Greek Uncertainties Drive Flight to Safety
The US dollar continues to rally as uncertainty over the fate of Greece boosts demand for safety. Indeed, despite the well received euro zone bond auctions from, Spain, France and the Netherlands, the euro is trading near a 1-month low of 1.299, retracing nearly 50% of the up move that began in mid January. Sterling is largely unchanged against the dollar. The yen continues to remain under pressure, down 0.5%, while the Australian dollar has given back all of its Asian session gains following the strong employment report and is currently down 0.3%, to 1.066. Sweden’s Riksbank cut rates by 25%, as expected, with the central bank indicating that it expects the repo rate to remain at 1.5% until sometime in 2013. Swedish CPI also deteriorated sharply (-0.9% vs., -0.5% expected), while Norwegian Q4 GDP growth dropped to 0.5% q/q from 1.4% in Q3, though this was better than market expectations of 0.4%. Global stocks are falling back with MSCI Asia Pacific down 1.2% and the EuroStoxx 600 is down 0.7%. European bank shares are under additional pressure after Moody’s placed 114 institutions on review.
The Greek tragedy is spinning into a farce. Greece has proposed new 325 mln euro in savings, signed assurances and the Troika has apparently completed its sustainability report. Yet a deal is not in hand. The newest obstacle is that the creditor nations are concerned about implementation. Indeed, the current hold up stems from the fact that creditor nations are looking to tighten up the surveillance through specific mechanisms that are yet to be finalized. The take away from these developments are two-fold. First, a growing number of officials from the creditor nations are growing more confident that a hard default by Greece can be absorbed. This coupled with the next LTRO pending may embolden their demands. Second, the injury and insult will leave its own scars even while steps are being taken to increase integration and coordination. Italy’s Monti, who is emerging as an important voice, while Sarkozy has consistently been outmaneuvered by Merkel and now is basing his re-election in part on his good relations with Germany. This illustrates the larger point. He attributed some responsibility of the crisis to the softening for the fiscal rules by previous German and French governments themselves. Ironically, Germany, Finland and the Netherlands now appear to prefer to wait for after elections to make new commitments, while previously a technocrat government was thought to be essential for a resolution.
Australia’s January employment report came in well above market expectations of 10K, recording an impressive surge to 46.3k. This marks the fastest pace of job growth in more than a year. The details were also quite impressive with January seeing the second month in a row of strong full time employment growth, while the unemployment rate dropped to 5.1% in spite of the uptick in the participation rate. Conversely, one of the weaknesses in the report was the sharp drop in average hours worked, with additional aggregate demand for labor being met largely through existing employees working longer hours. Hours worked is just 0.2% higher from a year earlier. Nevertheless, we believe the pace of full time employment growth and the decline in the unemployment rate is strong evidence that the RBA will likely remain on the sidelines in March. Following the release, OIS rates have moved to discount the probability of an interest rate cut in March to 36% today from 50% yesterday and looking ahead further expectations for cuts down the road have consolidated as well. However, we continue to believe that the AUD is driven less by domestic policy and more by external risks. And with the risks of disorderly default by Greece rising by the day we believe that in spite of its strong economic fundamentals that the AUD will be bogged down by moderating risk appetite. Near-term support seen at 1.054; resistance at 1.08.
Brazil’s GDP for December increased at a pace of 1.47%, up from 0.79% in November, but short of market expectations at 1.6%. Brazil policy-makers are intent on boosting growth in 2012, with more easing ahead. Next COPOM meeting is March 6/7, and another 50 bp cut is expected then to 10%. This is likely to be followed by another 50 bp cut to 9.5% at the April 17/18 meeting. After that, further cuts are likely to depend on how the data responds to the previous rate cuts. BRL offers the unique and interesting combination of high implied yields and very low volatility. As we saw last year, central bank intervention led to collapsing BRL volatility, which when coupled with high NDF implied yields gave investors a very attractive risk-adjusted return. However, we appear to be in the midst of a much-needed correction in EM, something that we really haven’t seen all year. For USD/BRL, some initial retracement levels to look for from the big December-February drop are 1.7777 and 1.7984. 1.75 should also offer some resistance on the upside. The 200-day moving average around 1.70 is going to prove tough to break on the downside, especially as more FX intervention and other FX measures are likely to be seen when 1.70 is threatened. We remain bullish on EM longer-term, but see scope for a deeper correction before the next leg higher. Any near-term weakness should be viewed as a buying opportunity for EM.