Risk assets pull back on global economic slowdown

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The price action in JPY lately has been somewhat puzzling. Its previous tight correlation with US rates has broken down, and it does not seem to trade much as a safe haven either. The threat of intervention below the 80 level keeps it somewhat anchored at that level, and the current soft tone in risk assets prevents the dollar from rising much above 81. JPY ended the week nearly unchanged against the dollar, and this recent breakdown in correlations is worth watching carefully.

All three dollar bloc currencies generally tracked the equity markets during the week. However, AUD was generally weaker, dragged down by falling commodity prices and signs that the RBA is in no hurry to hike rates again. NZD held up rather well, as the New Zealand economy shows signs of rebounding from the damage of the Christchurch earthquake. The Canadian dollar ended the week nearly unchanged against the greenback, while NZD rose about 1% and AUD dropped about 0.5%.

Another week another record high for the Swiss franc against both the US dollar and the euro. Peripheral woes and generalized risk aversion have given CHF new legs, and the rally is kept going by the absence of Swiss National Bank intervention and the continued unwinding of legacy carry trades that used the CHF as funding currency. It remains to be seen how much longer the Swiss export machine can hold on in the face of relentless franc appreciation.G

Financial markets had a volatile week in which most assets lost ground. The steady drumbeat of negative macroeconomic news worldwide continued. This week, European PMIs surprised to the downside, and the Federal Reserve revised its growth forecasts for the US sharply downwards. The Greek government survived (as expected) a no-confidence motion in Parliament, and approval of yet another round of harsh austerity measures is expected next week. However, markets are sceptical that this new bailout will succeed, and peripheral spreads broke to new highs. Amid the gloom and uncertainty risk assets traded lower, led by commodities and news that the International Energy Agency would release oil from strategic reserves into markets, pushing oil sharply downward. Government bonds rallied to yet another high for the year.

EUR

It was a difficult week for the euro. The critical PMI business sentiments both surprised to the downside. While the overall levels are still consistent with decent output growth, two issues cloud the prospect. First, the euro-wide figures have been dropping rapidly, with the blended composite index down 2 points in June after having dropped 2 points in May. Second, the regional discrepancies between core Europe and the rest are widening. This implies very weak growth in the periphery. On the sovereign risk side, the Greek Government survived a confidence motion in Parliament. However, peripheral bond markets were not reassured, and tier one peripheral spreads (Spain, Italy and Belgium) blew out to new all-time records. Given the downpour of bad news, it is actually surprising how well the common currency held up, dropping only a bit over 1% against the US dollar.

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