Long Dollar Liquidation Featured

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Highlights

The US dollar is beginning the new week as it finished last week, with a heavy tone.  Position adjusting in the wake of the European/IMF deal and ahead of month end is the main driver.   Also prompting some profit-taking on long dollar positions may be concern about the market’s appetite for US debt in the wake of last week’s tepid auction reception and news from the Congressional Budget Office that Social Security will likely pay out more than it takes in this year, 5-6 years earlier than had been projected. 

The global equity rally remains intact.  The MSCI Asia-Pacific Index rose 0.4%, led by metals and commodities.  Much stronger than expected Japanese retail sales (Feb +0.9% vs -1.2% expected) failed to support Japanese shares, with some 2500 companies going ex-dividend today.   The Shanghai Composite was the region’s best performer, up 2.1%.  Heightened tensions in Korean peninsula following the sinking of a South Korean ship saw the Kospi buck the regional trend.   European bourses are also mostly higher—0.33%-0.75%–with basic materials and telecoms the stronger sectors.  Oil & gas and health care are the laggards.  Of note, Ireland’s bourse is not participating in today’s advance; losing 1.7% following indications that the government may have to increase its stake in some of the country’s largest banks.    US S&P 500 is expected to open around 0.5% better.  Last week, this index eked out a 0.6% rise.  In the second half of the week, strong intra-day gains were pared back late turnover and the market will be watching to see if this pattern continues. 

Sovereign bond markets are mostly lower.  Strong retail sales and anticipation of a strong Tankan Report on Thursday weighed on the Japanese government bonds.  A strong signal by RBA Governor Stevens suggesting a rate hike as early as next week, coupled with the US Treasury decline before the weekend took a toll on Australian bonds.   Weak mortgage approvals and soft M4 helped underpin gilts, where the 10-year yield slipped 3 bp.  Greek bonds began firm but the gains have been reversed on news that Greece will seek to place 7-year bonds this week.  US bonds remain under pressure amid renewed steepening.  Israel hiked rates over the weekend.  The 25 bp hike to 1.5% is the fourth hike since August.  Robust growth coupled with rising inflation expectations was the main consideration.   Lastly, we note that Romania delivered its third rate cut this year.  The 50 bp cut brings the key rate to 6.5%.

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The foreign exchange market has responded to the EU/IMF deal by reducing short euro positions.  The latest IMM data showed that as of as of last Tuesday, March 23rd, the next speculative position was record short euros.  The short-covering rally began before the weekend, with the euro recording a fresh low for the move just below $1.3270.  The rally to $1.3425 on Friday has been surpassed by a full cent today.   Additional position squaring seems likely over the next couple of days.  The next target is near $1.3550-70.  Dips to $1.3400-20 will likely be bought.  Despite polls still showing the likelihood of a hung parliament, sterling is also benefiting from the unwinding of long dollar positions.  Sterling briefly poked through the $1.50 level where it hit a wall of sellers.  Provided initial support in the $1.4950 area holds, sterling can make another run toward $1.5025 and maybe even $1.51 over the next day or two.    Meanwhile cross rate pressures and ideas that Japanese repatriation ahead of the fiscal year end is complete may have emboldened some yen sales.  Japanese retail sales rose 0.9% in Feb for a 4.2% year-over-year pace.  This is the fastest since 1997, but failed to trigger yen buying.  Dollar support is seen in the JPY92.20-40 area and resistance seen last week in front of JPY93.00 may be vulnerable in the next couple of days. 

The fact that the EU/IMF came up with a backstop for Greece has some other implications.  For one, it showed a victory for the politicians over the central banks.  Both the ECB and BBK seemed to back down from their opposition to a more substantive role for the IMF.  Trichet’s opposition and climb down is well documented.  Less appreciated is the BBK’s stance.  In its monthly report released on March 22, the BBK noted: “The IMF’s mandate stipulates that it may only use its foreign currency reserves to bridge short-term balances of payments deficit.”  Solving structural problems doesn’t have a foreign exchange component.  Second, what began as a Greek debt issue, morphed into a more serious institutional threat to EMU, which very well may require treaty modifications and greater institutional capacity.  Third, some fissures have appeared in the German government, not just between the CDU and its smaller coalition partner the FDP, but also within the CDU.  The schism between Merkel and Schaeuble may reflect a deeper debate about Germany’s future role in Europe.  Fourth, Fitch’s downgrade of Portugal last week and today S&P reaffirmation its negative outlook for the UK (thought maintained the AAA rating) suggests that Europe’s debt problems will likely continue to hang over the market. 

US debt concerns have also risen in recent sessions.  While it is tempting to dismiss last week’s soft auction results as a one-off related to the proximity of the end of the quarter and fiscal year end, but there are a number of worrying signs that also may be encouraging the profit-taking on long dollar positions.  Due to falling payroll taxes due to high unemployment means that Social Security will likely have to pay out more in benefits than it receives to the tune of almost $30 bln.  A deficit was not expected until 2016.  The other big issue in the US debt market is fact that the 10-year swap rate fell below the 10-year Treasury yield.  This is seen as an unintended consequence of the huge supply of US Treasuries.  The key economic report this week is the March jobs data.   The consensus is near 200k.  On top of that auto sales figures are expected to be strong as well (12 mln unit pace from 10.36 mln in Feb).  The combination of a stronger jobs market and healthy consumption figures may make for a difficult environment for US bonds, but could give the dollar better support in the second half of the week.  Separately, note that the swap rates in the UK have been below gilt rates since January.  It is near -20 bp from around -10 bp prior to last week’s budget. 

Upcoming Economic Releases       
The US reports personal income and consumption data for Feb.  While personal income remains subdued, consumption is expected to have advanced around 0.3%.  This would leave Q1 PCE tracking a slightly slower rate in Q4.  Meanwhile, the core PCE deflator is expected to slip to 1.3% year-over-year from 1.4%.

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Marc Chandler is the global head of Brown Brother Harriman’s Currency Strategy Team. For more of BBH’s currency views, visit the BBH FX website here.

This material has been prepared by Brown Brothers Harriman & Co. (“BBH”) and is intended for information purposes only.  This communication should not be relied upon as financial, investment, tax or legal advice.  This communication should not be construed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency.  This information may not be suitable for all investors depending on their financial sophistication and investment objectives.  The services of an appropriate professional should be sought in connection with such matters.  The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed. Sources used are available upon request. Any opinions expressed are subject to change without notice. Please contact your BBH representative for additional information. BBH’s partners and employees may own currencies in the subject of this communication and/or may make purchases or sales while this communication is in circulation.

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