GERMANYA EUROMONEY SURVEY – June 1996The most recent of the surveys that the Bank for International Settlements (BIS) conducts every three years showed Germany ranking a moderate seventh in the world currency trading league table as at April 1995. According to the same survey, Germany’s locations for foreign exchange (besides Frankfurt, also Düsseldorf, Hamburg, Munich, Berlin and several other local centres) together had an average daily trading volume of $76.2 bn or a market share of around 5%. The 39% increase over the 1992 figures is slightly below the weighted average of 46% for all the countries covered by the survey. These figures indicate a certain consolidation that is also reflected in the use of the German currency as a trading unit. Whereas in 1992, the Deutschmark accounted for 40% of aggregate turnover (in 1989 this was 27%) this share slipped to about 37% in the last survey. However, the Deutschmark remained second to the US dollar, and well clear of the third-placed Japanese yen with 24%. Trading in the other currencies of the European monetary system was up, with exchange rate expectations and position adjustments probably driven by plans for European monetary union. The above figures include spot deals, outright forwards and swaps.In the first such survey for derivatives the BIS has also ranked the world market players by countries, with separate figures for OTC and exchange-traded business as well as for product groups such as interest rates, foreign exchange, stocks and commodities. Accordingly banks in Germany trade FX products (outright forwards, swaps, options) worth an average per day of approximately Dm45 billion (notional amount). Virtually the entire amount is accounted for by OTC trading, meaning that on-exchange FX derivatives trading is obviously negligible. Yet a not insignificant amount in currency warrants, achieved above all in retail operations on Germany’s stock exchanges, deserves mention here. All things considered, Finanzplatz Deutschland (Germany as a financial marketplace) has caught up with the top group also in this more innovative segment. Fixing the official exchange rate in Germany One luxury the German financial sector continues to afford itself is that of the official fixing at the foreign exchange market in Frankfurt. Seldom has an institution been the target of such extreme opinions; they range from condemnations like “absolutely superfluous” and “stop immediately” to commendations such as “a highly liquid and efficient market”. Yet no-one can seriously be expecting this daily ritual to end. Too many market participants – for the greater part small and medium-sized companies, though also private investors consciously avoiding the labyrinth of the OTC market – feel very fairly treated and see their interests competently represented in this segment. Probably the weightiest argument in favour of the fixing is the fact that the prices determined here are ‘lived’: they are not based on opinions or surveys – they are prices at which trading has taken place. This makes them particularly suitable as benchmarks and as a basis for valuing assets and liabilities at certain cut-off dates. Despite the almost insignificant volume compared with the daily volume of business – after all, it is ‘only’ a snapshot, as it were – fixing also enjoys the keen attention of banks, at home and as well as abroad. Its very broad-based structure has a lot to do with it. At 1.00pm foreign exchange markets at five trading centres in Germany (Frankfurt, Düsseldorf, Hamburg, Berlin and Munich) commence a total of 17 currency auctions, starting with the US dollar and ending, roughly an hour later, with the Finnish markka. Bank representatives at the individual markets – joined by a German Bundesbank representative at Frankfurt – make up the auditorium that provides the necessary liquidity with customer orders and orders for own account. From the various locations, orders to buy and sell are then collected at Frankfurt for settlement at the rate fixed for the respective currency. One should emphasise that the fixed rate is not an officially ‘dictated’ rate but a market price. The decisive criterion in determining the price is the highest possible turnover, i.e. volume-wise the greatest balance between buy and sell orders. Orders of this kind can be put into the fixing ‘at the market/at best’ or at stipulated price limits. The fixing is neither obligatory for certain market participants nor are there restrictions of any other kind in currency trading in Germany or with the D-Mark. This holds good for the ‘pure’ foreign exchange market as well as for the money and capital market in general. First half 96: A phase of Deutschmark weakening The first half of 1996 is likely to be remembered by FX market observers as a phase of Deutschmark weakening. The Deutschmark lost considerably in value both against the currencies of its European neighbours and against the US dollar. Fundamentally, this represented a correction of the Deutschmark’s exaggerated appreciation during the monetary crisis in spring of 1995; to speak of a pronounced Deutschmark weakness seems to be overdoing it at the present point in time. The Deutschmark/Ecu exchange rate recently tested Dm1.8840/Ecu, the undershooting of which in spring 1995 sent the exchange rate plummeting to an all-time low of Dm1.8050/Ecu. The Deutschmark has been able to recover from its all-time low of Dm1.3455/$ on March 6 1995 to above the Dm1.50/$ mark, although the long-term downward trend has remained intact. Recently, the trade-weighted external value of the Deutschmark dropped from 115.20 in March 1995 to 108.20. MAIN REASONS FOR THE WEAKENINGIn addition to the idea of a technical rebound, i.e. that the foreign exchange markets overdid the appreciation of the Deutschmark in spring 1995, a number of fundamental arguments may be given for the weakening of the Deutschmark.1. Stifled development of the German economy “Slowdown in growth” and “mass unemployment” are the catchwords used to characterise the German economy in the first half of 1996. The first quarter saw the national product decrease by 0.2% after shrinking by 0.4% in the last quarter of 1995. Building investments in particular slumped (Q3 1995 -2.2%, Q1 1996 -2.5%). Unemployment rose above the 10% mark, and the number of jobless reached a record of more than four million people. 