BBH CurrencyView: Dollar Bid on Poor European Sentiment, EM Lower Too

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Highlights

The US dollar remains firm against the euro as Greek woes continue to weigh on sentiment.  The euro has practically returned to levels seen prior to last weekend’s financial aid package details.  That area, $1.3480-$1.3500 remains key support.  The $1.3560 area offers the initial cap now.  The immediate reaction to the UK televised debates had the LibDem’s Clegg as the winner and this reinforced fears of a hung parliament and appears to have pressured sterling, but it bounced back smartly in the European morning.  Offers in the $1.55480-$1.5500 area may provide the ceiling.   Heightened perceptions of risk may underpinning the yen.  Cross rate demand is also noted.  The dollar has recorded new lows for the week against the yen today, but support near JPY92.50 remains intact.  Emerging market currencies are mostly lower. 

Disappointment with Google earnings in the US late yesterday, coupled with a pullback in commodity prices encouraged profit-taking in Asian equity markets.  The MSCI Asia-Pacific Index fell 0.8%, with the Nikkei sliding 1.5% as exporter shares were sold-off.  Hong Kong and China’s indices were over 1.0% lower amid fears of more tightening in China’s property market.  We note that futures trading began today on China’s CSI 300.  Over time this may become an important benchmark.  Political pressures continue to undermine Thai stocks.  The SETI fell 3.1% to bring the week’s decline to 8.8%.   European bourses have recouped most of the initial declines and most are turning up by midday in Europe.  Strength is being seen in the industrials and this is largely offsetting the weakness in technology, leaving most of the major bourses marginally changed. 

The performance of peripheral euro zone bond markets is still the main focus.  Greek bonds remain under pressure.  The 10-year yield is up 12 bp today.  It had been essentially unchanged on the week until today as the rally early in the week was reversed.  The 2-year yield is up 19 bp and is still about 35 bp on the week.  Although other peripheral spreads to Germany have widened this week, it is Portugal that has been the most susceptible to the contagion.    Two-year Portuguese yields are up 8 bp today and 16 bp for the week.  The 10-year yield is up 5 bp today and 8 bp for the week.  US, German and Japanese 10-year yields are off 2 bp, while UK gilts are out-performing.  The 10-year gilt yield is off 4 bp and back below the 4% threshold.

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The key talking point today is whether the EU/IMF backstop for Greece will be formally tapped this weekend.  The summit in Madrid appears to be underway and the general news environment is poor.  The Greek Prime Minister still is denying that funds are needed, claiming the facility is a safety net and incredulously suggests that the IMF involvement was not his idea.  Recall that Papandreou previously suggested that if the Europe did not pony up, Greece could go to the IMF.  Germany, in effect, for its own reasons, called Papandreou’s bluff.  It will be used to demand more concessions from Greece.  But many European officials still seem to be in denial.  Rather than prepare the public for an eventual use of those funds, Germany’s Finance Minister, for example, is saying that Greece is on the right path and there is no need for emergency funds.  The ECB’s Notwotny is saying that backstop can only be activated if Greece losses market access.  Does not the cost of market access matter?   Simply put, investors are unlikely to get closure any time soon on this issue.  Europe’s facility, even if implemented, is short-sighted in two important ways.  First, the sums discussed a little more coverage for one year for Greece.  Then what?  Second, what is Europe doing to pre-empt the contagion risk?  European officials could have helped stabilize investor sentiment if they would have used the Greek crisis to recognize the sovereign risk and come up with a scalable blueprint and facility.   Meanwhile interest in a Greek dollar-denominated issue is reportedly poor and the anticipated size has been cut dramatically and the whole issue might be pulled.

Meanwhile the broader news environment surrounding Greece remains a weight on the euro.  Comments by ECB’s Trichet about the difficulties Greek banks are facing in terms of liquidity undermined whatever upticks the euro had enjoyed in the European morning.  A Wall Street Journal article, citing a Brookings Institute report, highlights the bribery, patronage and corruption behind Greece’s debt.  The study estimates that there nefarious activities cost Greece 8% of GDP or around 20 bln euros.  While no doubt these types of activities are not helpful, the real underlying problem is the lack of competitiveness.  This means that a stronger anti-corruption regime would be beneficial; it is not a sufficient solution.  Meanwhile, a large US investment is warning that the euro zone may degenerate into fiscal profligacy and it could lead to an eventual withdrawal by Germany.  This strikes one as a bit of hyperbole and too economic determinist.  Monetary union was first proposed not by economists, many who argue it is not a optimal currency zone, but by politicians.  It was an economic solution to a political problem.  The political problem in bald terms was under what conditions could Germany be reunified.  There were two conditions.  Share the uber-mark with Europe.  Share the Bundesbank’s anti-inflation credibility (and low rates) with Europe.   This would tie the united Germany, who had flirted with its own Ostpolitik, into Europe.  Germany is the first among equals in the monetary union.  While painting scenarios of a German exit may be colorful, it seems far-fetched and politically unrealistic.

There are several other developments to note.  First, the Japanese government appears to be increasing pressure on the BOJ to take more steps to counter deflation.  Yesterday a panel called for yen at 120.  The BOJ recently upgraded its assessment of the economy.  The government did not follow suit today.  Today a Japanese government spokesperson raised the prospect of intervention to weaken the yen (we think unlikely) and for the BOJ to buy more government bonds.  The dollar bounced to around JPY93, but quickly lost the upside momentum.  Second, South Africa adopted measures that will make it easier for South African companies to hedge their currency risk and adjust hedges, something that was previously discouraged.  This may help provide more liquidity to the rand market and is less about the underlying direction.  Today, like other emerging market currencies, the rand is under pressure.  Third, we note that Brazil’s central bank intervened twice yesterday in the foreign exchange market.  Usually it does so once a day.  This is the first time, it looks like, in almost three years that it intervened twice.  This may put a floor under the dollar near BRL1.7350-BRL1.7400, but with a 75 bp rate hike increasingly expected by the end of the month, the dollar’s upside looks capped too.

Upcoming Economic Releases
At 8:30 EST/12:30 GMT, the US reports March housing starts and permits.  Starts are expected to bounce back from the 5.9% decline in Feb, but the continued weakness in permits will likely limit the market reaction.  Preliminary Univ of Michigan consumer confidence report near 10:00 EST may be lifted by the slightly better employment picture, rising stocks, and warmer weather. 

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Marc Chandler is the Global Head of Currency Strategy at Brown Brother Harriman. For more of BBH’s currency views, visit the BBH FX website here.

The opinions expressed in this message are those of the author and not necessarily those of Brown Brothers Harriman & Co., its subsidiaries and affiliates (BBH). This information is not intended as financial advice or an offer or recommendation of any financial products and is subject to change without notice. Recipient agrees that it is solely responsible for any trading or investment decisions that it makes after reviewing this information and that BBH bears no responsibility or liability for such decisions or use of this information.

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