by George Dorgan
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A quick explanation for our news bar readers, it is an extract from “Explaining Price Movements in FX Rates”.
Asian bloc versus American bloc
The differentiation into the Asian bloc and American bloc is quite important for price movements driven by algos. The most important countries for economic news and drivers of FX rates are the United States and China, thanks to their high total spending and strong growth.
- Good or better than expected fundamental data in China leads to a weaker dollar – even against the yen – and to higher commodity prices and stronger currencies in the Asian bloc, especially the “bullish” ones: AUD (FXA) and NZD (BNZ), but also NOK (NORW) and RUB that profit on higher Brent oil prices, the principal oil benchmark in Asia.
- Good or better than expected data in the United States helps USD/JPY and stock markets to make advances. In phases when the USD is the principal funding currency, “bullish” currencies of the American bloc appreciate: GBP and the Swedish Krona rise. SEK (FXS) is strongly related to technology and stock markets and often moves with the American bloc. Sterling is related to rising incomes of US and British banks and banking employees. As opposed to CAD and MXN, the British pound and SEK rise when oil prices are relatively low but stock markets improve.
- The Brazilian real BRL combines a American risk-on currency with commodity demand from China. Similarly as other currencies from Emerging Markets, like the Indian INR and the Indonesian IDR, the BRL was also driven down recently by high salary increases and inflation.
- Swedish exports are more concentrated on Europe than Switzerland or their neighbors Norway (e.g. Brent is the Asian oil benchmark) and Finland. The latter three have a far bigger exposure to Asia. Therefore CHF and NOK move more with the Asian bloc.
- In periods when the U.S. dollar is the investment currency and Asia is weak, this may lead to irrational exuberance. An example is the Asia crisis in 1998 accompanied with potential strong U.S. productivity growth that led to the dot-com bubble.The investment environment of 2013 slightly resembles the one from 1999: China and other emerging markets have weakened, while the U.S. housing market has recovered, albeit U.S. productivity has not risen yet.
- Weak or weaker than expected data in the United States leads to an appreciation of the “bearish” currencies of the Asian bloc, the ones with low interest rates; namely, the JPY, SGD and CHF – these have trade surpluses with Asia, while the U.S. has a big deficit.
- Weak or weaker than expected Chinese data leads to appreciation of the “bearish” currencies of the American bloc: despite recent improvements this remains the US dollar.
- Continued quantitative easing (QE) in the U.S. typically triggers a weakening of the dollar and an appreciation of all currencies of the Asian bloc, both bullish and bearish ones, including gold and silver. An end of QE or “tapering” does exactly the opposite. Japan QE leads to a weaker yen and an improvement in the American bloc, but to a far smaller price movements.
- Gold and silver behave like currencies and describe the growth differentials between the Asian and American blocs, they rise with higher growth and demand in Asia and other emerging markets, but they fall when the U.S. advances, see full details.
The euro is somewhere in the middle: Germany’s DAX and MDAX are driven by (machinery and capital goods) exports to Asia. German and Swiss stocks and the Swiss franc belong to the Asian bloc, they rise with commodities and Chinese growth. The European periphery, however, loses relative competitiveness when Asia becomes stronger and oil prices and inflation increase, the fear of a U.S. recession augment. As a result, peripheral bond yields move upwards, the extreme was reached in the inflationary and potentially recessionary scenario in August 2011. Therefore, the periphery belongs to the American bloc; their bond yields decrease when the situation in the U.S. improves.
This explains also why a solution to the euro crisis is possible when investments in China and oil prices do not increase as quickly as in 2010/2011. For us, not Draghi but the potential unlimited bond buying contained in the OMT program saved the euro zone. But stronger U.S. house prices – thanks to QE3 – and weaker Chinese growth in combination with Italian or Spanish current account surpluses removed the stress on the financial markets.
A common error is to associate the AUD/USD exchange rate with stock markets and not with commodities. Despite the recent strong correlation during the Chinese growth since 2008, the weak Aussie during the dot-com bubble is the most prominent counter example, repeat in summer 2013.
Current weak levels of NOK/SEK, around 1.11, indicate that the American bloc has become a lot stronger than previously. Apart from some short periods, the NOK/SEK has never been at these levels since 2005, while during the dot com bubble the NOK/SEK was at 1.03.
