BBH CurrencyView: US Dollar Firm Ahead of ECB Meeting
The US dollar remains firm against most of the major currencies today as the participants await the ECB meeting, which given the events in Europe, is the most important meeting arguably since 2008. There are three currencies that stand out today. First, sterling is independently heavy. A weak CIPS service PMI (55.3 vs 57 expected and 56.5 in March) and last minute jitters ahead of the election results weighed on sterling and encouraged paring back of long sterling/short euro cross positions after nine month lows were set just below GBNP0.8470 in Asia. Second, the Swiss National Bank that has been thought to have intervened in large size in recent days appeared to step away from the market today and this has led to sharp franc gains against the euro and dollar. Lastly, other notable stand out is the New Zealand dollar, which has been bolstered by a much stronger than expected employment report (1.0% increase in Q1 vs expectations of 0.2%).
After further sharp losses in Asian equities, the European bourses are posting modest gains. The MSCI Asia-Pacific Index fell 2.6% and all ten industry groups fell. Tokyo returned from the Golden Week holiday and had some catch-up to do. The Nikkei slid 3.3%. China’s Shanghai, though, tumbled 4% amid concern officials will take more measures to cool the real estate market and that largest destination of it exports, namely Europe, is going to experience weaker aggregate demand. Foreign selling has been evident in most Asian markets this week, with the notable exception of the Philippines. European bourses are up around 0.5%. Basic materials, financials and utilities are bouncing back today, while health care and telecom are slightly lower.
Southern European bond markets and the related credit-default swap market remains under pressure. This comes despite an apparently successful Spanish 5-year bond auction. Yet the 2.35 bid-cover comes at a steep price. The 3.58% yield represents a 70 bp increases from the last auction. Safe haven flows appears to have diminished, as German bunds and US Treasuries are trading a bit heavier today as well. Elsewhere, the yield on the benchmark 10-year Japanese government bonds slipped a coupled basis points to 1.26%, a new four month low.
The European Central Bank meeting today is critical. As is its pattern, it holds two meetings a year outside of Frankfurt. Today’s meeting is in Lisbon, which is one of the local governments (five in all) that Moody’s put on credit-watch yesterday for a possible downgrade alongside the sovereign. To be sure, what is at stake here is not so much a change in rates. ECB President Trichet’s prepared remarks and the following press conference is where the real interest lies. The market is looking for the ECB to take some additional measures to address the crisis.
Two potential courses of action seem highly unlikely and can be ruled out. There has been talk that the ECB could buy sovereign bonds outright. This is a non-starter for now and the foreseeable future. There is already a backlash from previous climb downs from the ECB, including willingness to accept Greek bonds as collateral regardless of their creditworthiness. ECB member and BBK President Weber appeared to close the door on the issue when he was quoted yesterday saying that the Greek crisis does not necessitate “using every means.” In addition, recall that the ECB charter bans it from buying sovereign bonds directly, though apparently and theoretically could do so in the secondary market. The second potential course that is ruled out is that Greece is asked to leave the union. This is also a non-starter. If some think that having the IMF participate in the financial support facility for Greece was a loss of face, Greece leaving would be an even greater admission of failure. Moreover, it does not really solve very much. Greece would still owe (mostly European banks) more than hundred billion euros. The idea of Greece being able to reintroduce a currency with the sole purpose of debasing it seems unrealistic and a dangerous experiment.
There are a couple of more compelling options for the ECB. The first requires taking our eyes off Greece for a second and looking at the funding stresses that are evident in European money markets. Short dated Euribor rates have moved above the German 2-year yield, for example. The spread now is around 20-25 bp. During late 2008, the spread widened to around 80 bp and the ECB responded by injecting massive liquidity into the banking system. It will be disappointing to the market if the ECB does not address this liquidity issue in some fashion today. It could renew its facility to provide unlimited cash for a longer period of time, say three months, and could revert back to fixed rates repos. Some US money market rates also reflect some distortion as European financial institutions scramble to secure dollar funding. This could prompt the ECB to explore renewing the dollar swap lines with the Federal Reserve. A successful press conference today could see the euro stabilize, which could encourage some of the momentum traders to move to the sidelines. However, over the medium-to-longer terms, the path of least resistance remains a weaker euro. If the austerity in the Meds is effective, weaker domestic aggregate demand can be blunted on the margins with increased foreign demand—and in export-oriented Europe this means a weaker euro. And of course, if the EU/IMF program is not successful and contagion is not arrested, surely further declines in the euro are likely.
Money leaving the euro zone appears to have sought safe harbor in Switzerland. There has been relentless pressure on the euro-franc cross, but one would not notice it looking at a chart of the price action. The Swiss National Bank is believed to have provided several billions of francs this week to meet the dramatic demand. At some point, though, we thought there were limits to the SNB’s willingness to fight the market. That point appears to have been reached today. Perhaps the recent data provided the spur. Switzerland reported a dramatic 0.9% rise in April’s CPI. The year-over-year rate remained steady at 1.4% due to base effects. Frankly, a good part of the month’s rise appears to be a function of the seasonal increase in clothes and shoes (+17.6%). It is true that last month the SNB increased this year’s inflation forecast to 0.7% from 0.5%. However, it seems on balance that the SNB used the cover of today’s report to alter tactics. Don’t be surprised to see them re-enter at lower euro/higher franc levels.
Upcoming Economic Releases
The ECB’s decision is announced at 7:45 EST/11:45 GMT followed by the press conference at 8:30 EST/12:30 GMT. US productivity and unit labor cost data are derived from GDP are reported at 8:30 ET. Former continues to rise albeit slower and later declines slower. Lastly US chain store sales are unlikely to match the early-Easter induced 9.0% year-over-year rise in March.
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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