Five Key Developments Including Vote on Greek Deal 2.0

BBH CurrencyView

The US dollar is broadly higher against the major and emerging market currencies to start what promises to be an important week, with several parliaments due to vote on Greek 2.0, the second and possibly final LTRO, and PMI readings. Eurogroup head Juncker’s admission that a third package for Greece cannot be ruled out may also be taking a toll on sentiment. The main exception to the generalization is the Japanese yen, which has seen initial losses reverse amid talk of Japanese exporter offers. Global equities are mostly lower, though the Shanghai Composite bucked the move to close at new 3-month highs, building on last week’s 3.5% gain amid expectations of further easing of monetary policies. The MSCI Asia-Pacific Index fell 0.8% and the Dow Jones Stoxx 600 is off about 1% near midday in London, with technology, health care and financials leading the way lower. Telecoms is the only sector ahead today. Italian and German bill auctions were well received, while the Belgian supply was absorbed without much fanfare. The decline in equities has encouraged a bid tone in most bond markets. Of note, Euribor has eased for the 48th consecutive session and is slipping below the ECB’s 1% benchmark floor for the first time since January 2011.

The euro is trading inside last Friday’s range. There was no follow through on the break of $1.3400. Look for a bounce back toward $1.3450 in the North America today. The dollar rose through JPY81.50 in early Asia only to meet a wall of sellers, thought to be Japanese exporters, but it took early European trading to break the JPY81.00 level. Bidders came back near JPY80.30. The JPY81.00 level now offers immediate resistance. Sterling barely took out Friday’s $1.58 high, but there was no follow through and it is in a narrow range, consolidating its recent advance.

There are five key developments. First, Australia’s Prime Minister Gillard successfully withstood a leadership challenge by former Prime Minister Rudd. However, the Australian dollar has not benefitted. Instead, the Australian dollar has seen follow-through selling after the pre-weekend reversal. Unwinding of yen crosses and fears that Gillard may call for elections appears to be weighing on sentiment. While support is seen near $1.0650, it may take a break of the $1.0570-$1.06 support to signify something of greater significance. Second, euro zone money supply improved in January (0.7%) and lifted the year-over-year rate to 2.5% from 1.5%. Yet the credit growth to the private sector rose a minor 0.4% to 0.7%. The gap between the rise in base money (ECB’s balance sheet) and broad money (M3) is still worrisome. Third, the G20 meeting pushed the IMF funding issue off to April. The pressure is on Germany to agree to a stronger firewall, which in essence means combining the remaining uncommitted guarantees of the EFSF (~250 bln euros) with the ESM (500 bln euros). This is seen as necessary to boost the IMF coffers. Yet, contrary to the press reports that simply add the projected funds the IMF will likely raise to the euro zone funds, as if all the IMF funds can be used to support Europe, there is already a push back against over-exposure of the IMF. Fourth, the German parliament is due to vote on Greek 2.0 today, even though the IMF’s role has yet to be determined, which means EU’s tab (and Germany’s) is also not fully known. Nevertheless, with the help of the opposition Social Democrats and Greens, the measure will pass, even though polls suggest a majority of Germans are opposed. Fifth, oil prices are lower today after hitting 9-month highs before the weekend. Brent is off almost $1 and WTI is off half as much. The profit-taking appears to have been spurred by concerns of weaker global growth and concerns that pressure is mounting to tap strategic reserves, as was coordinated last year to address the supply shock emanating at the time from Libya.

The Israeli central bank announces its rate decision later today and markets are looking for rates to be kept steady at 2.5%. Last cut was 25 bp in January and during this easing cycle, the central bank has cut by 25 bp every other month. However, economic data has been soft recently and so there is a chance of a dovish surprise cut today. CPI inflation is running at 2.0% y/y in January vs. 2.2% y/y in December, and is the lowest since August 2010 and right at the center of the bank’s 1-3% target range. 12-month inflation expectations of 2.4% in January remain near the January trough of 2.2%. ILS has been one of the worst performing in EM pack so far this year, basically flat against USD YTD. We think ILS is likely to continue underperforming, with major reasons being that authorities are likely to remain sensitive to currency strength along with rising political risk due to tensions with Iran. Even though much of EM is seemingly back on track after a very short and shallow correction, USD/ILS continues to test the upside after support held around 3.71 (trendline support dating back to August). Near-term target is the January high around 3.8654 after today’s break of3.80. After that is a retracement level from the 2009-2011 drop around 3.92.