Dollar Correction May Not Be Over

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Highlights

The US dollar is consolidating yesterday’s decline and has largely been confined to narrow trading ranges.   With the Greek bill auction behind it, the market may lack a clear focus, but sentiment towards the euro remains poor, even though there had been some short-covering in the futures market in the most recent reporting week that ended April 6.  Key euro support is seen in the $1.3480-$1.3500 area.   Resistance is seen in near $1.3640-60.  A smaller than expected trade deficit lent sterling support, but it too looks capped ahead of yesterday’s European high near $1.5465.  In Japan, a DPJ panel called for ¥120 level and 2% inflation target to help break deflation.     The market was unimpressed and the yen is firmer against the dollar and against the euro. 

Global equity markets are generally seeing modest losses.  The MSCI Asia-Pacific Index was off 0.4%, with the resource sector particularly heavy.   Of note, the Shanghai Composite bucked the trend and posted a 1% gain, with the oil and gas sector and financials particularly strong.  Like others in the region, however, Chinese tech sector was lower on profit-taking.   Although it is one of the few Asian equity markets still lower on the year, it closed at a 3-month high today.    European bourses are 0.3-0.4% lower today.  The only sector that appears to be doing well today in Europe is health-care, though telecom and consumer services are little changed.  Weakness is seen in basic materials and industrials.  The Greek market is off 1.45%, with financials down twice as much. 

Japanese government bonds were firm, but the real interest today in Tokyo was in the corporate bond space.  Five corporations issued bonds, raising ¥305 bln, making today the busiest day of the year, thus far, for corporate bond issuance.  The spread between corporate bonds and JGBs is a little more than 30 bp, about a third of levels seen last Feb.  Also, of some interest , the with the move in the five-month tenor, the entire yen LIBOR curve is now back below the dollar LIBOR curve, for the first time in almost 8 months.  Meanwhile, European and US bonds are little changed today.   Greece was able to raise more funds than intended in the bill auction, and while the euro initially bounced 30-40 points on the relief, it quickly gave it back and more.

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There was much drama around the Greek T-bill auction today, which ended up going off better than expected.  The amount of money that Europe and the IMF are willing to commit to the backstop facility is enough to substantially lower the risk of default by Greece this year.  The cautious assessment is that the conditions which Greece has to meet in order to tap the facility are unclear.  Moreover, the political dynamics in Germany further complicate the issue.  Germany’s large state (by population) North Rhine-Westphalia go to the polls on May 9th.  Chancellor Merkel’s government has seen support deteriorate in the opinion polls and the moral hazard of Greek assistance is well appreciated.  It is a hard sell.  German workers are being told that part of their efforts will help finance the relatively early retirement of the Greek civil servant.  Although the reality is more complicated than this, on some level this is how it appears.

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Greek T-bills were oversubscribed.  The 26-week bill sale raised 780 mln euros, with a 7.67 bid-to-cover.  The bid-cover at the Jan auction was almost 5 and the auctions last year generated a bid-cover to a little more than 6.  However, in Jan. these bills paid 1.38%:  Today 4.55%.  The 52-week bill was 6.5x over-subscribed, which is twice the Jan. auction and higher than last year’s auction,  But in order to achieve this the EU/IMF had to provide a backstop and the yield was 4.85% rather than 2.2%.   The bill auction also does not resolve very much.  We do know Greece can raise funds, under the right conditions.  However, because the terms of accessing the backstop facility are not obvious, it is not clear that Greece has a choice between the market’s terms and the EU/IMF terms.  Moreover, it is also not clear what the rating agencies are going to do.  Moody’s has already indicated that the EU/IMF package does not remove the downgrade risks.  Greece is reportedly still preparing for a dollar-denominated bond issue for next month.  This may be a more significant test of the market’s appetite for that which is Greek.

Sterling is holding its own against the dollar today with the help of a better than expected trade report.  The Feb trade deficit came in at –£6.18 bln after an upwardly revised £8.07 bln deficit in Jan. (initially –£7.99 bln).  This was roughly 10-% smaller than the market expected.  Some will likely play up the improvement as a function of the weaker sterling.  Exports did rise 9.5% in Feb.  However, this may well be a hasty conclusion.  In Jan., exports fell 6.6%.  Currency shifts rarely generate such a dramatic swing.  The more likely explanation is that January was the outlier, perhaps weather-induced and February represents some sort of snap-back, but perhaps too much.  It is the smallest deficit since June 2006.  The BOE’s effective exchange rate index for sterling bottomed in January 2009 and is currently about 10% above that low, which is the lowest of the time series that goes back to 1990.  Meanwhile, the polls continue to play up the risk of a hung parliament in next month’s election.  Arguably making a virtue out of a necessity, there seem to be an increasing number of observers who are suggesting that a hung parliament could force a broader national government with a strong mandate.  It is not immediately clear that this is really the best way to describe a center-right or center-left coalition.  However, the point is that sterling has appreciated 4.8% against the dollar and euro since late March despite the polls suggesting that no party will get a majority of the votes or seats in parliament.

The US reports the Feb trade balance.  A slight deterioration is expected from the $37.3 bln shortfall in Jan.  The monthly deficit peaked a couple of years before the financial crisis, in Aug 2006 at $67.8 bln.  The recent low was set in May last year near $25.8 bln.  Growth differentials and the rise in oil prices underscore the risk of further deterioration of the trade balance.  The US exported almost $142.7 bln of goods and services in January.  This is well above the 12-month average of about $131.1 bln, but also well off the July ‘08 peak of $164.4 bln.  The Obama Administration’s goal of doubling exports seems to be quite a stretch and it is not clear whether the US has the industrial capacity to reach the goal, unless domestic demand would compress and foreign demand would increase markedly.

Upcoming Economic Releases               
In addition to the US trade balance and the related import/export price indices, there are several Fed and Treasury officials speaking today, including Bernanke and Geithner in 12:45 and 1:00 pm ET today.

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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.

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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