Dollar Continues to Pullback

By Marc Chandler of Brown Brothers Harriman


The US dollar is extending last week’s pullback in what appears to be largely position adjustments, partly as a function of a better news stream and a healthier appetite for risk.  For the first time since mid-April, the euro has traded above its 20-day moving average and sterling has completely recouped the losses seen in response to the unexpected weakness in April manufacturing output reported before the weekend.   The greenback’s losses are widespread, with the emerging market currencies also fully participating.  The main exception is the Japanese yen, which is under pressure especially on the crosses.  The dollar lost nearly 2% against the Korean won as the new regulations were in line with guidance and domestic and foreign banks were given time to adjust. 

Global equity markets are broadly higher.  The MSCI Asia-Pacific Index gapped higher for the second consecutive session to rise about 1.6% on the day and to trade at its best level since May 20th.   China and Australian markets were on holiday.   The Nikkei was the regional leader with a 1.8% rally, led by consumer services and services, and industrials.  Rising commodity prices also boost the basic material sector in the region.  Progress on China-Taiwan trade deal encouraged foreign buying of Taiwanese shares for the third consecutive session.     European bourses are following suit.   The Dow Jones Stoxx 600 is advancing by more than 1%, led by basic materials, industrials and financials. 

Sovereign bond markets are under pressure as the safe-haven bid evaporates.  Ten-year yields in Europe are mostly 5-7 bp higher with a couple notable exceptions.  Political uncertainty in Belgium following the weekend election and anticipation that it may take some time to cobble together a coalition have seen Belgian bonds under perform, with 10-year yields rising 11 bp.   UK gilts are among the region’s better performers today, perhaps helped by government’s Office for Budget Responsibility suggesting a GBP22 bln smaller deficit in the 2010-2015 period than the Treasury Dept projected.   Lastly, Fitch revised its outlook for India’s local currency debt to stable from negative.

Currency Markets

This is the first substantial upside correction in the euro in the better part of two months.  The euro’s move above its 20-day moving average puts momentum traders on alert.  While the next target comes in near $1.2300, given the extended positioning and the pace of the losses in recent weeks, a short-covering fueled recovery can exceed technical objectives.   There was talk at the end of last week of some leverage fund interest in short-dated euro calls, with 1-month $1.25 strikes seemingly popular.   The recent news stream has encouraged the short-covering.  The ECB promised to provide unlimited liquidity over the next three months and this has helped ease some strains in the money markets.  At the end of last week, Moody’s offered a fairly optimistic assessment of European banks’ ability to cope with losses related to their holdings of peripheral euro zone bonds.  China and India’s recent string of data gave hope that the global recovery was intact despite the volatility of the capital markets.  The ECB revised its forecast for euro zone growth to 1.0% (from 0.8%) and the Bundesbank revised up German growth to 1.9% this year from 1.6%.    Earlier today the CBI lifted its forecast for UK GDP this year to 1.3% from 1.0%. 

Last month there had been concern that the key pillar of Europe, the Paris-Bonn axis was strained, but Sarkozy and Merkel showed greater signs of cooperation/coordination with the co-authored letter to the EU last week urging the expedited action on financial reform.  Earlier today the euro zone reported better than expected April industrial production figures.  The 0.8% rise in April industrial output compares with consensus expectations for a 0.5% increase and the March series was revised to show a 1.6% increase rather than 1.3%. This news stream has also seen the 3-month implied volatility of the euro ease below 14% (from above 16% a week ago) and is now at its lowest level since mid-May.  The premium the market pays for three-month euro puts euro calls has fallen from almost 3.5% a week ago to about 2.3% today, the lowest since early May. 

Japan is participating in the better news steam as well.  Today it reported sentiment among its large manufacturers improved markedly, with a 10 reading on its index compared with 4.3 last quarter.  Of particular note, they said they plan to boost capital expenditures by 9.7% in the current fiscal year.  Last quarter they projected a 5.5% cut in capex.   This report may help lift expectations for the next Tankan survey due out 1 July.   The BOJ’s two-day meeting concludes tomorrow.  Of course, no change in rates is expected, but the market does anticipate more details about the new loan program.  Local press reports suggest the facility may be capped at JPY2 trillion and will be aimed at lending for targeted purposes (environment, energy, medicine, and technology.  The dollar briefly poked through the JPY92 level, but the generally heavy US dollar tone seemed to discourage new buying above JPY92.10.   To keep the tone constructive for the dollar, it needs to hold above JPY91.50. 

The Swiss National Bank also meets this week—17 June.  There is little doubt that it will keep its 3-month LIBOR target at 0.25%.  Earlier today Switzerland reported a 0.3% rise in May producer prices.  The year-over-year pace stood at 1.4% from 0.8% in April and expectations for an increase to 1.2%.  There is some thought that the SNB may revise up its growth and inflation outlooks but without altering its declared QE/intervention stance.   The dollar has broken below the CHF1.14 level for the first time May 18th.  The dollar’s 5-day moving average has crossed below the 20-day average for the first time since April 21st, further illustrating the dollar’s loss of upside momentum.   A break of the CHF1.1330 area could see another 1-2 big figure decline.  On the euro-franc cross the CHF1.40 level is a key overhead barrier.   

Upcoming Economic Releases
There are not important US economic releases or scheduled speeches today.  Canada reports April auto sales figures today, which are not typically market-moving.

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