Currencies Be Calmed


The US dollar is broadly weaker today as is the Japanese yen as the latest bout of market anxiety eases.  News that China indicated that it is not planning on selling its European bond holdings helped the euro recover yesterday’s slide.  A couple of Japanese life insurers made similar supportive comments as did South Korea’s central bank.  At the same time, reports are suggesting that North Korea may be looking for a back channel way to step ease tensions and this has also encouraged a more stable tone in capital markets. 

Global equity prices are sharply higher today.  The MSCI Asia-Pacific Index gained nearly 2% today.  Robust exports from Japan, a larger than expected current account surpluses in South Korea,  stronger than expected Q1 growth figures from the Philippines, and New Zealand’s first twelve month trade surplus since July 2002, all contributed to the better sentiment and performance.   European equities are advancing for their third consecutive session, with many bourses hitting one week highs.  Some indication that the Prudential deal with AIA may be off is positively impacting Prudential and Aviva shares.   Financials are generally holding their own, matching the market’s performance.    There are exceptions.  Spanish financials are posting small gains, while the resource sector and industrials carry the day.    Greek shares are under some pressure, backing the overall advance, with financials down twice as much as the overall market. 

The easing of anxieties is sucking the safe haven bid away from bond markets.  Sharp rises in yields are being seen today.  The 4 bp increase in the 10-year JGB yield is the largest in several weeks.  10-year German bund yields are 3 bp higher.  Most peripheral European spreads are stable, with Italy being the main exception today.  The 10-year BTP yield is up 5 bp, the most in Europe today.    US Treasury yields are higher with the 10-year yield up 9 bp in European trading and the coupon curve is steepening today after flattening in recent sessions. 

Currency Markets

The euro has largely retraced yesterday’s losses.  The euro’s cyclical low was recorded last Wednesday and it has successfully been retested.  This is the longest the euro has gone without making a new low in a month.  The $1.2150 area marks the lower end of the range that has emerged.  The upper end of the range is seen in the $1.2350 area.  A move through the band of resistance that extends to $1.24, would signal an advance toward $1.26 initially.  Some of the recent losses in the euro were likely fueled by momentum traders and now that the momentum has stalled, some of these seem vulnerable to a squeeze.  On the other hand, the negativity toward the euro we have picked up in discussions with medium term and longer term investors is powerful.  It will take more than a modest correction to force a strategic change from that market segment.  The leveraged community may roll spot positions in to the options market to give them more staying power.  We note that the premium that is being paid for euro puts over euro calls is wider today despite the euro’s advance and this lends credence to this assessment.

China’s central bank and sovereign wealth fund both have come out indicating no intention to reduce euro holdings in light of the financial crisis.  South Korea’s central bank and a couple of Japanese life insurers have made similar supportive remarks.  There are a couple of take away points from this that should not be lost on investors.  First, it drives home a rule of thumb we noted yesterday that China does not leak.  Second, medium and long term investors typically react gradually to developments.  It is those with shorter-term time frames that panic.  Third, this does not mean that they do not monitor developments that impact their investment.  So the PBOC and CIC denial that it is abandoning European investments is perfectly consistent with the claim by the President of the European Parliament Jerzy Buzek that China has expressed concern about the European debt crisis.    Fourth, some medium term and longer term investors may decide to reduce European investments.  There are reports suggesting that Kuwait’s sovereign wealth fund, one of the largest in the world, is considering doing just that.

The euro has made a marginal new multi-month low against sterling today.   Today this reflects more sterling strength than euro weakness.    Pessimism over the Prudential/AIA $35.5 bln deal is thought to be aiding sterling today.   However, as it approached the $1.46 area, the CBI retail sales survey showing an unexpected collapse to 14 month lows stopped sterling in its tracks.  Moreover, the forward looking aspects of the report were also rather dismal and the weakness was broad based.  Investment intentions and confidence may wane in anticipation of a much tighter fiscal policy going forward and the prospect that the VAT may be increased too.   For the North American session today, sterling looks vulnerable, with short-term momentum indicators over extended.  Support is seen near $1.4450.  Over the slightly longer term, if calmer conditions do return, sterling may under-perform, but can still rise toward $1.4700-50 against the greenback.

The Canadian dollar is poised to out perform when calmer conditions emerge.  Canada is still on track to be the first G7 country to raise interest rates.  The Bank of Canada meets June 1st.  Some softness in recent data, including retail sales and CPI and the market turmoil may encourage the BOC to stand pat, but this will likely simply reinforce ideas that it will hike in July.  Canada and the Canadian dollar are also likely to benefit from what should be a string of strong US economic data.  Note that yesterday’s April durable goods report contained an upward revision to March’s durable goods inventories and this will likely reinforce expectations that Q1 GDP, which will be reported in the North American morning today, will be revised higher.  Even if the ISM data is a fit softer next week, the economic highlight will be the US employment report.  The Bloomberg consensus is for a 500k increase headline increase (over 200k private sector).  This in turn may support the Fed’s Lacker’s assessment that his preliminary forecast would be that the European crisis shaves only 0.1-0.2% off US GDP this year.

Upcoming Economic Releases
US Q1 GDP revisions and weekly initial jobless claims will be reported at 8:30 EST/12:30 GMT.  GDP is likely to be revised upwards form 3.2% with most estimates coming in around 3.4-3.5%.    The market may be more sensitive to another rise in weekly jobless claims than a set back after last week’s unexpected rise. 


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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