Possible Shift in Germany’s Position on Greece Supports Dollar

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Highlights

The US dollar is firmer against most major currencies. The euro, together with the Swiss franc and Swedish krona are the worst performers.  The euro failed to make a clear break above $1.38 yesterday and news reports suggesting Germany may have shifted its stance on Greece seeking IMF aid saw the euro slip back to around $1.3650 support.  Greek PM Papandreou has subsequently indicated he is seeking EU political support, not aid from the EU or IMF but the euro remains below the $1.3700 area. Sterling is slightly softer after a brief spike above $1.53 on a smaller than expected Feb budget deficit (GBP12.4 bln vs. GBP14 bln exp) as tax revenue rose at the fastest pace in two years.  Still, business lending fell at the fastest pace on record in Jan (down GBP6.5 bln) while mortgage approvals fell for the third consecutive month in Feb (to 48K) damping the rally.

Global equity markets are mostly lower in Asia and Europe.  The MSCI Asia Pacific index closed down -0.3% after reaching a two-month high yesterday as concerns about FOMC tightening and the Greek crisis abated.  The renewed concerns about Greece may have encouraged some profit taking.  In Japan, the Nikkei gave up most of yesterday’s 1.2% gains, slipping -0.9% today led by financials.  The leading European bourses are flat to down -0.5% while the Greek Athex is down -2.6%.

Global sovereign bonds are mixed particularly in Europe.  Greek bonds are lower after the CDU spokesperson called for Greece to seek IMF aid.  The Greek/German 2- and 10-year spreads have widened 31 bp and 12 bp respectively.  The 10-year Italian spread has also widened 4 bp after the EC warned its fiscal position could be worse than expected.  The heavy supply of bonds (15 bln euros or $21 bln) from Spain and France are also in focus with Spanish 10-year yields up 3 bp but comparable French yields flat.  UK 10-year gilt yields are down 4 bp after the better than expected public sector borrowing report.

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The German position vis a vis Greece and the IMF may have shifted according to news reports.  Until now, Germany had seemed to agree with other European officials– including ECB’s Trichet, Eurogroup’s Juncker, France’s Sarkozy–that the IMF can provide technical advice, but this is a problem for the euro zone to resolve.  A financial spokesperson for the ruling CDU party, Michael Meister, is quoted on the news wires suggesting that only the IMF has the credibility and what he calls "instruments" to help Greece get access to the capital markets if it was ultimately needed.  We have long argued that the main obstacle to the IMF’s material involvement was the fear of loss of political face.  And the realist says that in the face of economic necessity, pride is among the first sacrifices. Having Greece go to the IMF, if (when?) needed, would avoid the issue of European treaties and the political backlash that one can only imagine, for example, of the proverbial German worker postponing retirement to finance the earlier retirement of her Greek colleague.  On the other hand, it is not clear yet that this is the new German strategy.  It seems clear the political opposition to material assistance is great.  Yet German Finance Minister Schaeuble was quoted yesterday along the conventional line that IMF involvement would signal the inability of the euro zone to address its own problems.  Bottom line—this could potentially be an important story, though it is difficult to know at this juncture whether it is a trial balloon or something more serious.  As distasteful as a euro zone member going to the IMF may be, it may be the least costly political decision for the euro zone.  Greece is a member of the IMF–(in a way that incidentally, California by contrast can never be).  Until material aid is needed, this is just a theoretical discussion.  The negative implications for the euro stem from the potential disagreement in Europe, the weakening of the Franco-German pillar, and the institutional vacuum.  This is the not stuff that a reserve asset is made.

The Turkish central bank meets today and despite a surprise jump in Feb inflation, we expect rates to be left unchanged at 6.5%. The central bank is aiming to lower inflation to 6.5% y/y by year-end, so the recent spike in inflation would not have gone unnoticed. Expecting an immediate monetary policy response may be premature though. Recent economic indicators have shown some improvement but from a real economy perspective, the case for a rate hike is not compelling at this stage. We expect Turkey to start its tightening cycle by mid-year. The Turkish lira has struggled over the past few weeks and political uncertainty will keep the lira volatile going forward. However, even the end of talks for a new IMF program does not dent our enthusiasm for the lira as underlying economic fundamentals remain solid and higher yields will increasingly play at the lira’s advantage.  In the EM cross play, we still like TRY/HUF, with the recent pull back a good buying opportunity – last year’s high (at 145.497) is a reasonable target

In what we thought was a close call, the central bank of Brazil left its overnight rate steady at 8.75%, a record low.  The decision was made by a 5-3 majority.  The dissenters wanted a 50 bp rate hike.  The closeness of the vote is a strong signal that Brazil’s central bank will hike rates and could very well be the first BRIC country to formally hike rates.  Both China and India have raised reserve requirements, but neither has hiked benchmark rates.  The political future of current central bank governor Meirelles may have been the wild card.  However, if he does resign to enter electoral politics, his successor will have the opportunity to brandish anti-inflation credentials at the very first meeting and deliver a 50 bp rate hike.  Until the next COPOM meeting in late April, key things to monitor would be of course Meirelles’ decision which has to be made by very early April.  In terms of economic data, there may be some seasonal distortion to Brazil’s price pressures.  Watch the inflation reports and the central bank’s survey of expectations.  The relative strength of the currency against the dollar does not appear to be a very salient issue, but if in six week’s time the dollar is testing support in the lower part of the BRL1.60 and volatility has increased, the real could become more important.  That said, currency strength is consistent with monetary tightening in a way it wasn’t when Brazilian officials were trying to fuel a recovery.  A stronger BRL could help dampened imported price pressures.  

Upcoming Economic Releases
US CPI, weekly jobless claims and the Q4 current account are due at 8:30 AM EDT/12:30 GMT.  The consensus is for headline CPI to accelerate 0.1% m/m in Feb after rising 0.2% in Jan and putting the annual pace at 2.3%.  Ex food and energy, CPI is exp up 0.1% m/m (vs. -0.1% in Jan) and 1.4% y/y, vs. 1.6% in Jan.  Weekly claims are exp at 455K.  The current account deficit is expected to widen to -$119.0 bln (from -$108.0 bln.)  At the same time, Canada releases international securities transactions for Jan (exp at C$8 bln in Jan vs $11.2 bln in Dec.  At 10AM/14:00 the Mar Philly Fed index is exp at 18.0, up from 17.6 in Feb.  Leading indicators, due at the same time are exp at 0.1% in Feb vs. 0.3% in Jan.  Turkey is expected to leave rates unchanged at 6.5% (10AM/14:00.)  Speakers include the Fed’s Hoenig, Lacker and Pianalto (9AM/13:00) and the Fed’s Greenlee (10AM/14:00).

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Marc Chandler is the global head of Brown Brother Harriman’s top ranked Currency Strategy Team. For more of BBH’s currency views, please 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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