BBH CurrencyView: US Dollar Softer, Market Takes a Pause
The US dollar is somewhat softer today as the market takes a pause to consider recent developments. News that Fitch reaffirmed its AAA rating for Spain, despite S&P’s move yesterday, and heightened speculation that European officials are working on a larger multi-year fund for Greece, and a relatively smooth Italian bond auction, are helping to calm the foreign exchange market for the moment. Sentiment towards the euro remains poor, but many seem increasingly reluctant to add to short positions, fearful of a short-term bounce on some news development that would offer a better selling opportunity. With Tokyo markets closed today, the yen is also in a consolidative mode. Some suggestion that UK Prime Minister Brown’s gaffe may reduce the risk of a coalition government may be offering sterling support is probably more wishful thinking, especially ahead of tonight’s television debate.
Equity markets are mixed today. The MSCI Asia-Pacific Index excluding Japan extended its losing streak to the third consecutive session with a 0.3% loss. The commodity and telecom sectors were the weakest. While many of the large markets lost ground, including China, Korea and Taiwan, many of the smaller market, including Malaysia, Thailand and Indonesia managed to post modest gains. European bourses are mostly around 0.3%-0.5% higher. All the sectors represented in the Dow Jones Stoxx 600 are higher. Telecom and consumer good sectors are leading the advance. Of note the Athens market is posting around a 5% gain, with financials up nearly 8%. This illustrates the corrective forces at work today.
This corrective tone is evident in the sovereign bond markets, where peripheral European bonds are firmer, with Greece and Portuguese bonds doing the best. Italy’s bond auction was alright and in any event better received than the bill auction earlier in the week. Note that tomorrow Italy has a large 13 bln euro maturity and Spain makes a 1 bln euro coupon payment. In the current environment, there is a risk that some of the funds flow out of the euro zone and potentially a weight on the euro itself.
Many if not most foreign exchange participants understand that the short euro position is a crowded trade and that this leaves the market vulnerable to a short-covering bounce on a favorable news development. However, fundamentals and sentiment suggest there will be selling into euro bounces. In the European morning euro has been lifted through yesterday’s highs, we suspect this will give North American operators a better selling opportunity. Sterling too appears to be running out of steam after Europe bid it through the $1.5250 area. Stops on new short positions should be placed above $1.53. There is much speculation around a larger Greek package, with rumors of as much as 120 bln euros. This would ostensibly be conditioned on additional savings measures by Greece. Market talk suggests Greece may be considering a 2% hike in the VAT and another round of wage cuts among government workers. A Reuters poll found 30% of those surveyed expect Greece to restructure its debt in the next five years. News that Fitch reaffirmed its AAA rating for Spain after S&P’s downgrade yesterday also is seen as a break in the negative news stream. Our proprietary assessment warns that Fitch’s affirmation notwithstanding, Spain does not deserve triple A status.
The FOMC statement contained no surprises. Nor did it elicit a market response. However, it again noted that bank credit was not growing. That is to say, that credit conditions have tightened by the private sector not by the Fed. We suspect this is a development that the Fed is watching closely. With the banks doing some tightening already, inflation subdued (illustrated by the large number of goods in the core CPI basket and core PCE basket still falling on a year-over-year basis), the market recognizes the Fed is in no hurry to raise interest rates. A Reuters poll found a majority now expecting the first hike toward the end of Q1 11. The survey found about a 1 in 3 chance of a hike at the end of this year, down from about a 2 in 3 chance earlier this month. The contraction in bank credit is not simply a US phenomenon. The euro zone reported that money supply continues to contract. On a year-over-year basis M3 has fallen 0.1%, which is the same rate on a 3-month year-over-year basis, which is often used to smooth out the time series. Lending remains poor in Japan and weak in the UK. Part of this may simply be a function of the unwinding of the deluge of liquidity officials made available during the darkest days of the financial crisis. Most measures still show liquidity even if not as much as previously, but the longer it persists, the more disconcerting it becomes.
German economic data were stronger than expected and this may also be encouraging the short-covering bounce in the euro. Seasonally adjusted unemployment figures showed a 68k decline (162k decline on an unadjusted basis) with the unemployment rate slipping to 7.8% from 8%. The consensus called for around a 10k decline after a 42k decline in March (revised from -31k). It did not expect any change in the unemployment rate. Although there may have been some distortion by the early Easter, the German labor picture, even with the short-term scheme, where the government subsidize wages to minimize lay-offs, continues to show some resiliency. Separately the VDMA engineering association reported that plant and equipment orders rose 21% year-over-year in March, with domestic orders up 28% and foreign orders up 18%. The VDMA’s data seems to confirm our point that after poor finish to 2009 and a weak start to 2010, the German economy gained some momentum in late Q1 and this appears to be carrying into Q2. Norway in contrast today reported disappointing March retail sales data. The 0.1% decline contrasts with consensus of a 0.5% rise. This is important because the Norges Bank meets next week with widespread expectation of a 25 bp rate hike. A Reuters poll found 8 of 11 expect the hike. Given the uncertain growth outlook for much of Europe, and the mixed nature of the recent Norwegian data, the market appears to be too confident of a hike. The krone seems vulnerable to a reassessment in the coming days. The euro finds support near NOK7.86. The nearby cap around NOK7,89 needs to be taken out to signal a more serious short-covering move.
Upcoming Economic Releases
The US reports weekly initial jobless claims at 8:30 EST/12:30 GMT. A continued pullback is expected after recent distortions appear to be correcting. The week’s highlight, the first look at Q1 GDP, will be reported tomorrow. Expectations have generally risen in recent weeks and the consensus now is just north of 3%.
This was the BBH CurrencyView by Marc Chandler. Marc is the Global Head of Currency Strategy at Brown Brother Harriman. For more of BBH’s currency views, visit the BBH FX website here.
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