China Tightening Fears Pressure Higher-Yielding Currencies

China’s consumer-price index spiked higher in February, leading to speculation that its central bank will raise interest rates to curb economic growth.

China’s consumer-price index spiked higher in February, leading to speculation that its central bank will raise interest rates to curb economic growth. The inflation report showed an acceleration from the year-earlier month, to a greater-than-expected pace of 2.7%. The higher growth was tied to greater-than-expected gains in fixed-asset investment, bank lending, and industrial production.

Higher yielding currencies fell on the prospect of further tightening by China. The low yielding Japanese Yen benefitted the most. Any attempts to dampen economic growth after inflation jumped to a 16-month high should continue to fuel demand for safe-haven investments. If China decides to move further on its attempt to curb excessive growth in the economy then look for the Yen to be the major beneficiary of rising risk aversion.

Although speculation that China will tighten its monetary policy further helped drive the Yen up initially following the release of the inflation news, the USD JPY is trading better. Traders seem to be paying more attention to an earlier report which showed a government revision of fourth-quarter gross domestic product growth. The government cited slightly weaker corporate capital expenditures and private inventories as the main reasons for the downward adjustments. Further evidence that the Japanese economy was in a weakened state was a report which showed the government adjusted down a price measuring gauge to show record deep deflation.

Today, traders will get an opportunity to react to major economic reports for the first time this week. On board this morning are the International Trade Report and Weekly Initial Jobless Claims. Economists say the trade deficit in the U.S. probably widened for the third month as imports climbed faster than exports. The rise in oil price was most likely the cause. Weekly Jobless Claims are expected to drop by 9000 to 460K. The range is 450K to 470K. An increase in the number of unemployment claims is likely to fuel a rally in the Dollar. A greater than expected drop should fuel demand for higher risk assets.

The USD CAD is trading slightly better this morning after reaching its lowest level since October 2009. Oversold conditions and less demand for higher risk assets is helping to contribute to the strength. The bigger picture still suggests that the stronger currency is the Canadian Dollar. Higher oil prices and the prospect of rising Canadian interest rates have helped increase the view that the Canadian Dollar could test parity. Investors are beginning to believe that the Bank of Canada is likely to hike interest rates before the Fed.

The Euro is trading mixed this morning. Technically this currency is trading in a range and building a support base while waiting for a catalyst to trigger an upside breakout. The easing of fiscal tensions in Greece is contributing the most to the developing bullish tone. Traders seem to be waiting for some event to shake up the record number of shorts in the market in order to trigger a short-covering rally.

The Swiss National Bank is expected to leave interest rates at historically low levels while softening its attitude toward intervention. It is also likely to express its worries about inflation risks and excessive appreciation in the Swiss Franc. Further appreciation in the Euro this morning will drive down the USD CHF.

The GBP USD is trading better after a Bank of England report predicted that inflation would be 2.5% this time next year. This projected increase was slightly better than the November guess of 2.4%. The overnight move is probably light position paring or short-covering. Shorts still feel that there is much more potential to the downside because of the weak economy, political uncertainty and the BoE’s dovish tone.

The AUD USD fell overnight on speculation China will have to raise interest rates to curtail its economic growth. Since this report, however, the Aussie has recovered and is trading positive. The volatile overnight tone is likely to spillover to the New York session. There is not question the Australian economy is strong, but speculators may begin to question whether it can sustain this growth without the support of China.

The NZD USD is trading lower after the Reserve Bank of New Zealand left its benchmark interest rate unchanged. NZRB Governor Bullard said weak consumer spending and higher bank-funding costs are slowing the recovery. He stated further, “Households are still cautious with house sales and credit growth remaining subdued”. Given the tone of this report, investors are speculating that interest rates will remain low until at least June, but some are even projecting until the end of the year.