Optimism About PSI Boosts Risk Appetite; Brazil Cuts 75 BPS

The dollar is weaker against most major and EM currencies with Greece still the major focus. The euro broke above 1.32 against the dollar in the European morning as it becomes evident that the Greek PSI deal will likely go through, as we had expected. The Brazilian central bank cut by 75 bp last night, surprising some market participants but in line with where expectations were moving towards in the last few days.

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The dollar is weaker against most major and EM currencies with Greece still the major focus. The euro broke above 1.32 against the dollar in the European morning as it becomes evident that the Greek PSI deal will likely go through, as we had expected. The next level to watch on the upside for EUR/USD is the 100-day MA at 1.3268. AUD and NZD are both up about 0.75% against the dollar, ignoring weaker employment data in Australia and a dovish statement by the RBNZ, while NOK and SEK are up over 1%. Once again, JPY is the notable outlier, falling 0.5% against the dollar and rapidly approaching its recent high of 81.87 earlier this month. This follows a string of weaker data overnight including a record current account deficit in January, faster contraction of GDP in 4Q, and a dismal 8.6% contraction in machinery orders. Moreover, the weekly securities transactions showed Japanese investment outflows continue.

In sovereign debt markets, optimism towards the PSI agreement helped drive the spread between German and Italian 10-year debt below 300 bp, the lowest level since early September driven by a 15 bp decline in Italian debt. Spanish yields are also lower but only by 5 bp, thus widening further the spread between Italian and Spanish debt, now at 25 bp, a level not seen since July 2011. However, it is important to note that Portuguese yields continue to trend higher, rising 5 bp on the day. This is consistent with our view that while markets and the euro will likely rally on a muddle through Greece deal, closure on the debt crisis is unlikely and the next countries to come under pressure will probably be Portugal or Spain.

Global equity markets are sharply higher with S&P futures up 0.9% and the Euro Stoxx up 1.7% led by solid gains in the financial sector, especially banks. The MSCI Asia Pacific Index up 1.2% and the Nikkei closing 2% higher with gains in part supported by expectations that a weaker yen will boost exporters. Chinese equities received a boost today from reports suggesting that provincial pension funds (worth RMB1.9 trln) are about to begin investing in the stock market. This follows headlines yesterday suggesting banks’ wealth management arms (worth RMB4 trln) will invest in stocks. Other reports from the sidelines of the NPC meeting hint at increases to QFII quotas and as usual, there is some speculation that the PBoC will cut RRR after the release of CPI tomorrow. Again, it does seem like policymakers are getting more serious about supporting equity market. Whether it will work is an entirely different question.

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While the Greek PSI deadline remains in place for today at 3 PM EST, the results will not become known until Friday. Our base case is for the participation rate to fall within the 75-90% range. While averting the disaster scenario of a rate below 75%, a rate between 75-90% represents a muddle through solution. While markets and the euro will likely rally on a muddle through, there will still be more questions than answers. How will holdouts be dealt with? Is there any risk that CACs will be invoked? Euro zone finance ministers will hold a conference call to discuss Greece PSI results Friday at 8 AM EST.

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Central banks meeting today are expected to remain on hold. Already, BOE left policy and its asset purchase target on hold as expected. The decision was not accompanied by any comments or color, and so markets will have to wait until the minutes come out on March 21 to come up with any analysis. ECB and BOC are still to come with steady policy expected from both. Draghi press conference will be key, as this is the first meeting since the ECB’s LTRO on February 29 and markets will be looking for clues on future policy. Markets have in recent weeks dialed back ECB easing expectations for this year.

No major US data releases today, though weekly jobless claims may continue to show a firming US labor market ahead of Friday’s jobs report. Consensus for February NFP is +215k (+k private) vs. +170k (k private) in January, and would be consistent with continued improvement in the US labor market. Indeed, we still believe that the fundamental theme of an improved US outlook coupled with euro zone recession could help the dollar to continue firming even after this current bout of euro zone turmoil ends.

The Brazilian central bank cut by 75 bp last night, surprising some market participants but in line with where expectations were moving towards in the last few days. The central banks of Korea and Indonesia left rates on hold earlier today as expected at 3.25% and 5.75%, respectively. Mexico February CPI is due out today, and is expected to remain steady at 4.2% y/y. Target range is 2-4%, but core inflation remains low near 3%. Banxico is likely to remain on hold this year, contrary to expectations last year of an easing cycle starting in 2012. This is MXN-supportive longer-term. USD/MXN broke below the 200-day MA today as EM rallies, around 12.89 currently. With the US outlook improving and the Greek PSI likely to go through, we think that the peso will outperform near-term as a high beta currency in EM.

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