Dollar Rally Stalls as US Yields Back Up

BBH CurrencyView

The US dollar is mixed after the broad dollar rally is losing steam into the North American open. The euro is currently flat after rallying from overnight lows of 1.300 following the encouraging auction results from Spain. An eventual downside break of 1.30 sets up an eventual test of 1.26, the January low. Sterling is the weakest performer in the G10 against the dollar, thanks in part to Fitch’s move to place the UK’s outlook to negative. The dollar is losing steam against the yen as well after breaking 84, driven again by the rise in US yields. US 10-year treasury yields continues to rise, up 4 bp to 2.305%. Global stocks are mostly mixed, with the MSCI Asia Pacific up 0.3%, though stocks in China closed lower on the day. The EuroStoxx 600 is flat, with banking shares down 0.2% on the day.

Euro zone is on the back burner for now. Despite what we see as an unsettled solution to the Greek saga and ongoing risks in Spain, euro zone governments were able to place a heavy load of debt issuance this week at lower yields. Today, Spain placed EUR3 bln of debt. While below the EUR3.5 bln maximum, demand was strong as bonds maturing in 2016 saw an average yield of 3.37% vs. 3.75% previously and a bid-cover ratio of 4.13 vs. 2.21 previously. Similarly, French yields declined and bid-covers rose at its bill auctions today. That suggests much of this current leg of the dollar rally is due more to the improved US side than from what we see as a still-worrisome euro zone side. In that regard, Greek unemployment rose to 20.7% in Q4 from 17.7% in Q3, while Spain house prices collapsed -11.2% y/y in Q4 vs. -7.4% in Q3.

Indeed, the recent back up in US yields over such a short time period has been astounding. Even with the Fed seemingly intent on anchoring the short end of the US curve, the 2-year UST yield continues to march higher and is now around 40 bp, up 15 bp year to date. On the long end, the 10-year yield has risen 43 bp to 2.3% and the 30-year by 53 bp to 3.43%. As note before, higher US rates have been a big part of the story behind recent dollar strength, as interest rate differentials continue to move in the dollar’s favor. As dollar/yen rose today to a new high for this move above 84, the 2-year US-Japan spread rose to an intraday high around 30 bp, the highest since July 2011, before falling back to 27 bp. The 60-day rolling correlation between the levels of USD/JPY and the 2-year US-Japan rate differential has risen sharply since late January, and currently stands around .92 vs. the trough of -.59 back in mid-December. We still target the April 2011 high of 85.53. Similarly, the 2-year US-German spread is now around 16 bp, the highest since June 2010. While the 60-day correlation with EUR/USD has been weakening steadily since mid-January, the 30-day has been rising back to positive territory in recent days, and is one of the factors we see as dollar-supportive. US data today for March could give the dollar rally another boost.

The SNB leaves policy unchanged, as expected. The economy is seen in relatively good shape with the SNB revising its forecast for Swiss GDP this year up from 0.5% to 1.0%. EUR/CHF spiked yesterday but has come down a bit, but the Swiss franc should continue to weaken against a backdrop of reduced tail risks in the euro zone. As a result, it remains unlikely that Swiss policy makers will increase the EUR/CHF floor as some have speculated. EUR/CHF seen moving higher, but support seen at the 50-day MA around 1.208.

Fitch late yesterday followed Moody’s in placing the UK outlook to negative on its AAA, implying a one-in-two chance that it will downgrade within a two-year time frame. Chancellor Osborne will deliver the 2012-13 Budget next Wednesday and he has also already made clear that there will no unfunded spending increases. Osborne will likely stress supply-side reform and other initiates as the best means to boost demand next week. Our own model puts the UK at AA, and so we think a downgrade is long overdue. Sterling is likely to remain under pressure against both the dollar and euro. EUR/GBP has likely bottomed near-term and likely to move higher as sterling outperformance ebbs. This pair is now pushing up against near-term resistance at the 50-day MA (0.835). Support is near recent low around 0.830.

Brazil COPOM minutes are due today at 7:30 EST. These will be particularly interesting after the bank’s decision to deliver a bigger-than-expected cut of 75 bp at the last meeting, and markets want to see the rationale behind that move. USD/BRL seems to be in a 1.79-1.85 range for now, and the real has staged some impressive recoveries from recent selling pressures. Charts point to a test of the December higher around 1.8860, but strong demand has emerged above 1.83. Much depends on whether markets are comfortable with the more aggressive easing stance, so the near-term tone for Brazil markets hinge on these COPOM minutes. Longer-term, we do think the EM rally will resume and gain traction, leading to USD/BRL to move back towards 1.70. We understand 1.70 to be the new line in the sand, and so an approach of that level would likely bring on more FX measures. At current levels, however, we do not see any new ones emerging.

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