ECB Rate Outlook Still Dominates Currency Markets

BBH CurrencyView

Highlights

The US dollar begins the week on a softer footing with expectations that the Fed will lag behind many of the developed market central banks remaining the key underlying theme. The euro continues to firm, shrugging off the news of the Greece downgrade, and closing in on a 4-month high. Sterling, likewise, continues to trade on a firmer footing after falling for the previous two trading days, closing in on last week’s high of $1.634. The dollar is mixed versus the Swiss franc and the yen, with the dollar declining versus the yen as the yen shrugged off the resignation of Japan’s foreign minister, while Swissy is the weakest performer in the G10 versus the dollar as investors take some profits. The New Zealand dollar remains under pressure as the market begins to anticipate a rate cut from this week’s RBNZ meeting. Asian currencies are mixed, with the South Korean Won and Indian Rupee the weakest performers as crude pushes higher.

Global equity markets are mixed as the surge in oil prices may eventually translate into lower profits. Asian stocks tumbled after reaching their strongest levels in two weeks on Friday, with the MSCI Asia Pacific index declining 0.9%. Japan’s Nikkei fell 1.7%, declining on the back of higher oil prices, which continues to impact Japan’s terms of trade as a major importer of oil. European bourses reacted less violently to the fluctuating price of crude oil, with the Euro Stoxx 600 up 0.1% buoyed in part by M&A activity. And despite the advance, financials were a drag on the Spanish, Portuguese and Irish indices ahead of the results of the banking sector stress tests. Crude oil advanced over 2% amid MENA tensions, with gold attracting safe-haven flows and a touching a new high, while base metals are softer.

Global bond markets are heavy, despite the rising geopolitical tensions, as investors still remain cautious over inflation. In Europe, the main development is that Greece was downgraded to B1 from Ba1 by Moody’s, which continues to see a risk of restructuring. The downgrade move in turn prompted the outperformance of short-date German bunds, with the 2-year down 1bps, while periphery yields were under pressure. As such, the 10-year Irish yield reached a euro-era record of 9.477%, while the Portuguese 10-year yield advanced by 10bps – reaching a new record as well to sit near 7.392%. Elsewhere, gilts are softer with both the 2- and 10-year yield up 1bps and 5bps amid a higher run in the FTSE, while US Treasuries are softer ahead of this week’s $66bln worth of auctions.

Currency Markets

It appears the foreign exchange market is being driven by one overriding consideration and that is that the ECB is going to raise rates as early as next month. The debt crisis on the periphery has been ignored. Fitch cut the outlook for Spain before the weekend, noting that the financial sector may need another 38 bln euros and the euro bulls where unfazed. Earlier today Moody’s slashed Greece’s rating by three notches to B1 and retained a negative outlook, citing difficulty collecting revenues and implementation risk. The rating agency said that the risks of default or distressed exchange had increased since it last cut Greece’s rating near the middle of last year. Moody’s noted that 20% of the B1 rated sovereigns and companies default within five years. The euro wobbled, pulled back to near $1.3960 and then soared to new highs since November.

Reports indicate Germany has rejected Irish requests for lower rates on the aid package from the EU. Ireland’s request is not finding sympathy among several other members either. The new Irish cabinet is expected to announce as early as tomorrow. With very little room to maneuver, the new Irish government may introduce laws that allow a restructuring of senior bank liabilities that are unsecured and not guaranteed. The actual impact on Irish debt budget is thought to be relatively modest, but of some symbolic value. Meanwhile on Wednesday, Portugal is going to try to raise 0.75-1.0 bln euros in a new bond issuance, the first since the mid-Feb syndicated offering. It appears that foreign investors were net sellers of Portuguese bonds last year, while domestic banks and insurers absorbed the government’s supply. Some estimates suggest the ECB absorbed the foreign selling. Unlike Ireland and Spain, Portugal did not really experience a boom and its problem stems from the chronic grind of lost competitiveness. The EFSF head Regling was quoted over the weekend suggesting that he did not expect Portugal or Spain to ask for aid. The market is less sanguine.

Japan’s foreign minister Maehara resigned over the weekend over a funding scandal and this has negative implication for Japan’s fiscal position. Recall that the next fiscal year’s budget passed the lower house, which means it will become law, but the funding of it is being held up by a revolt within the DPJ and by the opposition in the upper house. Maehara had been tipped as a possible successor to Prime Minister Kan, but his resignation appears to weaken Kan’s hand. Kan’s support continues to fall and there is increased speculation he may resign if the DPJ does not do well in local elections in April. Meanwhile, in the week through March 1, speculators in the IMM futures market swung position around again by buying tons of yen. Recall that up until the middle of February, the net speculative position was long yen. As of Feb 8, the next speculative position was long 36,7k contracts. This swung to a short 18.5k by Feb 15. The next short position was extended to 27.7k as of Feb 22, but as of March 1, the position swung back to net long by 41.3k contracts. This is the largest net long position since last Nov. Last week we noted the divergence between speculators, who where short yen (at the IMM) and real money, which had been buying Japanese stock, bonds and bills in size this year. The latest data shows speculators and real money are on the same side: long. Support for the dollar is in the JPY81.50-60 area looks likely to be tested and a break signal a return to the JPY81.00 area.

Upcoming Economic Releases

The US data calendar is light today with the only release coming at 3:00 EST / 20:00 GMT, where the US releases January’s consumer credit. The market consensus is for $3.400bln from $6.099bln prior. In Canada, January building permits are released at 8:30 EST / 13:00 GMT with the market expecting a decline to 0.5% from 2.4% prior. Events: Fed’s Lockhart (FOMC non-voter) speaks at 8:00 EST / 13:00 GMT followed by Fisher (FOMC voter) at 9:15 EST / 14:15 GMT, EU Panel votes on short-selling legislation, Bank of Portugal releases data on banks