Economic Weakness Boosts Demand for Dollar and Yen; Chinese PMI Down

BBH CurrencyView

The US dollar is broadly firmer after weaker-than-expected data reports in China and the euro zone. The euro is erasing earlier gains and breaking below this week’s previous lows around 1.313 after March’s PMI composite disappointed expectations, even in Germany, with readings below the boom-bust level of 50. Sterling is down after February retail sales also disappointed. The dollar is softer against the yen, with USD/JPY breaking below 83.0. Global stocks are mixed, with the MSCI Asia up 0.4%. Despite the softer data, policy action gave some investors hope that China will ease policy further. European stocks are faring much worse, down for the fourth day. The EuroStoxx 600 is down 1.1% with bank shares down nearly 1.5%. Portuguese yields are coming down for a second day, despite a general strike organized by unions as a protest against the government’s austerity measures. Oil prices are down today from soft data worldwide, which is the lone bright spot today since high oil remains a big risk to the global recovery.

The theme of the day is one of economic weakness. New Zealand GDP (0.3% q/q vs. 0.7% prev), HSBC China PMI (48.1 vs. 49.6 prev), euro zone PMI composite (48.7 vs. 49.3 prev), and UK retail sales (-0.8% m/m vs. 0.6% prev ex-auto fuel) all came in weaker than expected. While some of these numbers can be volatile, the timing of the reports couldn’t be worse given rising concerns in recent days about a China hard landing along with softer global growth. German manufacturing PMI was particularly weak, falling to 48.1 vs. an expected rise to 51. Needless to say, the high beta currencies are taking it on the chin today while the dollar is largely firmer. Despite this week’s corrective trade, most currencies remain within this month’s trading ranges. Notable exceptions are AUD and ZAR, with the dollar today making new highs against them for March. The dollar seems likely to remain firm for now, but we need to see more trading ranges broken before declaring that the next leg of the dollar rally is upon us. On the yen front, it may have reverted back to a safe haven play as dollar/yen broke below 83, helped by a slight narrowing of the 2-year US-Japan yields to 24 bp.

The yen may also be benefitting from the unexpected rise in February’s trade surplus. The trade balance returned to a surplus of ¥32.9bln in February against expectations for a ¥120bln deficit. While exports are still declining (-2.7% y/y), the speed of deceleration eased from January’s -9.3% y/y. It’s too early to say this improvement is due to the weaker yen, but the trend bears watching in the coming months. Given the reconstruction efforts in Japan and the return to normal supply chain activity following the Thai floods, Japan’s economy is showing signs of improvement. In the near-term, however, we think that the yen is likely to advance from market positioning, which needs to adjust from what appears to be a stretched short yen trade. Support tested today around 82.80, which is a retracement level from the March rise in dollar/yen that is followed by 82.40 and 82.0. Recent highs near 84 offer upside resistance.

The US reports weekly initial jobless claims for the week ending March 17. The report may draw more than usual attention today as it covers the same week as the non-farm payroll survey. Weekly claims are on their cyclical low, but improvement has slowed. The four-week moving average has been essentially flat for almost a month, though at 356k compares with 389k a year ago. Still, the improvement from the February survey week is small, warning of some moderation in US job creation after the strongest six months since 2006. Such a report may reinforce the more constructive tone in US Treasuries and the profit-taking in equities, and would fit in with the soft tone set by other data globally.

The unofficial China PMI softened to 48.8 from 49.6 in February, fuelling growing concerns about the prospects for the economy. This was followed by the PBOC announcement that it will cut required reserves by 2% for the Agricultural Bank of China. That this easing comes before the official PMI on April 1 appears to give the unofficial measure some more weight. On top of the cut, an editorial in the China Securities Journal noted an increased likelihood of more aggressive interest rates cuts because lending volumes remain depressed. The article speculated that easing would come after the bank earnings reporting season has ended on March 30. There are also reports that more banks (this time in Nanjing and Beijing) are offering lower interest rates for first-time home buyers between 5-10%. All of the above is right in line with our expectations for a combination of slower growth with gradual increase in easing. On the FX front, CNY saw the strongest one-day appreciation this year today, fixing nearly 0.4% stronger to just below 6.3 and cancelling out the entire depreciation since the start of the month. We expect USD/CNY volatility to increase this year, but for spot to stay roughly around this level until the end of the year. Speculation is that the stronger fix is a bid to curb capital outflows. It seems completely reasonable that outflows are increasing, but we doubt this would be a problem for the PBOC just yet.