods will not change, and a basket of currencies will still be used as a reference for the yuan exchange rate so as to avoid sharp fluctuations. Since the US, Euro-zone, Japan and South Korea are China's biggest trading partners, their currencies were naturally established as the main ones in the basket when the composition was initially revealed in August 2005. Also included in the calculation were: the Singapore dollar, the British pound, the Malaysian ringgit, the Russian rouble, the Australian dollar, the Thai baht and the Canadian dollar.

What motivates China to do this?

China has many reasons to want to revalue their currency. First and foremost the country wants to preempt any protectionist measures imposed against it by the US Congress. US legislators have been in a uproar, saying that an artificially weak currency has given China an unfair trading advantage against American competitors. The Congress recently showed its discontent with China’s $177.5 billion trade surplus by levying taxes on imports of coated paper. Although the move was largely symbolic as it comprised a tiny fraction of Sino-US trade, it was nevertheless a warning shot aimed at Chinese policymakers. Therefore, today’s announcement by the Chinese was partly diplomatic, intended to soothe tensions ahead a key meeting between Chinese Vice Premier Wu Yi and US Treasury Secretary Henry Paulson May 22-24 in Washington to discuss economic and financial issues, of which the value of the yuan will surely be a primary topic..

However, the Chinese decision may be driven as much by economic necessity as by political consideration. The move while not dramatic is a clear a gesture by the Chinese authorities signaling their willingness to move the yuan exchange rates closer to a free-floating model. The Chinese authorities now find themselves combating the growing asset bubbles in the Shanghai equity market and have become quite concerned about the possible fallout should it collapse. This policy change is just the latest attempt by the Chinese government to reign in speculative sentiment in the country by slowing inflationary pressures. Instead of simply viewing this policy change as a one off diplomatic event traders should consider the possibility that this may be a precursor to a more free-floating model of foreign exchange in China. Until recently most analysts believed that China would never consider a free –float solution given the enormous problems with non-performing loans in its banking sector. However, several years of double digit GDP growth, along with major recapitalization of its four primary banks through recent IPOs in Hong Kong, have radically changed the financial stability of this sector over the past year. With more than 1 Trillion dollars in foreign exchange reserves which most market observers believe will increase to 2 Trillion by end of 2008, China’s balance sheet appears rock solid, allowing monetary policymakers far greater freedom to entertain the idea of a more free-floating foreign exchange regime.


What does it mean for the markets?

Treasuries - China’s decision has ramifications for all of the financial markets. Notably, effects will be felt in the US treasury market as Chinese officials will likely continue their investment in US dollar based assets. Although their currency is widely managed by a basket of currencies, reducing the exposure to US treasuries, demand for US bonds will remain for the time being in controlling the band that still remains over the currency. The notion will help to suppress long term yields in the long bond market, exacerbating the already rising sentiment that Federal Reserve officials may be cutting rates at the end of the year.

Currencies - The increased demand for US treasuries and investments will be more than beneficial for the dollar, no question. However, the focus will be placed on the Japanese yen as pressure will likely come on the heels of the People’s Bank of China decision. For some time now, the global market place has demanded for further flexibility in the Chinese currency regime. Now that the trade band has been widened, economic leaders will want to see some tangible results from Japanese officials. Although central bankers have not intentionally suppressed the value of the yen, world leaders will want some answers for an undervalued currency and an increasing competitive advantage.

Stocks - The stock market should have a mixed reaction. Shares of companies such as Wal-Mart and Target have and will probably continue to be under pressure because the widening of the trading band means that their cost of imports will increase. So Wal-Mart and Target will either have to increase prices or take a cut out of profits. Comparatively shares of manufacturing companies that compete against China should rise along with shares of companies that are targets for Chinese acquisition. On one hand, the decision to widen the band would help boost the competitiveness of the American made goods on the open market as the price of Chinese exports would rise. On the other, an the same appreciated yuan makes its cheaper for Chinese companies to snap up US companies while at the same time giving them more political sway to a demanding US Congress. Both scenarios will ultimately help US companies attract investment interest as it benefits the bottom line.

Commodities - Commodity markets are set for a boost in demand for the short term as raw materials will now become cheaper for China based manufacturers. With a higher valued currency, producers and manufacturers will be able to not only afford more of the materials they need, but may increase their desire for raw materials in order to increase capacity and meet rising demand. The resultant effect will be higher prices in the commodity markets, with significant focus on base metals, especially copper and gold, and crude oil.

Is there more to come?

It was said before, and will be said again. More flexibility is on its way. Although the recent decision to widen the trading band was not as market moving as the July 21st revaluation, it shows that Chinese officials have a longer term plan to finally move the currency to a free floating status. The notion couldn’t come at a better time with global funds continuing to pile into any Chinese asset. The increase in foreign investment, a widening trade surplus and an overheated economy still leave the necessity for further adjustments in the short term, leaving the yuan to even greater appreciation.

18.05.07

Today's open
GBP 1.9744
EUR 1.3487
JPY 121.27
AUD 0.8220
NZD 0.7295
CAD 1.0995
CHF 1.2275

Euro Slips after ECB Report Fails to Give Further Guidance on Future Hikes

Central bank rates as on 18th May'2007

NZD 7.75%

AUD 6.25%

GBP 5.50%

USD 5.25%

CAD 4.25%

EUR 3.75%

CHF 2.25%

JPY 0.50%

FX Update 17.05.07

JPY on new lows after Bank of Japan keeps interest rates on hold. The rates are at 0.5%. The equity market should rally on the back of this data.