The dollar had a mixed day, first dropping and then gaining as the renminbi devalued and Asian markets pared yesterday’s gains. Euphoria earlier in the week turned to disappointment as market’s reassessed their evaluation of the impact of the de-pegged renminbi. The assumption had been that the Chinese currency was grossly devalued and would rise in the future but a fall yesterday against the dollar reminded investors not to assume too much. The new mechanism, a crawling-peg, only allows restricted movements in the renminbi of no more or less than 0.5% a day either way. Original hopes on Monday that the global economy might benefit from a stronger renminbi supporting exporters to China, seemed to evaporate. A general retreat was further fuelled by negative US economic data showing a surprise drop in existing home sales for May from 8.0% the previous month to -2.2% and a slight improvement in consumer confidence from -45 to -43. The drop in existing sales led to a broad based sell-off in the equity markets as investors questioned the strength of the economic recovery and safe haven demand increased. The dollar vacillated at the impact with the yen seemingly taking most of the gains. It ended the session up against the euro at $1.2270 but down against the pound at $1.4813.

   The euro dropped against most of its counterparts as global risk appetite decreased following disappointment in Asia and lingering concern about the banking system. The results from three major business surveys in Germany showed a stable outlook but concern for the future. The IFO business climate survey rose from 101.5 last month to 101.8 this month and the IFO current assessment survey increased from 99.4 to 101.1. However these positive figures were offset by a drop in the IFO expectations survey results which came in below estimates, revealing a lack of confidence in the sustainability of growth in the future, as many government stimulus programmes are set to be withdrawn at the end of the year following fiscal tightening. The Euro-zone current account figures released for April showed an imbalance in trade which must have surprised many also. European exporters would have been expected to benefit more from a weaker Euro when actually the figures showed a widening of the deficit from 1.5bn to -5.9bn. (seasonally adjusted – s.a) and 1.3bn to -6.9bn (n.s.a). Concerns over the state of European banking were highlighted by a comment from Christain Noyer, of the Banque de France in an interview with La Tribune that “some banks have started facing increasing funding problems,” Mr Noyer gave no further details but he suggested one reason for heightened nervousness was the expiry at the end of this month of €442bn in 12-month loans provided by the ECB a year ago.The common currency fell as fear set in reaching ¥111.12 vs the yen and £0.8281 against the pound.

   The pound strengthened against most of its counterparts after the markets broadly approved the measures outlined in the emergency budget delivered on Tuesday. Sterling rose to $1.4813 against the dollar but was down slightly to ¥134.13 against the yen as the new coalition government outlined its ambitious plans to cut the budget deficit and restore the public finances to health. The large size of public spending cuts – which in most government departments will amount to 25% of their total revenue - and included an increase in V.A.T from 17.5% to 20%, a goods and services tax which is added to everything except children’s clothing and food, have, however, raised fears that the budget may derail the fragile economy and force the UK into a double dip recession. And whilst rating agencies approved the step there is a fear that the BOE may need to cut its forecast for growth and use additional stimulus measures to keep the UK from a downturn.

   The yen rose against most currencies on Tuesday as risk appetite faltered after markets reassessed their optimistic view of the renminbi’s future. The yen gained the most from the volte-face in risk exposure after doubts crept in about the sustainability and extent to the renminbi’s expected rise. Poor US housing sales results also pushed the yen higher as investors questioned the strength of the global recovery. Further increased austerity measures introduced throughout Europe are expected to reduce global growth and demand in those countries. The yen rose to finish the session at ¥90.56 against the dollar and ¥111.12 against the euro.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst