Post EU/IMF Euphoria Continues to Recede but Market Stays Calm
The post EU/IMF bailout out euphoria continues to wind down and this means that the US dollar and the yen are in solid shape. The euro has eased back to pre-weekend levels, trading closer to the $1.2650 mark by late euro session and with $1.25 within sight. A calmer mkt environment prevails though. EZ Q1 GDP was better than exp (see below). Cable is stable, just below $1.50 – with limited impact from the formation of a new government (see below). Mixed news from the UK econ/BoE inflation report (see below). EURCHF approaching key 1.40 level, but intervention risk is high, with SNB’s Hildebrand stressing that he will not allow excessive currency strength as deflation remains a problem. EMEA currencies are bid, with CZK outperforming (+0.6%) following relief over the Q1GDP data. South Korea CB kept rates on hold (at 2%). Meanwhile, China’s tightening concerns dominate as April property prices were reported at a high 12.8% y/y. Latest US/Cad trade figs are due today.
It was a more hesitant session for the Asia equity mkt, with China tightening concern weighing on sentiment. Negative closes were seen across the board, with the Nikkei (-0.16%), the Hang Seng (-0.5%), the Shenzen (-1.4%) and the Kospi index (-0.4%) all ending the session lower. The S&P/ASX 200 index outperformed, up 0.55% by the end of the session. Reports that Morgan Stanley is being investigated for misleading clients about mortgage derivatives is weighing on sentiment. European bourses were flat to slightly higher by midday and the S&P future points at a slightly positive open on WS later today. Crude oil prices have recovered from the overnight low, with WTI trading just above the $76brl level.
The risk off trade has returned and this is good news for the bond market. 10 year JGB yields were down from a 2 wk high and the European bond market has opened marginally higher. 10 yr bond yields were down in France (-2bp), Germany (-1bp), Italy (-2b0) and Spain (-2bp). Despite change in sentiment, a calmer environment in periphery bonds stays in place. UST 3 yr auction went well, with a bid to cover ratio at a high 3.27 yday. Canadian 3 yr, US 10 year auction due.
David Cameron is the UK new PM, with a coalition government being formed. Lib Dem Clegg is getting the deputy PM position while Osbourne will be confirmed as Chancellor – nothing too surprising there and we will get further fresh details on the shape of the government at the 2.30pm BST press conference. The coalition govt will focus on narrowing the deficit and prepare an emergency Budget within 50 days. Sterling’s reaction has been muted so far. As we noted previously, the hung parliament scenario is priced in and the market will give the new government a chance to work. We had mixed economic news for the market to digest morning. On an encouraging note, April unemployment was reported down 27.1k on the month, following a 32.7k monthly decline previously – the third consecutive monthly decline. More disappointing was the BoE latest inflation report though. The BoE latest inflation forecast showed a slightly higher inflation profile in the n/t (logical considering the higher than exp. CPI data of the past few months) but it is still expected to undershoot the target by the end of the two year projected period. This means that the BoE keeps a certain degree of flexibility, with QE still likely to be used.Economic growth is still expected to pick up, but the BoE acknowledges that downside risks have increased. All this suggests that UK rates are not going up anytime soon and that the QE tool has not been completely abandoned just yet. Note that in a highly unusual fashion and importantly for sterling, Mervyn King welcomed the conservatives’ budget plans.
The euro zone economy has started the year on a marginally more promising note, with Q1GDP reported at +0.2% q/q (vs +0.1% expected), following a flat outcome previously. The yearly economic growth rate has moved back in positive territory, at +0.5% from -2.2% in Q409. The regional breakdown confirms macro cyclical discrepancies within the euro area, with positive output growth reported in Germany (+0.2% q/q vs +0.2%), France (+0.1% q/q vs +0.5%) and Italy (+0.5% vs -0.1%) while the periphery struggles. Negative output growth was recorded in Greece (-0.8% q/q vs -0.8%). Q1 GDP was reported at +0.1% q/q (vs -0.1%) in Spain and at +1% q/q (vs -0.3%) in Portugal but the outlook for Q2 is worse. Indeed, we expect the discrepancies between core and periphery to widen over the next few months/quarters, with the Greek debt crisis and negative spill-over likely to exacerbate the intra-euro zone growth divergences. Diverging intra-euro growth performances will require differing macroeconomic responses. This is more a theme for 2011 than for 2010 as at this stage, a loose monetary stance suits all EZ countries. However, as the French and German economies gain momentum, the need for a tighter monetary stance will become increasingly obvious. On the other hand, a tightening in monetary conditions earlier than needed could prove particularly counterproductive and damaging for periphery EZ bearing in mind the much tighter fiscal stance already in place. Overall, it was relatively good news from the euro zone economy this morning and the weaker euro also points at a more promising growth outlook into Q2/Q3, especially for countries like Germany and Italy. The market impact was limited as there is still a wary sentiment in the post EU/IMF package context. We are still of the view that selling the euro in the rallies is the most appealing strategy at this point. However, we note a much calmer market environment with Spain’s latest spending cutting measures announcement and confirmed buying of Greek, Portuguese and Irish bonds by the ECB helping.
In the US, the March trade deficit is expected to post a small deterioration (to -$40.5bn from -$39.7bn), with an improving domestic demand bringing an upward bias on import growth. Meanwhile, the Canadian March trade surplus is expected on the rise again (at +C$1.6bn from +C$1.4bn), reinforcing our bullish sentiment towards the loonie. In fact, we would argue that the return to a calmer market environment provides good opportunities to re-enter long CAD positions, in particular versus the yen. Look to re-enter long CADJPY positions within the Y90.00-Y91.00 range.
Upcoming Economic Releases
America: US March trade balance, April budget statement, Canadian March trade balance, new house price index.Asia: Japanese March trade balance, April bank lending, April bankruptcies figures due. Events: Fed’s Lockart, Bullard to speak.
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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