2. Fiscal problems The government has found itself faced with a considerable need for consolidation, also with regard to the fulfilment of the Maastricht criteria for European Economic and Monetary Union (Emu). A Dm60 billion hole in the budget has got to be plugged, half of it by the federal government. Hence the government is currently working on an austerity drive which is also intended to improve the condition of Standort Deutschland (Germany as an industrial centre) by reducing the incidental wage costs embedded in social legislation. 3. Interest rate policy With its policy of continued interest rate cuts, the Bundesbank has supported by monetary means the government’s tight fiscal policy in a phase of economic weakness. On December 14 1995 it cut back the discount rate from 3.5% to 3.0%, and reduced it again to an all-time low of 2.5% on April 18. Only after the 1987 stock crash has such a low level been recorded. The Bundesbank took the low inflation rate (Q1 1996: 1.4%) into account as it did the moderate collective pay agreements. Although monetary growth overshot the 4% to 7% target corridor (M3 annual rate was 12.2% in March 1996) the interest rate cut was in step with the monetary scenario. Through its interest rate reductions and continued ‘verbal interventions’, the Bundesbank clearly signalled that it was interested in a weakening of the Deutschmark. In a situation in which the inflation potential has been curbed and the federal government is obliged to steer an austerity course both to improve conditions in Germany as an industrial location and because of the Emu criteria, monetary stimuli are the right political option for a sound policy mix. 4. Dollar-positive interest rate spread expectations Market participants consider the US economy a good deal more robust. Whereas the US, with unemployment at 5.6%, virtually boasts full employment, Germany is wrestling with mass unemployment. No further interest rate cuts are therefore expected of the Fed; indeed, some voices are even recommending interest rate hikes while Germany sees the repo as offering further scope for lowering interest rates. The interest rate differential at the long end also did an about turn in the first half-year, so that US rates are again above those in Germany. The interest rate spread expectations both at the short end and at the long end of the market strengthen the US dollar and weaken the Deutschmark . 5. European high-yielder bond markets on the up The interest rate cuts made by the German Bundesbank and the progress made in combating inflation have allowed the central banks of our European neighbours to lower their key interest rates substantially. The bond markets of these high-yielders have derived a lasting benefit from this, and now leave the German bond market trailing in their wake. Another contributory factor here was the historically low yields in the core bond markets like the German Bunds. The ‘high-yielder story’ played a considerable part in the marked weakening of the Deutschmark against the European crosses. 6. Problems as an industrial centre First and foremost, however, the ‘Germany bonus’ has played out. Standort Deutschland and the German economic situation have not faced such fierce criticism at the hands of the international press for a long time. The federal government’s austerity package is the logical conclusion, demonstrating as it does the need to reduce structural disadvantages of Standort Deutschland with regard to the social security and tax system and the labour market. The government’s panel of economic advisors (the so-called ‘Five Wise Men’) and the country’s leading economic research institutes call for additional concepts to restructure the social security system, and have revised downwards their growth forecasts for 1996 to between 0.5% and 0.75%. We expect the weakening of the Deutschmark to persist at least until June of this year. Our upside target for June 1996 is Dm1.57/$. SECOND HALF 1996: A COMEBACK?In the second half-year we are looking for a firmer Deutschmark and for dollar rates to lose ground. The yen is likely, on balance, to firm up against both the dollar and the Deutschmark. The European currencies, too, will again trend downwards.We expect the German economy to pick up in the second half of the year; as a result, growth of 1.5% should be attained for 1996 as a whole. The economic recovery will be supported, among other things, by the trend in exports. Orders received from abroad have been on the rise since November 1995, and in the first quarter of 1996 should be almost 3% over the level for the previous quarter. The growing impetus in world trade and the Deutschmark’s significantly lower external value will continue to boost this development. With an economic revival on the cards in Germany, things will change. Expectations of interest rate cuts in Germany are likely to be dispelled. The scope left to the Bundesbank for cutting interest rates is limited in any case with the key rates at an all-time low. Only the repo, currently at 3.30%, might still be reduced slightly. Whereas the markets are already predicting US interest rates to rise by the end of 1996, we consider an increase in interest rates improbable in the near future on account of the growth and inflation scenario. This is to say that the much-heeded interest rate spread expectations will turn again for the Deutschmark and against the dollar. At the current level, the US stock markets do not seem particularly attractive to foreign investors. We anticipate relative strength against US Treasuries in the German bond markets, and even more so in the high-yield bond markets. Dollar-negative interest rate expectations could encourage the