Aim low - avoid disappointment

Aim low - avoid disappointment
26/06/12 @ 07:24 GMT by Simon Smith, Chief Economist

Leaving aside the yen, FX markets were confined to fairly tight ranges through yesterday and there’s a similar pattern in European policy-making. The path of least resistance remains piecemeal country-specific approaches vs. more radical and far-reaching solutions likely to bring about a more lasting resolution to the crisis. The press today is highlighting EU plans to re-write budgets, but this is decidedly old news, does nothing to solve the current solvency problems and there are issues of enforceability. Ultimately, unless the EU is prepared to fine nations, imprison leaders or threaten with EU and/or eurozone expulsion, it’s difficult to see how such measures can be enforced. That’s why no-one was ever been fined under the Stability and Growth Pact. From somewhere, the EU needs to find a rather large stick.

[You must be registered and logged in to see this image.]

Commentary

EUR/USD hugging 1.25 as yen benefits. The break back below the 1.25 level happed fairly early on during Monday’s session, but there appeared to be limited appetite to push lower below that level, resulting in a relatively subdued start to the week. On the sidelines, there were few signs that Germany was likely to change its tune ahead of the EU summit later this week and this added to the modestly bearish euro tone. The big move was on EUR/JPY, down nearly 1% on the day as the yen gained on the back of the generally risk-averse tone to markets. EUR/USD has held the late Monday move back above 1.25, with resistance initially coming in at 1.2540 ahead of 1.2570.

The gold rush risk. Spot gold is currently 4% below the average for the year to date and only just in positive territory vs. the start of the year. It was back in 2004 that gold was last this weak vs. the start of the year, when it was down 6% in the first half of the year. The interesting thing is that ETF holdings of gold are at the highs of the year, up nearly 4% YTD. There is also talk of large hedge funds having taken out significant positions in gold towards the start of the in the belief that it would benefit from further global turmoil and further quantitative easing from central banks. In reality though, even though quantitative easing prospects have risen in the US and elsewhere, gold has not benefitted. As we’ve mentioned before, the impact of further QE on currencies isn’t as clear cut as has been the case in the past, with this a world far less awash with under-priced assets vs. 2009 when central banks embarked on QE with a vengeance. Furthermore, the inflationary impact of such measures has not materialised and thus, investors are less convinced that a strong inflationary hedge is required. The upshot is that there are a lot of frustrated gold bulls out there and there remains a risk of capitulation from these positions should they start to lose faith in gold’s ability to reach new highs on a multi-year basis.

Paying down debt is not confidence-inspiring. It’s telling, but also not surprising, that US consumer confidence has failed to reach the levels seen through most of the boom years, when the headline index averaged around 100. In contrast, the best that has been achieved in recent years is 72. But don’t see that as a bad thing necessarily. Paying down debt and/or defaulting is not a confidence-inspiring activity but is a necessary one for the US as it tries to achieve a more balanced economy and one less dependent on leverage, especially in the household sector. Therefore, in an economy still weighed down by debt, renewed consumer confidence is not always a good thing in terms of future prospects. The market expects today’s data to show a fourth consecutive monthly fall, down to 63.0.