Markets Stabilizes but Tensions Remain High

BBH CurrencyView

The US dollar is flat to lower against most major and EM market currencies. Yesterday’s pessimism over the Greek PSI participation has given way to a nervous holding pattern after more debt holders say they will accept the offer. The euro is slightly higher against the dollar after having retraced more than 61.8% of the rally since February 16. German January factory orders at -2.7% m/m came in far below the expected 0.6% m/m gain, with export orders contracting -5.5% m/m. The data helped bring EUR/USD off its intraday highs. AUD made some modest gains, moving back to test the 50-day MA at 1.0562 despite a weaker 4Q GDP release of 2.3% y/y (exp. 2.4%) and 0.4% q/q (exp. 0.8%) fanning expectations of further easing by the RBA. NZD is outperforming amongst majors ahead of today’s RBNZ meeting after failing to break below the 200-day MA yesterday. Oil prices are up about 0.5% after yesterday’s sharp declines. The MSCI Asia-Pacific Index fell 0.9% catching up with declines of US stocks yesterday, while the Nikkei fell 0.6%. European bourses are 0.25-0.9% higher with the notable exception of the Spanish IBEX index, falling 0.7% driven by sharp declines in the utilities sector.

Spanish 10-years yields continue to rise above those of Italy, and suggest that Spain may be the next country in the hot seat. Data released today confirms that the contraction in Spanish industrial production is still ongoing, with January IP falling -4.2% y/y compared with a decline of -3.5% in December. The spread between the two country’s bonds are now at 13 bp, a level not seen since August 2011, and up from a low of -202 bp in at the start of the year. News out of Greece is quiet ahead of the PSI announcement tomorrow, but markets appear to be pricing out the worst case scenario in favor of a likely muddle through solution. Even with Greek PSI out of the way, we fear that the news stream from Spain, Portugal, and others will continue to underscore the negative debt and growth dynamics.

ADP data today may offer some clues about Friday’s jobs report, but we suspect both reports will be overshadowed by euro zone concerns. Consensus for ADP is +215k vs. +170k in January, and would be consistent with continued improvement in the US labor market. Indeed, the fundamental theme of an improved US outlook coupled with euro zone recession could help the dollar to continue firming even after this current bout of euro zone turmoil ends.

RBNZ meets today and is expected to leave rates steady at 2.5%. Like RBA earlier this week, we expect RBNZ to maintain a dovish bias and to warn of downside global risks. AUD and NZD were hit particularly hard Tuesday. For NZD, next level of support is at the 200-day MA around .8090, which coincides with minimal retracement target of .8086 from the December-February rise. AUD has outperformed NZD recently, with AUD/NZD cross moving up to break 1.30 on Tuesday. However, that AUD outperformance may be over for now. Weak Q4 GDP growth print for Australia of 0.4% q/q (0.8% expected) represents a sharp slowdown from a revised 0.8% q/q (was 1.0%) in Q3, and will likely fan expectations of another RBA rate cut when it next meets April 3 as March RBA meeting contained language that left the door open to further easing. Add in worries about China growth. With regards to AUD vs. USD, 200-day MA around 1.04 is a good near-term target, while retracement targets are 1.0476, 1.0359, and 1.0241 from the December-February rise in AUD. While this point is moot now, RBA Deputy Governor Lowe said the bar for FX intervention is “quite high” and suggests low risk of action against AUD strength ahead. We do expect AUD to strengthen further along with most EM currencies once this risk off trading ends.

Brazil IP fell 3.4% y/y in January, far weaker than expected and supportive of further stimulus. Central bank makes its policy announcement later today and market is somewhat split. Analysts are still split between 50 bp and 75 bp cut, while the swaps market in Brazil is pricing in 75 bp, so someone is going to be surprised. We don’t think the economic arguments are strong enough to warrant accelerating the pace of cuts, but we also understand that political pressure is pointing that way. On Tuesday, USD/BRL traded up to 1.7650, the highest since February 1 and near the retracement target from the December-February drop in USD/BRL at 1.7644. Next one is at 1.7877. Poland central bank kept rates on hold as expected at 4.5%. Officials have sounded very hawkish recently, while economic data has come in on the firm side. For now, we think rates are on hold but we would downplay talk of tightening in this current global environment. PLN remains a high beta currency, and so EUR/PLN is likely to march higher given ongoing Greece concerns. Minimal retracement target for the 2012 drop comes in around 4.26, just above the 200-dav MA around 4.2466. EU warnings to Hungary regarding central bank and judicial independence suggest scope for disappointment in getting an IMF deal. EU also took action on Hungary’s excessive deficit, and gave it one month to respond. EUR/HUF should move higher to test 300.