Dollar Softer on Better Risk Backdrop

BBH CurrencyView

• Dollar is trading on its back foot following solid EZ debt auctions; IMF seeks to increase lending capacity
• The key issue today is whether North American players will sell into euro bounce; 20dma seen at $1.2875
• UK Claimant count better than expected, US production data in focus; Chinese equities lower on the day

The dollar continued to trade on its back foot as the market maintained a better risk backdrop following the solid debt auctions in both Portugal and Germany and news that the IMF is seeking to boost its lending resources to $1 trillion. Tomorrow’s longer data auctions in France and Spain may prove more challenging and the outcome of Greece’s negotiations with private investors remains uncertain. There are also news reports that Fitch will follow up its December ratings warning with downgrades of 6 euro zone countries. Nevertheless, the euro advanced for the second day in a row, currently up 0.6%, trading at 1.281 followed by a 0.2% gain in sterling off the back of the better than expected claimant count data, though the jobless rate moved up to 8.4%. Asian stocks rose, with the MSCI Asia Pacific index up 0.3%, while European shares recovered earlier losses, with the EuroStoxx 600 essentially flat on the day.

The key issue today is whether North American players will sell into the euro bounce as they did yesterday, frustrating the euro bottom pickers — especially on the crosses. The euro now has scope to test the $1.2875-$1.2900, before coming back off. Note that the euro has not closed above its 20-day moving average against the dollar since Oct 31. It comes in today near $1.2875. The $1.29 area corresponds to a 61.8% retracement of the euro’s losses since Jan 4. The €14.5bln that Greece needs to repay on March 20 is increasingly becoming an important date for market participants. Fitch yesterday warned Greece was going to default on the payment. Yesterday’s comment from a hedge fund manager, partly involved with the negotiations with Greece suggested that a deal would be worked out (PSI), and seemed to suggest that the March 20 payment could be included in the agreement. Many participants are understandably concerned. There is talk of very good demand for $1.10 euro puts that would cover that period. The PSI talks resume today and one of the most effective incentives to induce the private sector participation to make an agreement the least bad scenario. Brinkmanship tactics may be effective for negotiators but it is difficult for market participants.

In the UK, the December claimant count was much better than expected at +1.2k, versus the consensus of 7k. The November data was revised slightly lower to just +0.2k from 3.0k. The claimant count rate remained at 5.0%, though the November ILO unemployment rate unexpectedly rose to 8.4% from 8.3%, the highest rate since January 1996. Average earnings growth slowed to a 1.9% pace in 3m y/y terms to November, having moderated further to 2.1% in September from a July high of 2.8%. The drop-off in the claimant count over the past couple of months is certainly welcome news. While public sector wage increases were capped at 1.0%, yesterdays inflation figures revealed a sharp drop in CPI to 4.2%, suggesting that real incomes may receive a marginal boost. Overall, despite the improvement in claimant count, stagnant wage growth and moderating inflation should provide more evidence for the BoE to expand its QE program next month. We still expect sterling to gradually depreciate against some of the non-European crosses and the dollar. However, the likely intensification of the euro zone debt crisis should keep sterling well support against the euro. Near-term resistance is seen near 1.548, while support is expected to come in near the recent low of 1.524. In the North American session the main data release will be the US industrial production for December. The consensus is for a 0.5% improvement driven by the recovery in global production following the Thai floods. Indeed, recent data suggest that apart from the November reading, manufacturing output appears to have extended the streak of strong growth seen since last summer. This would be positive for risk appetite and sentiment.

Chinese equity markets are lower on the day after yesterday’s biggest one-day move since early October, but once again the news flow was positive. Local news wires suggest that RRR will be cut later this month, given that about CNY 12bn of PBoC bills maturing in February. Note, however, that SHIBOR rates continue to spike hiker, up a whopping 426bps over the last five sessions for the 14-days maturity. This suggests to us that the chance of a cut in RRR over the Chinese New Year’s is growing, which surprise many investors and would be positive for markets. Separately, another report said that QFII quotas may be doubled from the current $30bn cap. In addition, the China Securities Journal reported that authorities are considering cutting taxes and introduce other policies to encourage long-term stockholdings by institutional investors. According to 2011 data, 26.5% of local stocks were held by individuals, 57.9% by corporates, but professional investors and funds only accounted for 15.6%.