Dollar Softer In Narrow Trading Ranges

From the BBH Currency Strategy Team.

Highlights
The US dollar is mostly softer vs. the majors as earlier risk aversion during the Asian session has been reversed during early European trading.  Overall FX trading has been in very narrow ranges, but the euro is seen remaining under pressure as peripheral bond markets have yet to recover from recent spread widening.  Next big level for EUR seen at 1.26 but for now, the single currency is finding modest support around 1.27.  The yen is mostly firmer today as policy-makers did not talk about FX intervention, while Swiss franc mostly weaker after making a new cycle low in EUR /CHF (see below) on SNB comments.  EM currencies are largely softer, with Asian currencies outperforming and EMEA underperforming.  Biggest gainers vs. USD so far today are THB, ILS, JPY, NZD, and AUD, while biggest losers are PLN, HUF, TRY, CHF, and CNY.  The fact that CNY is one of the biggest movers underscores how narrow trading ranges have been today.  No major US data out today, but recent technical damage on top of weaker than expected euro zone PMI data points to further EUR losses.  AUD has stabilized after being hit during the Asian session as election results point to a hung parliament (see below).             

Asian equities were little changed, with the MSCI Asia-Pacific Index posting a small 0.1% rise after dropping 1.4% Friday.  Indonesia, Malaysia, and Taiwan outperformed, while Hong Kong, Korea, and Singapore underperformed and fell on the day.  Nikkei 225 posted a 0.7% drop.  European bourses are trading higher so far today.  US shares are likely to stage a bounce too as futures trading points to up opens for the major US indices. 

Core bond markets are steady in the wake of the recent rise in risk aversion.  The Greek-German spread has narrowed 2 bp to +846 bp but remains near the highs.  Portugal, Ireland, Spain, and Italy 10-year spreads are mixed, with the former two wider and the latter two narrower so far today.  US Treasuries have regained some traction on the flight to quality trade, with 10- and 30-year yields 1 bp higher on the day. 

Currency Markets
The euro has softened during early European trading again after holding steady in the Asian session.  Weaker than expected European PMI data for August did the euro no favors.  Germany’s manufacturing PMI slipped to 58.2 vs. a forecast 60.5 and 61.2 in July, though the services index rose to 58.5 vs. 56.3 expected and 56.5 in July. For the euro zone overall, the manufacturing PMI fell to 55 vs. 56.1 expected and 56.7 in July while the composite PMI fell to 56.1 from 56.7 in July.  Since Germany’s impressive Q2 growth results, confidence about European growth prospects has been fast draining away.  The end of last week saw the French government cuts its forecast for growth in 2011 to 2% Friday, down from 2.5%; European Central Bank governing council member Axel Weber suggested continued fragility in the financial system when he said the ECB should extend unlimited lending to banks through the year-end, and only then begin work on exit strategies; and the specter of Europe’s sovereign debt stresses return with the European Commission’s demand for Greece to cut spending even further.  We remain convinced that Greece cannot avoid some sort of debt restructuring, and the bond and CDS markets seem to bear this out.  When the global backdrop was more supportive, markets could overlook the warts on euro zone periphery, but now that risk appetite is drying up, those flaws look extremely worrisome.  Key EUR levels to look for are around 1.26 (50% retracement level of the June-August euro rally) and then around 1.2430 (62% level). 

The yen has continued its recent gains.  The way higher was smoothed after it was acknowledged that Japanese Prime Minister Naoto Kan and Bank of Japan Governor Masaaki Shirakawa had not discussed possible intervention measures today while having a conversation about the economy and the yen. Swiss franc firms as SNB signals little willingness to intervene.  SNB President Hildebrand said over the weekend that “We’d reach our limits at the point where a possible additional expansionary monetary policy would spark inflation over the longer term.”  However, he added that the central bank would still be able intervene if needed.  Swiss franc is firmer across the board today and so EUR/CHF is making new lows for this move and is on track to continue probing the downside and is nearing the July 1 low around 1.3070.  Given the safe haven flows being seen by rising risk aversion, we had questioned whether the SNB would dare intervening now.  If market sentiment continues to deteriorate, then there’s not much the SNB can do to counter the safe haven demand into the franc and so new lows in EUR/CHF are likely in the cards.

Australian dollar has stabilized after trading softer during the Asian session due to weekend elections ending in a likely hung parliament.  Early results with 75% of the voted counted show a dead heat between ruling Labor (72 seats) and opposition Liberal-National coalition (70 seats).  We note that 2 independents that won seats have expressed opposition to the resource tax.  The Greens won 1 seat but 5 seats are still too close to call.  Absentee ballots may prove to be decisive, as final results won’t come out for another up to another 10 days.  Hung parliament for the 150-seat body suggest the Greens and/or independents will play king-maker.  Liberal’s Abbott has pledged to rescind the controversial tax if elected, and so a Liberal victory is the most bullish outcome for Australian markets.  AUD vs. USD will be tricky to trade given the recent swings in risk on/off sentiment, but we remain confident that our long AUD/short NZD trade recommendation remains in play despite the election uncertainty.  With news of Potash board rejecting BHP Billiton’s hostile bid, there was other M&A news today as Australia’s biggest brewer Foster’s saw its shares surge after a press report that UK-based SABMiller may make a GBP7 bln ($10.9 bln) bid for its beer division.  Foster’s announced back in June that it was planning to split its wine and beer business lines.

Strong growth figures from Thailand underlined the current optimism about EM prospects compared with developed countries.  The Thai figures echoed recent reports from other Asian countries such as Taiwan and Malaysia with better than expected growth rates. The Thai economy grew 0.2% in Q2 from the previous quarter, down from 3.3% growth in Q1, but compared with an expected contraction of 1.4%. From a year ago, growth was at 9.1%, better than the 8% growth expected, but down from the 12% pace seen in Q1.  Of course, we acknowledge that EM will find it hard to decouple if the US/global slowdown intensifies, but that is a story for tomorrow (and beyond) and optimism is underpinning EM assets for now.   Singapore’s CPI inflation climbed more than expected to 3.1% in July, up from 2.7% in June.

Upcoming Economic Releases
Only US data release scheduled today is the June Chicago Fed national activity index due out at 8:30 EST/12:30 GMT, and is expected to improve to -0.1 from -0.63 in May.  Hungary central bank announces policy decision at 8:00 EST/12:00 GMT, and is expected to keep rates steady at 5.25%.  At 9:30 EST/13:30 GMT, Brazil reports July current account data that is expected at -$4.35 bln vs. -$5.18 bln in June.  At 10:00 EST/14:00 GMT, Mexico reports June retail sales that are expected to grow 4.3% y/y vs. 5.0% y/y in May.  Israel central bank announces policy decision at 10:30 EST/14:30 GMT, and is expected to keep rates steady at 1.75%.  At the same time, Fed’s Hoenig testifies at Congressional hearing.  At 13:00 EST/17:00 GMT on the US economy.