Earthquake Sends Yen Higher, Dollar Remains Firm

BBH CurrencyView

Highlights

The US dollar is set to end the week higher, up four of the last five trading days, stemming from a combination of fiscal woes in the periphery, heightened geopolitical tensions and waning risk appetite. The euro headed for its biggest weekly drop in over two months after slipping down to the $1.3790 area ahead of today’s summit, which in our view is expected to provide a watered-down version of the competitiveness pact and likely to be a euro negative event. Sterling, likewise, continues to slide, down six of the past seven trading days, with today’s downside momentum stoked in part from weak PPI figures. The dollar is weaker against the yen, declining 0.7%, as the yen quickly rebounded amid the repatriation of flows into Japan following today’s devastating earthquake. In the dollar bloc, the Australian dollar is softer on weaker-than-expected Chinese data and the softer risk backdrop, while the Canadian dollar softened on a weak employment report.

Global equity markets continue to be battered with the “day of rage” protests in Saudi Arabia, coupled with the severe earthquake and subsequent tsunami in Japan, weighing on risk appetite. Asian stocks declined for the fourth day in five, with the MSCI Asia Pacific down 1.1%, while Japanese stocks lost 1.7% (mostly towards the end of the session), suggesting that cash market losses may be exacerbated on Monday. European bourses continued the downside momentum following the heavy losses on Wall Street and Asia, with the Euro Stoxx 600 at one point down over 1%, though it has pared some of its early session losses. Insurance companies sustained heavy losses, while the VIX is set to push through its 200-day moving average, following yesterday’s 8% gain. And finally, despite the fall of 2.4% in the global crude benchmark, base metals continue to fall as well, with “Dr Copper” declining another 2% today as growth concerns rise.

Global bond markets continue to be dominated by heightened risk aversion, stoking demand for safe-haven and pushing bonds higher. Atop the European agenda are today’s summits, after Moody’s downgrade of its Spain rating yesterday brought euro zone debt concerns back to the forefront. Peripheral yields are modestly higher, with Ireland’s 10-year up 6bps followed by Portugal’s, up 4bps. Otherwise, core bond market continue to receive safe-haven flows, with the 2-year bund and gilts yields down 5bps and 6bps, while US Treasuries are bid as well, with the 2- and 10-year yields both down 2bps. In the EM space, Malaysia, as expected, left rates unchanged at 2.75%.

Currency Markets

There are two main features in the foreign exchange market as North American participants return to close out the week. The first is a continued recovery of the US dollar in a backdrop of widening peripheral European bond spreads, the continued reversal of the global equity market rally and the ongoing MENA tensions. Indeed, within the context of market positioning (which has amassed a sizeable short dollar position in recent weeks, judging from the IMM data) the dollar’s steady decline and proprietary information. The second feature is the strength of the Japanese yen in the wake of an earthquake that may have been near 9.0 on the Richter scale. The typical expectation, based on past experience, is for Japanese investors to repatriate funds. This, of course, was very unlike the market response to the recent earthquake in New Zealand, when the local dollar was sold off. Two key differences: Japan’s net international investment position is in surplus. It has funds it can repatriate. And judging from the margin trading figures, retail in Japan, which industry estimates suggests could be in excess of 25% of the Japan’s foreign exchange turnover, had built a large long dollar position. Market talk suggest the liquidation of these dollars and may have been a key factor driving the dollar from above JPY83.20 to JPY82.00 and in the process adding to the weight on other major currencies as short-term cross positions are forced to unwind. Below JPY82.00, there is additional chart-based support near JPY81.60 and JPY81.00. In terms of the euro, it has slipped through the 20-day moving average (~$1.3760) for the first time since Feb 22. Initial support is seen in the $1.3730-40 area and a break could spur another 1% drop

In the euro zone, Portugal has announced additional spending cut measures, worth almost 1% of GDP and has brought forward to next year when its budget deficit will return to 3%. Nevertheless, the market has sold off Portuguese bonds today. Pressure is most acute in the short end of the coupon curve, with 2-5 year yields up 12-15 bp, while the 7-10 year yields are up 5-9 bp. There are some reports suggesting EU pressure may be built on Portugal to accept aid. Portugal, of course, wants to hold out. The government claims that the average yield on its debt stock is 3.6%-3.7%. Even assuming 4% yield on bills and 7% on all bonds, the government estimates that the average yield on its debt stock would still be below 5% in 2013. It has become quite obvious that the assistance packages to Greece and Ireland have not stabilized their interest rates and the terms of the assistance is not particularly attractive to Portugal. Germany seems more sympathetic about extending the duration of Greek (and by implications, it would seem, Ireland). Moreover, the new spending cuts today also may be understood as a precondition for assistance. A package for Portugal is possible from the weekend summit; we suspect March 24-25 summit is a more likely venue. However, we continue to resist the idea whenever it is forthcoming that a bailout of Portugal is any more useful than that of Greece or Ireland. Those countries are more indebted than they were before, while interest rates are higher. The EU/IMF funds are used primarily to keep private sector banks, often foreign to boot, whole.

China, the world’s second largest economy, reported a slew of economic data. The key take away is that activity appears to be leveling off and price pressures may have begun stabilizing. One of the key issues has been inflation and Feb CPI came in at 4.9%, the same as in January and a bit higher than the "leaks" in the local press. The other key is retail sales which rose 11.6% on a year-over-year basis, matching the slowest rate since March 2006. That said, industrial production and investment were reported stronger than expected and this would seem to point to only a modest slowdown and one in which the Lunar New Year may obscure.

Upcoming Economic Releases

At 8:30 EST / 13:30 GMT the US reports Feb retail sales (1% expected vs. 0.3% expected) followed by Mar UoM confidence (76.3 expected vs. 77.5 prior). Afterwards, business inventories which are expected to remain unchanged. Canadian January trade figures (2.6bln expected vs. 3.0bln prior) at 8:30 EST / 13:30. Events: Fed’s Dudley (FOMC non-voter) at 8:30 EST / 13:30 GMT, BoE King at 3:45 EST / 20:45 GMT.