Dollar Broadly Stronger as Euro Zone Concerns Deepen

BBH CurrencyView

The US dollar is posting modest gains against most of the major and emerging market currencies to start what is likely to be among the most important weeks here in the first quarter, with numerous central banks meeting, first tier economic data and the deadline for the Private Sector Involvement (PSI) in Greece. The yen is bucking the trend, recovering from its pre-weekend losses helped by cross rate gains. Global equity markets are lower, with the MSCI Asia Pacific Index losing almost 1%. Chinese Premier Wen cut China’s GDP target this year to 7.5% and the sub-50 reading on the official service sector PMI (48.4 from 52.9) is taking a toll on regional bourses and sending the yuan to a four week low against the greenback. European equities have followed suit, as a downward revision from the flash service PMI (48.8 from 49.4 flash reading and 50.4 in Jan) and concerns of light participation in the PSI weighed on prices. The Dow Jones Stoxx 600 is off nearly 2/3 of a percent near midday in London, with basic materials and the financial sector the heaviest sectors with only health care advancing. Given the disappointing data and equity losses, and pullback in gold and oil prices, one would have expected a greater reaction in the debt markets than the largely flat reading from the core and modest losses in the European periphery.

There are three main highlights of the week ahead outside of the plethora of central banks that meet, for which we do not expect any change in the G10, but do expect Brazil to deliver another 50 bp cut in the Selic rate on Thursday.

First, the PSI “invitation” to participate in the bond swap ends 3 pm EST Thursday. Given the complications of the process, it is expected that many investors will have to really decide by Tuesday. Press reports indicate a slow start and soft participation. Investors seem more cognizant that the risks of triggering the retro-fitted collective action clauses are higher. Recall that 75% must participate to avoid this, which would most likely been seen as a credit event in the sense of triggering credit default swaps. Less than 66% participation and even the CACs will be invalid, which would seem to scrap the entire Greek 2.0 package. The second LTRO is thought to have helped strengthen the firewall, protecting Spain and Italy and the sharp drop in yields in recent weeks have provided some cushion to absorb the shock, but there remains great uncertainty.

Second, US employment report at the end of the week is expected to show the third consecutive month of more than 200k job growth. The unemployment rate has fallen for five consecutive months, but the fact that this is not just a function of job growth, but also large numbers of people leaving the work force has tended to take the gloss off the numbers. However, this has come under greater scrutiny and it appears there is a structural shift taking place. One study found that only about a third of those leaving are classified as wanting a job. Only about 1 in 7 of those leaving the job market is in the 25-54 age group, which is regarded as the prime employment age. The bulk of those who are leaving the job market and do not want a job are in the 55+ age group. In turn this would suggest the output gap may not be as great as those viewing the labor market developments in purely cyclical terms claim. The Mexican peso and the Canadian dollar have tended to react positively to strong US data.

Third, at the end of the week China reports it monthly series that includes, consumer and producer prices, industrial production, retail sales and investment. It is important that these reports are for the month of February and are expected to be cleaner reads after the Lunar New Year distorted the January series. Nevertheless, we expect the data to confirm a gradual slowing of the economy, while more moderate food prices can see the CPI rate fall back under 4% from 4.5% in January. We look for the gradual easing of monetary policy. Meanwhile news that China plans to increase its defense spending by 11.2%, has grabbed media attention, though the growth rate is somewhat smaller than last year. Separately, there were no big surprises from China’s high profile meetings so far. The headlines focused on (1) the GDP target set at 7.5% from an 8.0% for the last several years; (2) the inflation target was set at 4%, the same as last year; (3) the increase in 11.2% in defense spending, which was actually lower than last year’s spending, but still high enough to capture the media’s attention. All in all this seems consistent with China’s “selective easing policy,” which implies no large scale stimulus as in 2008-09 but still erring on the side of more stimulus, not less. As expected, Premier Wen focused his public address on financial sector and tax reforms, socialized housing and improving the living standards of low income Chinese people.