The Chairman’s Testimony

The US dollar remains under pressure as the divergent outlook in monetary policy across central banks continue to underpin currency movement. The euro extended its recent gains, just ahead of the yearly high near $1.386, supported this morning by better-than-expected economic data. Sterling, in addition, remains firm breaking through $1.63 and reaching a new 13-month high as the market remains optimistic about a BoE rate hike. At the same time, the so-called safe-currencies are the weakest performers in the G10, with the dollar edging above ¥82.00 for the first time in three days, while the Swiss franc sold off despite the strong-than-expected GDP print.  The Swedish krona is the best performer on the day, up 0.4%, after Swedish GDP came in faster-than-expected.  EMs continue to firm.

Global equity markets continued on their recent ascent as stocks returned to last month’s cyclical highs as they continue to absorb Mideast tensions and rising oil prices. Asian stocks advanced for the third straight day with the MSCI Asia Pacific index up 1.1%, while Japan’s Nikkei made its biggest single day gain in a month advancing by 1.2% as the weak yen boosted sentiment. European bourses took their cue from Wall Street and Asia to trade at their best levels in five days, with the Euro Stoxx 600 up 0.3%.  The Swiss benchmark index was amongst the best performers in Europe led by a 4% advance in the energy stocks, while German stocks rallied for the third straight day as the European Commission (EC) raised its economic-growth forecast.  Elsewhere, Mideast stocks continue to reverse heavy losses.

Global bond markets have pared recent gains, at both the front-end and back-end of the curve, as risk appetite returns, softening demand for safe-haven securities. In Europe, economic data continues to outperform expectations, prompting a move out of bonds.  As a result, 2-year bunds and gilt yields are up 2bps, while US yields are firming ahead of Bernanke’s testimony and as market tensions continue to abate. Peripherals are mixed, with Spanish and Italian bonds apparently benefiting from rate hike expectations and the spread over bunds coming in, while Ireland, Portugal and Belgium look more mixed.  The cost of insurance against a default of Mideast nations continue to moderate, with the 5-year CDS price of Egypt, Tunisia and Qatar all declining from recent highs.  The bank of Canada meets this morning and is expected to leave the lending rate unchanged but may offer some insight into its currency views.

Currency Markets

The combination of the strength of the European data and Federal Reserve Chairman Bernanke’s semiannual testimony before the Senate, which is unlikely to signal an early end to QEII, is reinforcing ideas that Europe is likely to raise rates before the US.  This continues to weigh on the dollar.  Talk of recycling of petrodollars as oil producers seeking to maintain allocation of reserves adds to the dollar pressure.   Nearly every euro zone country that reported a manufacturing PMI came in above market expectations.  Both the German and French series beat the flash report out last week.  Germany posted a new record high.  The overall euro zone reading matched the flash at 59.0 from 57.3 in January, which is the best since June 2000.  That that priced moderated to 85.3 from 85.7 in the flash report offers little consolation.  It was 79.2 in January and the EMU flash February CPI came in at 2.4%, a tick higher form January. 

The strength of some of the periphery PMIs, such as Ireland to 56.7 from 55.8, its highest since 2000, must be seen as a favorable development.  Even Spain’s headline that ticked up ever so slightly to 52.1 from 52.0 is the strongest in 10-months.  On top of this Germany reported joblessness fell 52k in February, more than three times better than the market expected.  The EC followed this up with revising higher euro zone growth forecast to 1.6% from 1.5%.  German and French growth was revised higher to 2.4% and 1.7% respectively from 2.2% and 1.6% in the November forecasts.  Spanish growth was lifted to 0.8% from 0.7%, Italy was unchanged at 1.1%.   Taken as a whole, the deepening and broadening of the euro zone recovery may boost ECB confidence to continue to normalize liquidity provisions and lay the groundwork for a rate hike later this year.

Bernanke’s testimony is unlikely to be surprising.  As chairman, he has increased the transparency and enhanced the effectiveness of the Fed’s communication with the market.  He is likely to acknowledge the evidence that the economic recovery is strengthening.  However, the mandate of price stability and full employment remain elusive.  This is after all what the FOMC statements have indicated.  More recently, Fed officials have also seemed to emphasize that their commitment to ensure that inflation expectations remain anchored.  At the same time, Bernanke may have to explain how a commodity shock pushes weighs on growth while lifting measured inflation.   In such an environment, the Fed has, in the recent past, used official speeches to contain inflation expectations, not monetary policy.

There has been a slate of other European data.  Sweden reported Q4 GDP of 1.2% quarter/quarter for a 7.3% year/year pace. This simply reinforces expectations of additional Riksbank hikes and a stronger krona.  The Swiss economy expanded 0.9% in Q4.  The 3.1% growth for the year shows the resilience of the economy in the face of the strength of the Swiss franc, even though Q3 GDP was revised lower to 2.6% from 3.0%.  Exports did slip on the quarter, but the 4.0% surge in investment shows how Swiss businesses will cope with the currency strength–boost productivity through capital investment.  Lastly, note that the UK PMI was also better than expected at 61.5, the same as in January.  This is important.  It should boost the sense that the Q4 contraction is not being repeated in Q1.   On the margin, the risk of a surprise rate hike from the BOE next week appears to have risen.  While this is not the most likely scenario, the risk is rising, more so for it than the ECB on this Thursday or the SNB later this month. 

Upcoming Economic Releases

At 10:00 EST / 15:00 GMT the US reports January construction spending (0.4% expected vs. -2.5% prior) followed by  February ISM manufacturing (61.0 expected vs. 60.8 prior) and February ISM prices paid (83 expected vs. 81.5 prior).  Afterwards, February total vehicle sales (12.6m expected vs. 12.53m prior).  Events:  At 9:00 EST / 14:00 GMT the BoC announces interest rate decision, 10:00 EST / 15:00 GMT Bernanke’s testimony, Bundesbank Nagel speaks at 10:30 EST / 15:30, Greece Retail sales for December and EU issues economic forecasts.

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