Look for North America to Fade Euro Moves

BBH CurrencyView

• The dollar is broadly weaker as sentiment improves in the wake of an agreement on fiscal integration
• European officials have struck what appears to be significant agreement; one of the costs is a new split in Europe as the UK and others are not in agreement
• UK trade deficits narrows but unlikely to change economic outlook; China’s inflation decelerates

The dollar is broadly weaker as sentiment improves in the wake of the agreement on a new fiscal compact for the euro zone. The euro rebounded from early session lows and is currently trading near 1.34, with sterling mirroring the euro gains, up over 0.5%. The EUR move has also correlated with a rebound in stocks markets and a concomitant drop back in Italian and Spanish yields. European shares are higher, with the EuroStoxx 600 advancing 1.2% led by the 2.2% gain in banks. S&P 500 futures also point to a strong open, up nearly 1%. The scandi’s are among the top performing currencies in the G10, with both the NOK and SEK up nearly 1%. Asian currencies were broadly weaker (in line with equity prices), led by KRW and PHP down 1.8% and 1.1%, respectively.

European officials have struck what appears to be a significant, even if still shy of a comprehensive agreement that moves the money union to greater fiscal coordination. One of the costs of the agreement is the potential for a new split in Europe, as the UK and a few other EU members (Hungary, Sweden, Czech) are not in agreement. The UK insisted on opt-out clauses, reportedly, over financial regulatory issues, which could not be conceded, and hence the deal breaker. The key components of the agreement appear to be structural deficits should not exceed 0.5% of GDP, automatic penalties unless overridden by a large majority, deference to IMF rules regarding private sector burden sharing under the ESM, which will be brought forward a year to mid-2012 and have initial capacity of 500 bln euros and will be subject to review. The national central banks will loan 150 bln to the IMF’s general resources and the non-euro zone members of the EU will lend 50 bln euros. The details of the initiative were not announced. Germany and France hope to be able to fast track the agreement, but the extent that treaty changes are needed or referendum/national parliament approval is not clear. Europe took the euro higher after it reached new lows for the month just ahead of $1.3280 support, but resistance at yesterday’s highs should ~$1.3460 and the entry of likely more skeptical North American participants may see the euro’s gains pared back ahead of the weekend.

On the data front Germany posted a seasonally adjusted trade surplus of €12.6 bln in October, down from €15.1 bln in the previous month. Exports dropped 3.6% m/m, which more than outweighed the 1.0% m/m decline in imports. October orders data showed a sharp rebound in export orders, which could mean exports will rebound, but the data nevertheless highlight that the debt crisis and the slowing world economy are leaving their mark on exports trends and the German trade surplus. The contribution of net exports to overall growth is likely to ease, although Germany’s improved competitiveness means its performance is better than most of the other euro zone countries. In the UK, the October trade deficits narrowed sharply but there is a big caveat as the data reflects month-to-month volatility following a soft month in September. So while the data seems encouraging the bounce in October generally reflects a bounce after from the dire numbers in September. That means, the data are likely to do little to impact the economic outlook . Sterling held support below $1.56 and it too moved back toward yesterday’s highs. The $1.5750-70 area may cap upticks, but sterling’s as an alternative to the euro remains intact.

In China a deceleration of inflation from 5.5% y/y to 4.2% y/y, the lowest levels since September 2012, is likely to be received as good news. The soft inflation data supports the recent cut shift towards a looser policy stance, which included cutting the PBoC reserve requirements, lowering the yield on auctions and faster lending by the large banks. Looking ahead, next week’s Central Economic Work Conference could mark the official shift in policy from stabilizing prices to stabilizing growth as the key objective – but this shift is by no means assured. Official rhetoric has lagged action during this transition phase, now referred to “fine tuning” and could continue to do so. While inflation was the good news, activity data was mixed with industrial production moderating to 12.4%yoy (from 13.2%yoy), but retail sales activity held up well at 17.3%yoy (from 17.2%yoy) in November. Overall, we expect that China’s monetary policy to continue moving towards easing regardless of whether the official stance changes. We would not be surprised to see another cut in reserve requirements in the near term and/or further relaxing credit condition.