Greece Or China: Which Is Bigger FX Risk?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

• Is Greece or China the Bigger Risk for FX?
• Dollar: Rise in Jobless Claims Not a Worry
• USD/CAD in Play with Employment on Tap
• AUD Lifted by Stronger Labor Data
• NZD Hangs Tight Amidst Recovery in Chinese Stocks
• GBP: BoE Leaves Policy Unchanged

Is Greece or China the Bigger Risk for FX?

Is Greece or China the bigger risk for currencies? The answer to this question lies in the hands of policymakers and how far they are willing to go to prevent a collapse in their local markets. China has taken quick and aggressive steps to halt the slide in stocks. And overnight, the 5.75% rebound in the Shanghai Composite Index suggests that their efforts could finally be paying off as the index bounced sharply off the 200-day SMA. Unfortunately it is far too early to call a bottom in Chinese stocks, particularly since the index is still below the key 4,000 level. While China is committed to stopping the decline, they are fighting market forces and valuation. The sell-off in stocks has been sharp and aggressive but they bring valuations back to reasonable levels. Chinese contagion is a big risk for the financial markets and even though only 1 in 15 Chinese are invested in equities, the blow to confidence and the economy could have global repercussions. Nonetheless we believe that the Chinese government will escalate its policy responses until a bottom is effectively manufactured.

European policymakers, on the other hand, still appear willing to let Greece go. According to German Finance Minister Schaebule, Greece needs a haircut but “leeway for Greek debt reprofiling is very small.” While he agrees with the IMF that “debt sustainability is not feasible without a haircut, he quickly dismissed the idea saying that, “there cannot be a haircut because it would infringe the system of the European Union.” German Chancellor Merkel appears to be more amicable having recently said that concessions can be made to keep Greece in the euro. Meanwhile at the time of publication, Greece had yet to submit its new proposals to the Eurogroup. Reports are that they will do so on Friday. This is obviously negative for the euro but given how long the crisis has dragged out, what’s another day? The Eurozone Finance Ministers and Leaders meetings are not until this weekend. In the short term, Greece is the bigger risk for the currency market but in the long term, if Chinese stocks do not bottom, it poses a bigger problem for global growth. European leaders will decide if Greece deserves new loans on Sunday and if the answer is 'yes', then currencies will rally in relief. But if the talks break down and the Eurogroup concedes to letting Greece leave the euro, then currencies and global equities are in trouble. While there will be fears of contagion, questions about what this means for Spain and Italy, more losses and pain for the euro and the financial markets, in the not-too-distant future, investors will realize that the Eurozone is better off without Greece.

Dollar: Rise in Jobless Claims Not a Worry

There continues to be very little consistency in the performance of the dollar. The greenback increased in value versus the euro, Japanese yen and Swiss franc but was basically unchanged versus the British pound, Canadian, Australian and New Zealand dollars. The EUR/USD was hit by the ongoing possibility of a Grexit while USD/JPY was lifted by the recovery in Chinese and Japanese stocks. Jobless claims were the only piece of U.S. data released on Thursday and while it is not a big market mover, it successfully shaved some of USD/JPY’s gains. Weekly claims rose to 297k from 282k, the highest level in more than 4 months. Economists were hoping for an improvement but seasonal plant closings drove claims higher. Even with the increase, however, jobless claims remained below 300k for the 18 straight week. The slack in the labor market continues to decline providing the case for a 2015 rate hike. With that in mind, the decision on whether or not to raise rates hinges on how much damage Greece and China has on U.S. financial markets. U.S. policymakers are divided with Fed President George warning Thursday that it is risky to continue holding rates near zero and Evans calling for the central bank to delay lift off to 2016.

USD/CAD in Play with Employment on Tap

For the first time in 5 trading days, the Canadian dollar traded lower against the greenback. The decline was driven by the bounce in oil prices and talk of a possible nuclear deal with Iran. Unfortunately comments from John Kerry suggest otherwise. Nonetheless after such a strong rally, a small pullback in USD/CAD is not unusual. Whether the currency pair breaks its 6-year high of 1.2835 depends on Friday’s Canadian employment report. Economists are looking for a loss of jobs and based on the sharp decline in the employment component of IVEY PMI, we fear that the losses could exceed the forecast 10k. Meanwhile down under, Australia reported better-than-expected job growth. Economists were looking for zero job growth but a 24.5k increase in full time jobs brought the net total of jobs created last month to 7.3k. The participation rate also edged higher while the unemployment rate rose less than expected. This report helped to lift the Australian dollar but only by a small amount because at the end of the day, the jobless rate increased and the amount of job growth is less than the previous month. The New Zealand dollar ended the day unchanged after Wednesday’s sharp gains. How AUD and NZD trade in the next 24 hours will depend entirely on the performance of Chinese equities.

GBP: BoE Leaves Policy Unchanged

Sterling ended the day unchanged against the U.S. dollar after the Bank of England held monetary policy steady. This decision was no surprise considering that the BoE is in no place to raise rates and the economy is steady enough to forgo easing. Sterling has been hit hard in the past week and while Thursday’s consolidation is encouraging, GBP/USD ended the day near its lows after having broken below 1.54. On a technical basis, the currency pair appears poised for a move to 1.52.