BBH CurrencyView: Turnaround Tuesday For Foreign Currencies

Highlights       

The US dollar has surrendered yesterday’s gains against most of the major foreign currencies, after the upside momentum stalled in North America yesterday.  The recovery of US equities yesterday helped arrest the heightened anxiety seen before the weekend and early Monday.  Constructive data from Japan in the form of a smaller than expected decline in the tertiary index (-0.2% vs. expectations -1.0%), a higher than expected UK CPI (3.4% year-over-year vs. 3.1% expected) and a stronger German ZEW survey (53 vs. 45.1 expected), helped lift the complex of European currencies.  Last Friday’s highs are seen as important swing levels now.  They are found around $1.3585 and $1.5507 for the euro and sterling respectively.   Although the yen is moving in the opposite fashion as positions scrambled out of yesterday are re-established.  Last Friday’s dollar high here is important as well.  It comes in near ¥93.20, which corresponds to a retracement objective and the 20-day moving average.  Hawkish minutes from the recent RBA meeting have propelled the Australian dollar higher.  It is more than 1.5 cents above yesterday’s lows.  Last Friday’s high near $0.9355 is the next objective.

Global equity markets have generally moved higher in the wake of the performance in the US yesterday.  The MSCI Asia-Pacific Index rose 0.5%, with Hong Kong and South Korean markets breaking a two-day drop.   Strong bank profits helped lift Thai stocks, though basic materials and commodities led the local benchmark.  The 5% rise and recovers a little less than half of the political unrest-inspired 13% drop since 7 April.  We note that Indian equities managed to eke out a modest rise (~0.5%) rise despite the 25 bp rate hike in key rates and reserve requirements.  Chinese shares continue to under-perform, with telecom, oil and financials the main drags.   European bourses are around 0.5% higher near midday in London, with consumer goods, technology and industrials among the leaders.  Telecoms are softer.

The recovery in equities and the firm economic data has taken a toll on the bond markets.  European bonds yields are mostly 2-3 bp higher, with 10-year gilt yields rising 4 bp.  Greek bond 10-year yields are up 18 bp and approaching 8%.    This despite a favorable reception to the much-watched 13-week Greek T-bill auction.  The 4.6 bid-cover was possible because the average yield was 3.65%–roughly double what it was in Jan.  Other European bill/bond auctions in Ireland and Spain went smoothly.   Sweden’s Riksbank left policy on hold, but continued to offer guidance that suggests a hike in H2.  The Bank of Canada meets today.  The issue here is not whether they hike or not, as not one expects a hike, but rather the kind of guidance it gives.  The market seems split between a June and July hike, though for medium term investors, it’s a bit of splitting hairs.  The BOC will be the first in the G7 to hike rates.

Currency Markets                                               

The Greek drama continues to be a key focus in the foreign exchange market.  It is expected to rival financial regulation as key topics at G7 meeting and G20 meetings at the end of the week.   Officials, Greek and others, continue to play down the risks of default. Even if Greece can muddle through this year, there is growing realization that that will also not mean closure.  BBK President Weber, who is a leading candidate to replace Trichet as ECB President, admitted what every one knew to be the case.  Greece would likely need more funds than the initial EU/IMF package.  Reports cited Weber as suggest as much as €80 bln  may be needed.  One of the important issues apparently unresolved are the conditions of drawing on the funds.  Meanwhile, many continue to suspect that at some juncture Greece will restructure its debt.  However, more immediately, the successfully auction of Greek bills at a yield less than rumored has helped steady the Greek debt market.  With the EU/IMF/ECB officials meeting with Bank of Greece officials, the risk is that some additional clarity is achieved that extends the fragile calm.   This would also suggest scope for additional near-term euro gains.

Sterling continues to be quite resilient in the face of the economic and political news stream.  The success of the Lib-Dems Clegg in last week’s debate appears to be prompting a change in tactics from Brown, who is sounding more sympathetic to electoral reforms, and Cameron who has softened his critique of the Clegg’s manifesto.  Clegg’s success, especially if repeated in this week’s televised debate, comes at the greater expense of the Tories.  They have to win more seats than it has in any election since the early 1930s.  In order to do so, it must not only take seats now held by Labour, but it needs to pick up some (some estimates suggest around 20) from the Lib-Dems.  On the economic front, the UK reported higher than expected inflation, which forces BOE Governor King to write another note to Darling to explain the overshoot.  The headline CPI rose 0.6%, twice what the consensus had expected.  The year-over-year rate rose to 3.4% from 3.0%.  The consensus had expected a 3.1% increase.  While no doubt there was an energy component to the increase an base-effects, the fact is that the core rate rose 0.5%, lifting the year-over-year rate to 3.0% from 2.9%.  There is beginning to be some questions raised over the BOE’s assessment that inflation will be just a transitory phenomenon.  The market recalls the outsized jump in PPI and now CPI and decline in sterling and the QE measures.  Nevertheless, it seems unnecessary to jump to that conclusion yet.  Commodity prices have risen, but the rise in the UK’s CPI could be a lingering effect of the increase in the VAT.

The German ZEW investor survey was much stronger than the market expected.  The gains snap the six month decline with emphasis.  The economic sentiment component rose to 53 from 44.5.  The market had expected a small rise to 45.1.  The assessment of the current conditions rose to -39.2 from -51.9.  The consensus had expected a -48.0 reading.  This one month’s report unwinds the much of the decline seen in Q4 09 and Q1 10.  The report also helped stabilize the euro.  After stagnating in Q4 09, the euro zone economy appears to have picked up some momentum as Q1 progressed.  Investors should be prepared for somewhat stronger European data in the coming weeks as late Q1 and early Q2 data are reported.   This is also within the context of what appears to be the broadening and deepening of the global economic recovery.

Upcoming Economic Releases                                                               
The US reports PPI data at 8:30 EST/12:30 GMT.  The consensus calls for a 0.5% rise, which would neutralize the 0.6% decline reported in February.  Still, because of base-effects the year-over-year rate is likely to rise toward 6% from 4.4%.  This is largely a function of energy prices.  Core PPI is expected to rise 0.1% and only 0.9% year-over-year.  At 11:00 EST/15:00 GMT, Bernanke and Geithner testify to a House of Representatives hearing on Lehman Bothers.