Dollar Broadly Stronger on Turnaround Tuesday
The dollar is broadly higher today, and reflects a Turnaround Tuesday from the previous two days of dollar weakness. US housing data may prove supportive of the USD, but markets will be more focused on any hints of additional asset purchases from Bernanke’s speech today. The euro is down after failing to hold the 1.325 level, which continues to remain a key level of resistance. Support is seen near 1.315. Sterling showed a limited reaction to the UK CPI, which came in above expectations (0.6% m/m vs. 0.4% and 3.4% y/y vs. 3.3%), though the y/y rate continued its deceleration path since September’s recent peak of 5.2% y/y. The dollar is stronger against the yen but is likely to meet resistance at 84.00. Global shares are mostly lower, with Asia stocks drifting lower led by weakness in Chinese equity markets. Rumors of heightened China political tensions made the rounds, but we discount this. Japanese markets are closed for a public holiday. European shares declined for a second day, with the EuroStoxx 600 down 1%. European bank shares are down roughly 1.5%. Oil prices are down today, helped by press reports that Saudi Arabia is sending tankers to the US full of oil in order to help bring down prices.
Italy’s Monti has won well-deserved praise since replacing Berlusconi, but his most challenging test begins in earnest today as he meets with union leaders to work out a deal on labor reforms. From a high level, the problem is this: because the legal framework (crystallized in "Article 18" from the 1970s), older workers have proprietary rights in their jobs. Younger people either don’t work or are relegated to more tenuous short-term contracts, for which banks are reluctant to lend. Although Italy’s unemployment rate is below the euro zone average, its employment rate is about 57%, among the lowest in the area. In addition, due to the unfavorable demographics, Italian unions represent retirees more than workers. The thrust of Monti’s reform is to make it relatively easier, though still far short of the employment-at-will seen in the US, to hire and fire and to link more benefits with shorter term contracts. Labor reform has been in Italy what Social Security reform has been in the US–so controversial and antagonistic of various and conflicting vested interests that politicians typically avoid. Already the metal workers union is protesting even the discussion with 2-hour intermittent slowdown today. Labor reforms are so integral to Italy’s structural reforms that the failure here would jeopardize Monti’s legacy and could very well signal the end of Italy’s “financial" outperformance. Any renewed concerns about Italy or Spain would surely lead to further euro weakness. In that regard, Spain continues to simmer. After reporting that bad loans jumped to 7.9% of total loans in January from 7.6% in December, the 12- and 18-month bill auctions got a so so reception as it sold EUR5.04bln vs. the EUR5.5bln targeted amount. Spain bank lending contracted 0.7% m/m and 3.1% y/y in January, so the economic backdrop worsens.
The AUD is amongst the weakest currencies on the day. Release of the RBA minutes from the March 6 meeting showed it sees plenty of room to ease should conditions take a turn for the worse, while noting that it feels the current policy stance is appropriate. The OIS market has been steadily implying a greater chance for a rate cut over the past week. While no move in April is seen, the implied probability of a 25 bp rate cut in May has increased from 40% on March 15 to 45% currently. Support lies at the 200dma (1.04) with resistance seen near 1.064 on the way to our objective to test 1.07 and then perhaps 1.08.
Indonesia exceeded its targeted sales of sovereign debt in an auction today, placing IDR7.3 trln vs. the indicative target of IDR6 trln. Total bids amounted to IDR14.1 trln. According to the latest available data from the central bank, as of March 16, foreign ownership of local government debt has remained stable around IDR225 trln since February, while as a percent of total debt, it has remained stable at around 30% since late last year. Concern about sales of local debt by foreigners seems to have subsided but IDR has not recovered along with other EM currencies. Part of the reason for the underperformance can be attributed to growing outflows from investment income, including FDI and interest accumulated portfolio investment which partially offsets the benefits of a trade surplus and robust remittances. USD/IDR has been on a gradual weakening path since its strong gains in January, but has once again found resistance around the 9200 level. We still think that the risks are favorably skewed for IDR, as a sustained break above the 9200 level is unlikely. Meanwhile, BRL is likely to take it on the chin today after sharp losses were seen near the end of trading yesterday. Beside broad EM weakness today, comments from Monday are likely to carry over. Treasury official Augustin talked of using many FX measures in which surprise is “part of the game.” He also mentioned the SWF as a potential tool for FX intervention. While the comments were not new, they reveal the ongoing obsession with the exchange rate, and the prospect of even more measures may finally be wearing on the market’s appetite for Brazil. While 1.80 has proven to be a good anchor in recent days, we believe USD/BRL is likely to test the 1.85 in the coming days.