Dollar Pops Back

BBH CurrencyView

• Dollar is broadly stronger against the majors and EM currencies after Greece rejected calls for direct budget control
• Asian stocks fell, with the MSCI Asia Pacific index down 0.9%; EuroStoxx 600 is currently down 0.7%
• Economic data saw Spanish Q4 GDP contract, EZ confidence rise less than expected; US personal income

The dollar is broadly stronger against most major and EM currencies as risk appetite dwindles on continued uncertainty over the developments surrounding Greece and French President Sarkozy’s pledge to impose a financial transaction tax starting in August. As a result, French banks are currently down 5.3%. EUR/USD is trading at 1.3126 down from a recent high of 1.3234, and looks set for the first lower close after rising in five consecutive sessions. As expected, AUD and NOK were the underperformers in DM while high beta EM currencies such as ZAR, INR and RUB saw the larger losses against the dollar. Italian sovereign debt yields are up as much as 30bp across the curve despite a favorable result a €7.5bln bond auction. Also of note, Portuguese 10-year yields are up 83bp to 15.48% as investors remain concerned that Portugal will be the next in line to have to restructure its debt.

EU leaders meet today, in the first EU heads of state summit of the year, to discuss the new fiscal compact for tighter budget control that would move the euro zone closer toward a fiscal union. Overall, the Summit is expected to focus on finalizing plans for the ESM (with the possibility of topping up the mechanism to €500bln, together with the fiscal compact and policies to stimulate economic growth and employment. The ECB has complained that the plans have been watered down compared to the original agreement in December and details of the proposed treaty changes will be watched carefully also by the central bank. Markets hope that the agreement will give the ECB more room to maneuver, given that stricter rules and further budgetary oversight is likely to limit moral hazard concerns. At the same time, a new fiscal compact is also hoped to help stabilize markets and reduce the fiscal risk premium in the euro zone. Yet there is no sign of an agreement in Greece, which has rejected calls for budgetary commissioner to oversee the Greek budget as part of a new bailout package. Consequently, developments on this front may steal the spotlight form the summit and in our view uncertainty over the outlook for Greece is likely to temper momentum in the EUR after its 5-day winning streak. Near-term support is seen between 1.3075 – 1.3080, with downside break of that range opening up 1.290. Resistance seen near 1.316.

On the data front, preliminary Spanish GDP contracted 0.3% q/q in Q4, as expected. Domestic demand was -0.5% and the positive contribution from external demand was somewhat lower than in Q3, reflecting the slowdown in exports and Spain’s trading partners due austerity and the intensification of financial market stress. German state inflation data, meanwhile, suggested that national CPI figures will come in higher than expected. Nevertheless, we doubt this is likely to limit the ECB’s ability to cut as euro zone CPI is expected to moderate further in January, supporting expectations for further easing.

Foreign investors have poured back into the Brazilian equity market since the start of the year. In the first three weeks of January, foreign investors have bought BRL5.3 bln, which could very well end up surpassing the BRL6.1 bln that came in May 2009. The Bovespa is up almost 11% through January 27, recouping a good chunk of the 18% decline seen last year. More foreign interest is expected as the six month IPO drought is soon to end with two new offerings–a Brazilian unit of Norwegian oil and gas company and a tourist company are expected to each seek around BRL1.2-1.4 bln. Foreign investors have also bought an estimated $4.8 bln of Brazilian bonds this year. The real itself has rallied about 7.5% against the dollar this year, trailing slightly behind Mexico to lead the region.

India’s rupee has appreciated for four consecutive weeks to reach an eleven week high. This is the longest streak since last April. The rupee has gained about 7.5% against the dollar,the same as BRL. The rupee is recovering from a slide in August through mid-December that saw it lose about a quarter of its value. What looks to be the best month in decades for the currency needs to be placed in this larger context. The recovery of the currency has allowed the central bank to ease a bit through cutting required reserves (January 24). The Sensex 30 benchmark fell a little more than 21% last year. It has recovered a little more than half of that here in January. Foreign investors have bought about $1.5 bln of Indian shares, which is about 3-times more than acquired in the same period last year. According to the exchange data via Bloomberg, foreign investors have sold Indian shares on only one day this year, January 2nd. Taiwan is an exception. Although it has seen foreign investors buy $1 bln of local shares, this represents a sharp fall (~95%) from a year ago.