movement of capital out of the US, which, in turn, would weaken the dollar. In these circumstances the US current account deficit (we expect $140 billion in 1996) will again put pressure on the US dollar. The current account deficit in the US is a structural problem, reflecting the domestic savings/investment behaviour. The fourth quarter of 1995 saw a narrowing of the current account deficit for purely cyclical reasons, as demand weakened and companies sought to run down inventory. These depressant influences will not last. Even if export growth revives later this year, import growth will be sufficiently robust to produce a renewed deterioration of the trade balance. And this, combined with a continued deterioration in the US net investment position, will generate a renewed widening of the US current account. While the budget for the fiscal year 1996 is now agreed and there have been lower public deficits due to cuts in public spending, the outcome of the November election in the US will have a pivotal bearing upon subsequent fiscal policy. Even if there is a genuine move towards a balanced budget, however, this is by no means unequivocally good news for a currency. While a lower deficit would make bonds more attractive, a tighter fiscal policy might produce an easier-than-otherwise monetary policy. Opinion is greatly divided on the issue on whether the dollar would benefit from a move towards fiscal rigour. Possibly the US currency might suffer in line with lower interest rates. Foreign observers are probably overdoing the doom-laden scenario in Germany at the moment. The monetary impellents (expansive monetary policy, low interest rates and a drop in the Deutschmark’s external value) should bump-start economic activity in the second half of the year. The competitiveness of Standort Deutschland will improve again in the long term thanks to the adjustments to social benefits and the labour market structures. Towards the end of 1996 we will be looking for the dollar rate to fall to Dm1.45/$. The Bank of Japan has unequivocally signalled that it will combat any renewed emergence of a bubble economy. With 0.9% growth in the final quarter of 1995 over the previous quarter, the Japanese economy showed clearly that it is on the road to recovery. Expectations of an early change of course by the Japanese central bank in the form of an increase of key interest rates will strengthen the yen, as yen credits raised for investments in higher-yielding currencies will probably then be repaid. We expect yen/dollar to fall to ¥100/$ and yen/Deutschmark to quote clearly below ¥70 /Dm towards the end of this year. The European currencies are also likely to slip against the Deutschmark in the second half of this year. First, the seasonal supports in the form of demand for Spanish and Italian currency from the tourist industry will cease. Second, the outperformance by the high-yielder bond markets is likely to come to an end. What is more, the markets seem at present to be ‘pretending’ that Emu will be launched on schedule in 1999. In view of the moderate economic trends in Europe at present, potential participant countries are likely to find it hard to meet the criterion governing public debt. If the market were to consider a postponement of Emu a probable scenario, a reflux into Deutschmarks could be expected which would add strength to the German currency. EMU FOREX IMPLICATIONSThe Maastricht Treaty presents a timetable for Emu in three stages. We are currently in stage two, which began in January 1994 and will last until stage three, which will see the irrevocable locking of exchange rates. The treaty states that by the end of 1996 the EU Council (a meeting of the heads of government) will have to decide on the basis of the convergence criteria, whether it is appropriate for the EU to enter stage three, and if so to decide when it starts. The treaty goes on to say that the EU Council must decide whether Emu starts by the end of 1997, otherwise it will begin on January 1 1999.The convergence criteria of the Maastricht Treaty 1. Budget balance: The deficit is not to exceed 3% of GDP, except if the ratio falls significantly and is around 3%, or is for once slightly above. 2. Debt: The gross national debt is not to exceed 60% of GDP, except if the ratio is on the decline and approaching the debt limit. 3. Inflation: CPI is to be no more than 1.5 percentage points higher than in the “most stable” EU countries (maximum of three). 4. Currency: A country’s currency has to stay within its ERM band for at least for two years without fluctuating sharply and without the central rate being devalued. 5. Interest rates: Long-term interest rates are to be no more than two percentage points higher than in the EU countries (maximum of three) with the highest price stability for at least a year. Looking at a weakening Deutschmark, and stronger Swiss and French francs, the foreign exchange markets seem to be anticipating that Emu will begin in 1999 or only one or two years later than scheduled. A lot of Emu speculation should be already discounted in current prices. If Emu started in 1999, a further slight weakening of the Deutschmark could not be ruled out. If, however, the market were to consider a postponement of Emu a more probable scenario, the Deutschmark is likely to strengthen again, especially against Swiss and French francs. Our sceptical long-term US dollar scenario would even be reinforced by a postponement of Emu. Chart 1: Deutschmark/Ecu exchange rate over three years Chart 2: the Bank of England’s trade-weighted Deutschmark index over five years Chart 3: Deutschmark/dollar exchange rate over five years Chart 4: Yen/Deutschmark exchange rate over five years Jürgen-Ponto-Platz 1 60301 Frankfurt am Main Germany For more information please contact: Global head of foreign exchange and precious metals Tel: +49 69 263 5786 Fax: +49 69 263 17473 Spot Tel: +49 69 234751 Fax: +49 69 263 17473 Forwards Tel: +49 69 234751 Fax: +49 69 263 17473 Options Tel: +49 69 263 2616 Fax: +49 69 263 11464 |
