Sterling, Antipodeans Lead Foreign Currencies Higher vs. US Dollar

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Highlights

The US dollar is softer against most major currencies.  The still expansionary FOMC statement, the BoJ’s extension of Q/E overnight and the conclusion of the EU finance ministers’ meeting yesterday may have helped ease tensions.  However, the dollar was already beginning to soften ahead of these events after failing to extend gains in early March.  That may have disappointed momentum traders who, based on IMM data, hold near record short sterling positions and record short euro positions.  Some speculators may have begun scaling back these short positions as the currencies lost downward momentum.  Sterling, which is the worst performing of the major currencies this year, is helping to lead today’s move higher getting an extra boost from firm UK jobs data and less dovish than expected MPC minutes.  While some pullback is likely given the pound is overextended, momentum traders are likely to re-emerge to buy pounds around $1.5260.  The euro is comparatively stable, briefly extending gains to the highest level since Mar 9th.  However, the single currency has made a clear break above the downtrend line drawn off the late 2009 highs (comes in today around $1.3700) and is likely to see renewed momentum trader buying above the $1.37 area.  The antipodean currencies are amongst the strongest gainers today, helped by firm commodities. 

Global equity markets are higher in Asia and Europe and commodities firmer after the Fed signaled rates would be left on hold for an extended period and the BoJ extended quantitative easing.  The MSCI Asia Pacific index gained ground for the fourth consecutive session, climbing to a two-month high (up 1.5% on the session) while Japan’s Nikkei rose 1.2% on the session led by oil and gas and basic materials.  S. Korea’s Kospi posted one of the largest gains, rising 2.1% bolstered by export related technology shares.  China’s Shanghai Composite gained 1.9%.  The leading European bourses are up 0.5% to 1.0% while S&P futures are firmer suggesting US markets will open on a firm footing.

Global sovereign bonds are mixed.  US Treasuries are lower, giving up some of yesterday’s post-FOMC gains, with the 10-year yield up 2 bp. In Europe, bonds are flat to slightly firmer.  The Greek/German 10-year spread has narrowed 4 bp to 295 bp after the conclusion of yesterday’s EU finance minister’s meeting and S&P’s removal of Greece from its credit watch list (though the rating was left at negative).  The spread compares with 309 bp a week ago but vs. 252 bp three months ago.  Japanese 10-year JGB yields are up 1 bp while the 2-year is flat after today’s BoJ meeting.  Iceland cut rates 50 bp to 9.0%.

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The Bank of Japan left the key target rate unchanged at 10 bp, but appeared to bow to government pressure and increased the size of the three-month loan facility arranged last December to JPY20 trillion from JPY10 trillion.  Tweaking this facility was widely tipped as a likely compromise formation between the BOJ who has argued that monetary policy was already extraordinarily easy and interest rates were extremely low, while the government wants more efforts to combat deflation.  Nevertheless, the compromise was not satisfactory and two BOJ members (Noda and Suda) dissented.  Japan’s CPI fell for the 11th consecutive month in January and the Q4 GDP deflator was a record -2.8%.   We agree with the BOJ that today’s move will not have much impact, yet the reason we suspect that the BOJ went along was that the JPY10 trillion facility had nearly been exhausted and the banking system faced the imminent withdrawal of liquidity at the end of the month as a separate credit facility (unlimited loans for collateral) was set to expire.  However, it also means that additional measures may require some marked deterioration in conditions.  It suggests that the BOJ is reluctant to extend its rinban operations–under which it buys government bonds–from the current JPY1.8 trillion.  Meanwhile the economic data suggests that the capex–export recovery is having a knock-on effect on other sectors.  The Japanese government appeared to have recognized this early this week, and today it released the Jan tertiary activity report.  The 2.9% increase was more than twice the consensus and follows a 0.9% contraction in December 09.  The dollar remains largely confined to a JPY90-JPY91 trading range.  Contrary to other analysis, we continue to suspect the risk of intervention remains low, as is normally the case.  We note that dollar-yen volatility has fallen to a new multi-year low today below 11.2% and the premium for yen calls over yen puts remains historically speaking (last few years) quite small.  Nor do we place much emphasis on the fact that 3-month yen LIBOR has been fixed in recent sessions below 3-month dollar LIBOR.  The difference is about 1.5 bp annualized and is simply insignificant to change investment strategies.  The Nikkei’s 1.2% advance, led by oil/gas, basic materials and consumer services, brings the month-to-date advance to nearly 7.5%.  Foreign investors were increased their purchases of Japanese equities in January, but slowed considerably in February and appear to be stepping back up this month.

Sterling was already leading the foreign currencies higher against the US dollar in early European trading and the less dovish MPC minutes and firm employment figures have given the pound an extra boost.  The March 4th meeting minutes showed the MPC voted unanimously to keep policy unchanged. Importantly for those looking for bullish sterling news, the case for fresh QE was not really debated as the MPC thought that there was ‘little evidence to suggest’ a change in the UK economic outlook since the prior meeting. Policy makers confirmed they stand ready to expand purchases of gilts or tighten monetary policy if needed, with a ‘bumpy’ path ahead for the economy. On the inflation front, some members considered that the upside risks to inflation had increased slightly over the month, while others felt that the balance of risks had not changed materially (January inflation has reached a 14-month high of 3.5% y/y as the VAT effect fed through).  Meanwhile, UK unemployment fell by 32.3k in Feb (vs a 6k rise exp and vs a 5.3k Jan gain.) Jobless claims fell at their fastest pace since 1997, which is a very encouraging sign for growth prospects. Jan average earnings were up by just 0.9% y/y (from 0.7% and versus 1.7% expected) but the ex-bonus y/y rate firmed to 1.4% y/y from 1.2%. This remains a very soft labour market so wage inflation risk is contained.  Sterling has now gained four big figures from yesterday’s low around $1.4978 and is overextended on an hourly basis. Still, technicals are supportive of the pound with the 5- and 20-day moving averages about to cross to the upside and longer term momentum indicators pointing up suggesting short term traders may trim some of their short sterling positions on pullbacks toward $1.5260.  

Upcoming Economic Releases

US PPI is due at 8:30 AM EDT/12:30 GMT.  The consensus is for headline PPI to slip -0.2% m/m in Feb after rising 1.4% in Jan and putting the annual pace at 4.9%.  Ex food and energy, PPI is exp up 0.1% m/m (vs. 0.3% in Jan) and 1.0% y/y, unchanged from Jan.  Canadian wholesale sales (exp up 0.5% m/m in Jan) are due at the same time.  Fed Chairman Bernanke and ex-Fed Chairman Volcker testify at the House hearing on bank supervision (2PM/18:00) while the Fed’s Fisher speaks at 4:30PM/20:30.

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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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