US Dollar Tone Improves as Market Awaits Results from EU Fin Min, FOMC Tomorrow

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Highlights

The US dollar is firmer against most currencies. The euro failed to extend Friday’s break up out of the $1.3436-$1.3788 range in which it has been trading since Mar 17th while against the Swiss franc, the euro is trading at its lowest level in 17 months.  The single currency is consolidating above $1.3685 support area vs. the dollar ahead of the Greek progress report (due at the EU Finance Ministers meeting that began today) and tomorrow’s FOMC meeting.  Poor results from Sarkozy’s UMP at this weekend’s regional elections had little impact.  Cable is the worst performing currency amidst a slew of poor news –Moody’s warned that the UK and the US have moved substantially closer to losing their AAA credit ratings over the past few years as the cost of servicing debt continues to rise, a weekend YouGov poll highlighted the risk of a hung parliament with the Tories lead over Labour at just 4bp, the BoE’s Barker warned of another quarter of negative growth and there is talk of M&A related selling. The yen is relatively steady after the Japan upgraded its assessment of the economy was expected.  The focus is on the BoJ where there is speculation MoF pressure to address deflation could see an extension of Q/E at the Wed meeting. 

Global equity markets are generally softer in Asia and Europe with early indications suggesting US markets will open lower.  In Asia, concerns about Chinese tightening weighed on equities after China’s Premier Wen refuted claims that the yuan is undervalued.  The one-year yuan NDF had continued to rise in recent days as US and other officials put pressure on the country helping to boost speculation of a revalution.  Today’s comments saw NDFs come in with the market now pricing in a 2.65% revaluation in the next 12-months, down from 2.97% Friday.  While the PBOC Gov downplayed the risk of an imminent rate hike after last week’s stronger than expected Feb CPI, Wen’s comments boosted talk China could hike instead of allowing the currency to appreciate.  The MSCI Asia-Pacific index closed down -0.5% while China’s Shanghai Composite closed down -1.2%.  Japan’s Nikkei was flat on the day.  In Europe, bourses are down 0.2% to 0.8%. 

Global sovereign bonds are firmer.  In Europe German 10-year bonds are off three-week lows with the yield down 1 bp as the EU Finance Minister talks get underway with Greece expected to meet its initial targets.  Greek yields are lower with the 2- and 10-year down 12 bp and 3 bp respectively.  S&P warned the markets they had exaggerated the risk of a Greek default given the country’s fundamentals and noting the country is still rated investment grade. 

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The FOMC meets this week.  While slower perhaps than desirable, the Fed officials should be generally pleased with the trajectory of developments since they met last in late January.  On the real economy side, Q4 09 turned out to be quite strong at 5.9% and Q1 10 appears to be tracking something closer to 3%.  Of course, Q4 was flattered by a large shift in the inventory component which no one expects to be sustained.  Consumption and hourly earnings are rising.  The Fed has cited three metrics they are watching to help determine the appropriateness of current rates:  resource utilization, inflation expectations and inflation.  In terms of resource utilization, the unemployment rate appears to have steadied for the moment, but it will likely be too early for officials to have much confidence.   On the industrial side, plenty of capacity still exists and manufacturing employment rose in both Jan and Feb.  The poor weather may have seen the trend improvement in utilization rates stall (to be reported today March 15), but should be expected to resume as the winter thaws.  There are various measures of inflation expectations Fed policy makers will access, but for a general view we would note that the yield curve (2-10 yr) has flattened over the past month and the 5-yr/5-yr forward fell from 2.75% around the time of the last FOMC meeting to 2.36% before recovering to trade around 2.55%, the middle of the lower range seen since.  Inflation itself has been largely steady.  The core rate of CPI was negative in January for the first time in more than a quarter of a century.  The key drag here appears to be coming from the owner equivalent rents.  Rather than a reflection of the general price level, the pressure on the core rate is a function of the housing market.  Since the Fed met last, the data from the housing market appears weak, even if some allowance is made for the weather.  The Fed could mention this in its statement.  Also the last FOMC statement expressed concern about the decline in bank credit for the first time.  It appears that bank credit has continued to contract and the statement will likely reflect this.  While consumer credit did increase in January for the first time in a year, the increase was a reflection of the Federal government’s student loan program.  There is some speculation that Fed officials are looking for some way to change the language to help modify expectations about its extraordinary policy stance.  The key phrase that many are focusing on is "extended period".  Previously–Dec 08-Jan 09–the Fed used the phrase "for some time."   While it is possible, and we suspect it is coming, this week’s meeting may be too soon.  At this juncture, nothing is lost by waiting another month.  More Fed-speak–verbally preparing the market may be deemed necessary.  There are a number of Fed officials who are scheduled to speak in the second half of the week.  

In Greece this week as the government is due to present a progress report on the deficit -cutting plan at the EU finance ministers meeting, starting in Brussels today. There is fresh speculation that a Eur25bn package to help Greece may be introduced, but we remain of the view that as market jitters have eased (see narrowing in spreads) and as the Greek refinancing schedules have gone quite well so far, euro members may not need to go for the package solution. Germany comes across strongly against this idea, still.  In Japan, the government upgraded its assessment of the economy for the first time since last July, noting that ‘The economy has been picking up steadily’, but also acknowledging that the rebound has been weak. However, MoF officials have been stressing the importance of fighting deflationary forces over the past few weeks, raising speculation that the BoJ could decide to introduce fresh QE measures (via more JGBs purchases) at this week’s meeting.

Upcoming Economic Releases

The Fed’s March Empire survey is due at 8:30AM EDT/13:30 GMT.  The consensus expects 22.0, down slightly from Feb when the highest reading since Oct07 was recorded at 24.9.  At the same time, Canadian new vehicle sales are exp flat in Jan.  US Treasury International Capital (TIC) flow data for Jan are due at 9AM/14:00 and the consensus expects net long-term TIC inflows of $47.5 bln, down from $63.3 bln in Dec.  At 9:15AM/14:15 Feb industrial production is exp flat (vs. 0.9% in Jan) with vehicle production limiting gains.  Capacity utilization is exp at 72.5% vs. 72.6% in Jan.  There are no scheduled Fed speakers ahead of tomorrow’s FOMC decision.  Mexico is closed today.

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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.

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