Dollar Pares Week’s Gains

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Highlights

The US dollar has been softening since yesterday in the European morning.  There has been follow through in euro buying today after the year’s low was successfully tested yesterday.   However, despite protestations from ECB Trichet that Greece would not default, the issues are far from resolved and this will likely contain euro upticks.  Buying interest already seemed to ease already as the European session got under way.   A recent string of constructive economic data coupled with much higher than expected PPI data have pushed sterling to its best level against the dollar and euro since late Feb.  The yen has been sold across the board.  It is seen as part of carry trades and greater appetite for risk assets in general today.  Disappointing Canadian jobs data keeps may see the Canadian dollar finish the week below parity against the US dollar. 

The recovery in US shares prices yesterday is helping support global markets today.  The MSCI Asia-Pacific Index rose 0.2% for a 1.0% gain on the week.  Favorable earnings news from Japanese retailers helped lift the Nikkei 0.3%, but it still posted its first weekly loss in about two months.  EPFR reported that emerging market equity funds saw their biggest inflow in six months in the week ending April 7 of $3.27 bln.  We note that in the month through yesterday, the stock exchanges in South Korea and Taiwan reported foreign purchases of $2.2 bln and $1.8 bln respectively.   On other hand, foreign investors appear to have turner to selling in Thailand and Indonesia.  European bourses are up around 1%, led by utilities, resource companies, and financials. 

The calmer Greek bond market appears to be the key development today.  The 10-year yield is 13 bp lower, but is still up 68 bp on the week.    The 2-year yield is off 18 bp, and up about 207 bp on the week.  Most other 10-year benchmark yields rise 1-2 bp.  Germany might be underperforming slightly as a safe haven bid is moderated.  This week’s US Treasury supply was relatively smoothly absorbed and the 2-year yield is 0ff 3 bp on the week and the 10-year yield is off 6 bp going into today’s session and are little changed in Europe.  

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Two issues dominate discussion of the global capital markets:  Greece and China.  The market appears to be somewhat impressed with ECB President Trichet and Greek officials claims that there will be no Greek default.  Can they say anything but that?  Isn’t it like a central banker saying that “rates are appropriate”?  Trichet has often said that the ECB does not pre-commit itself.  Is it reasonable to expect a country to pre-announce risk of default has increased?  Although there is a calmer tone today, investors cannot have much confidence in it persisting very long.  The market will likely test the resolve of officials.  As we argued about a role for the IMF, pride has a way of being swallowed in the face of political and/or economic necessity. This is not to argue that default is inevitable, but the ability of Greece to muddle through without external material aid has surely been challenged this week.  We have argued that if the conditions for getting funds become too onerous, from both an economic and political perspective, a default cannot be ruled out, especially given the high percentage of its debt is owned by non-residents.  The first large maturity of Greek bonds appears to be on April 20th.   Meanwhile, there is talk that some US and UK banks have cut or reduced trading lines with Greek banks, though we note that Greek bank shares are the best performers in Athens today, gaining almost 2% while the overall market is up less than 0.5%.  Separately, the central bank reportedly instituted daily repos, which seems to force banks to cover short bond positions on settlement days. 

China is the other main talking point.  Media claims of an imminent change in the Chinese currency regime are likely to prove exaggerated, even though we agree a move is coming.  Next week China’s President Hu will visit the US.  If China wants to avoid the appearance that it is capitulating to US pressure, it does not seem to make sense to place high hopes on a move then.  Moreover, next week, China reports a slew of economic data, including what officials there have tipped to be a trade deficit for last month.  Still, we suspect much too much attention has been given to what is likely to be a small move on the currency.  And while a wider band sounds nice in theory, it is not exploring the full range of its current bands.  Modest moves are unlikely to significantly alter capital and trade flows.   Our contacts in Washington have often argued that is Congress, the media and analysts that tend to exaggerate the significance of the yuan and that typically the Treasury and Commerce Depts do not.  For example, we noted that the recent US Trade Representative’s annual report cited specific complaints against Chinese trade practices and none involved the exchange rate per se.  Similarly, yesterday’s comments by Commerce Secretary Locke were very instructive.  He noted that Chinese discrimination against foreign goods and other barriers may limit the impact of even a material gain in the yuan’s exchange rate. 

Closer to the ground, Europe has released a batch of economic data that is noteworthy today.  First, in France we note that industrial output stagnated in Feb. after a strong 1.1% rise in Jan. (initially reported 1.6%), though manufacturing rose 0.4% and is 4.6% above year ago levels.  As was the case in Germany, where industrial production stagnated in Feb, survey data, like the PMI, has not been matched in the actual data.  Second, Germany reported a larger than expected Feb. trade and current account surplus (12.6bln euros and 9.1bln euros respectively) and is a timely reminder that underlying Greece deficit and debt issues (as well as many other euro zone members) is an issue of competitiveness which is not necessarily addressed even if Greece taps the EU/IMF facility or defaults.  Third, Sweden also reported soft Feb industrial output data (-0.8%) and this seems to have spurred a bout of profit-taking on long krona positions against the euro.  Fourth Norway’s headline CPI was in line with expectations with the year-over-year rate rising from 3.0% to 3.4%.  However the core rate only 0.2% and this was sufficient to push the year-over-year core rate to 1.7% from 1.9%.  Many expect the Norges Bank to raise rates again later this quarter.  Fifth, the UK reported a much sharper than expected increase in March producer prices.  Input prices rose 3.6% on the month (vs. consensus of 1.2%), lifting the year-over-year rate to 10.1% from a revised 7.5% in Feb.  These are the strongest reading since 2008.  Output prices rose 0.9%, which was twice the expectation.  Oil prices were the main culprit.  The wide gaps between input and output prices may raise concern about profit margins and we do note UK equities are higher, but lagging behind the other large bourses today. 

Upcoming Economic Releases                                                               
The US reports whole sale inventories today.  The consensus calls for a 0.4% increase after a 0.2% decline in Jan.  Inventory de-stocking or small outright growth is expected to contribute positively to Q1 GDP, even if not as much as in Q4 ‘09.

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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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