Sterling’s March: In like a Lion out Like a Lamb

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Highlights

The US dollar remains largely on the defensive despite the recovery in North America yesterday.  The euro slipped to almost $1.3380 in Asia, but has recovered smartly in Europe, but It is sterling that is the stand out today.  While the euro has made a lower low each day this week, sterling by contrast has made a higher low and a higher high each day.    Often it appears sterling is in demand ahead of quarter-end frequently amid talk of official interest.  While the dollar is heavy against the European currencies, its gains have been extended against the yen.  The greenback reached JPY93.60, just shy of the year’s highs set in early April near JPY93.77.   The dollar has also firmer against the Australian dollar, where an unexpected decline in retail sales and weak building approvals gave the market second thoughts about an RBA rate hike next week, despite the recent hawkish comments by RBA Governor Stevens.    The short-term technical indicators warn that it may be difficult for the market to sustain the momentum.  North American participants appear to be somewhat less dollar negative.  The risk is for the dollar to recover against the European currencies, while seeing its gains against the yen pared back. 

Asian equities were mostly lower, while European bourses are holding on to minor gains.  The MSCI Asia-Pacific Index is off a little more than 0.5% as most markets saw month-end profit-taking.  The 5.4% gain this month is the best performance since last July.  Raw materials and the financial sector in particular were soft.  European bourses are up about 0.2%-0.5%, led by technology and basic materials.  Of note the Irish banks that had been hit hard earlier this week have rallied back.  The Dow Jones Stoxx 600 is up almost 7.7%.  The S&P 500 looks a tad softer, but with two sessions left in the month, it is up about 6.25%. 

Global bond markets are generally quiet, but with two notable exceptions.  First, UK gilts are outperforming today with a 5 bp decline in the 10-year yield and is now off 10 bp since last Friday.  Initially it looked like the gilts were going to wilt after the DMO announced yesterday that it would issue GBP4.5 5-year gilts next week, but recovered fully today.  The other main exception is Greek debt.  The 10-year yield is 8 bp and the 2-year is up 15 bp.  The 7-year bond that was sold on Monday with a 6% yield rose to 6.27% yesterday and 6.44% today.  Elsewhere as expected, Poland left rates steady at 3.5%.  Lastly in the emerging market space, note that the stronger than expected Q4 09 Turkey GDP (6% year-over-year vs consensus of about 4.5%) has weighed on Turkish debt prices.  The 2-year yield is up about 10 bp (bringing the rise on the month to 40 bp). 

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Officials had hoped that last week’s EU/IMF deal on Greece would have put the issue to rest for a little bit, but it hasn’t.  Month-end considerations appear to be offsetting the impact on the euro.  Mediocre to weak demand for Greek bonds this week has resulted in  widening premium Greece is being forced to pay.  While the Greek government indicates that next month’s funding needs have been taken care of, it still needs to raise another roughly 11.6 bln euros by then end of May and another roughly 21 bln euros by the end of the year.   In the first three months of the year it has raised about 18 bln euros.  Greece budget appears to assume about a 5% interest rate and it is not seeing that.  In order to bring down its borrowing costs, Greece appears to be looking at shortening maturities and is devising a regular bill issuance schedule.  This poses its own roll-over risks.  In addition, Greece is considering a dollar-issue in the next couple of months.  Meanwhile, Moody’s warned that Italy, will have to generate a large primary budget surplus (budget balance excluding debt servicing), but Italian bonds appeared to shrug it off.    In this vein, we note that Portugal, which was downgraded last week, has seen its spread (over Germany) narrow by about 11 bp over the past week.

In Japan, improved exports and corporate profitability has not translated into higher wages.  Wages (including overtime and bonus pay) fell 0.6% year-over-year in Feb, the 21st consecutive negative monthly reading.  In Jan, wages were 0.2% below year ago levels.  Even a ten-month low in the unemployment rate has failed to push wages up.  However, the bigger economic story is the Tankan survey due out in early Tokyo on Thursday.  The market expects improvement, but with the diffusion index for both large manufacturers and large non-manufacturers to remain in negative territory.   Given the importance of capex for the Japanese economy, the market will be very interested its reading.  Recall that in the Dec survey, capex was expected to contract nearly 14%.  Another decline is expected, but much smaller—less than 1%.  Lastly, we note that the calculation of TIBOR (Tokyo Interbank Offered Rate) will include two more foreign banks starting tomorrow.  This is potentially important because foreign banks typically have lower rates than Japanese banks.  TIBOR rates are at a premium to LIBOR.  For the benchmark 3-month tenor, TIBOR is about 18 bp above the 24 bp LIBOR fix.

The euro zone did report Feb unemployment at 10% (from 9.9), the highest since Q3 08.  Germany reported its March figures.  Unemployment fell 31k, contrary to expectations that called for a small rise.  On top of that, the 7k rise in Feb was revised to -1k.  The market did not respond much.  Nor did it respond to the sharper than expected rise in the euro zone CPI.  The market had expected a small increase from the 0.9% pace seen in Feb, but the 1.5% year-over-year rise was well above expectations. The euro zone employment report may offer a stark contrast with the US jobs report released on Friday.  One of the reasons we suspect that European unemployment may be more intractable than in the US is that the real challenge in Europe is with integrated young people into the labor market.  Fro person under the age of 25, Ireland has an unemployment rate of nearly 29%, Italy is near 26%, France is a little above 22% and Portugal is close 21%.  Spain has the dubious honor of first place with an unemployment rate among young people of a little more than 40%. 

Upcoming Economic Releases       
The US reports ADP jobs report.  The consensus looks for its first positive reading since Jan 2008.  The Chicago PMI will be released as well.  A still healthy 61 reading is expected after 62.6 in Feb and factory orders will be released shortly thereafter and a small rise (0.5%) is expected.  Also on tap Canada reports Jan GDP figures and an expansion in line with the 0.6% rise seen in Dec is expected.  Lastly, we note that Brazil’s central bank governor, Henrique Meirelles is expected to announce later today his intentions about running for office.  There has been talk of either a run for governor of his home state or possibly as the vice president to Lula’s handpicked successor Dilma Rouseeff.   In any event, Brazil is expected to hike rates 50 bp next month.

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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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