Dollar Broadly Softer ahead of the Weekend

BBH CurrencyView

The US dollar is broadly lower against most major and emerging markets currencies with the notable exception of the yen. The euro broke above the 100-day MA to trade back to levels not seen since early December following the well received Italian auction and the approval of the swap plan by the Greek cabinet. The yen is underperforming amongst the G10 currencies, with the dollar rising against the yen to a recent high of 80.52. The Australian dollar is shrugging off the news that Fitch downgraded three Aussie banks, with the Australian dollar currently up 0.25%. Equity markets closed mostly higher in Asia and the EuroStoxx 600 is up 0.3%. Oil continues its parabolic rise with WTI up 0.5% on the day to 108.40 p/ barrel, bring the price of oil in EUR and GBP to historic highs. The rise in oil prices is also boosting the scandi’s with the Norwegian krone among the top performers in the G10 this week, up 2.2% against the dollar.

The two main features of the week’s activity are the euro strength and the yen weakness. The euro has moved to new highs for the year and has pulled the Swiss franc along for the ride. There has been some talk that the Swiss National Bank has quietly intervened today, but confirmation is lacking. The euro’s strength comes as investors accept official intent of building a firewall around Greece. Moreover, ECB’s Draghi hinted that there will be not more collateral liberalization. The market has priced in next week’s liquidity provision under the LTRO and suspects that could very well be the last one. The yen is the weakest of the major currencies, losing about 1.3% against the dollar this week and more than 3% against the euro. The driver was the BOJ’s unexpected expansion of its asset purchases announced on February 14. Yet, it seems incongruous that a country that has been implementing QE for years and continued to combat a strong currency through record intervention now sees the impact of its asset purchases.

The story appears a bit more complicated and the BoJ’s Feb 14 announcement was a stroke of good fortune. Two important factors seem to be at work. First, as we have noted, Japanese investors have stepped up their purchases of foreign assets this year just as foreign investors had slower their purchases of Japanese assets. Second, the same forces that have helped the euro strengthen are weighing on the yen. Namely, the great roll-over risk of 2012 has effectively been minimized by the LTRO and more liberal collateral rules. After trading roughly $1.30-$1.33, the euro has broken out to the upside this week. While the $1.3435 area is the next immediate target, we suspect the euro can advance toward $1.36 in the coming couple of weeks. The euro is moving above its 200-day moving average against the yen for the first time since last July. This will also help underpin the US dollar against the yen. There are barriers thought to lie around JPY81.00, but the more important offers may be closer to JPY81.50.

German Q4 GDP was confirmed at -0.2% q/q as expected and also in line with preliminary estimates. The second release also included a detailed breakdown of the components. The main drag to economic activity came from exports and private consumption. However, domestic demand slightly supported growth based on the strong underlying performance of investment, boosted by strong construction activity, though machinery and equipment investment remained flat. While the favorable weather conditions likely contributed to the strong construction performance, which may result in some payback in Q1, it is likely that moving forward a healthy outlook for wages and very low interest rates should both bode well for future household demand, while export performance should be supported by demand from the US and parts of Asia, though austerity in the periphery is likely be a drag. Italy’s December retail sales, which were much weaker than expected down -1.1% m/m against expectations of-0.5% illustrates the challenges facing domestic demand in the periphery.

The Colombian central bank announces its rate decision later today and markets are looking for another 25 bp rate hike to 5.25%, but we think the chances of a dovish surprise are significant. In the end, the exchange rate may be the deciding factor. The Colombian economy remains unquestionably strong but inflation has already started to moderate. CPI fell to 3.5% y/y in January from the 4% y/y peak in October, putting inflation back in the 2-4% range. Inflation expectations are well-anchored, as noted by the central bank, and the surprise 25 bp hike to 5.0% in January will certainly contribute to that. Moreover, COP is up 10% year to date, one of the best performing EM currencies. Officials have already taken measures to stem further declines, including resuming the USD purchase program and keeping dividends from the state-owned oil company abroad. A rate hike will only make their job harder. USD/COP is just 1.5% from the July 2011 lows after making a decisive break below the key 1800 level. We think that further COP gains could continue, but the headwinds will become ever stronger and the risk/reward may be more favorable elsewhere at this juncture.