Dollar Firmer as Periphery Pressures Mount

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Highlights

The US dollar is stronger, benefitting in part from euro weakness as the sovereign debt returns to the fore and geopolitical tensions linger. The euro fell to the lowest level in a week, down three of the last four days, following the downgrade of Spain’s debt rating. In addition, with the euro’s bearish break of January’s high near $1.386, downside momentum is likely to push the euro to test the $1.3750 level assovereign pressures mount. The BoE left rates on hold, as expected, with sterling staging a brief rally after strong industrial and manufacturing output, but stalled out ahead of $1.62. The tensions in MENA continue to weigh on risk appetite and in turn have stoked demand for the Swiss franc and the Japanese yen, both receiving safe-haven bids against the crosses, though weaker against the dollar. The Scandi’s are among the weakest performers in the G10, driven by weak inflation prints, while the New Zealanddollar softened on the RBNZ 50bps cut.

Global equity markets are broadly weaker heading into the third year of the bull rally, stymied in part by geopolitical tensions and the potential impact of higher oil prices on growth. Asian stocks retreated after the weak session on Wall Street, sending the benchmark index to a two-week low as the MSCI Asia Pacific index dropped 1.5%. Korean firms were among the biggest decliners, with the Kospi down by 1% after the Bank of Korea raised its lending rate. European bourses could not escape the lingering anxiety as the Euro Stoxx 600 is down 0.5% (at levels not seen since January 31), while Spanish financials are down over 2% on the downgrade. Despite today’s decline in crude oil the global benchmark advanced 21% YTD, while base metals are lower again with concerns about growth festering.

Global bond markets are firmer as the risk-off mode prompted demand for safe-haven assets. In Europe, the key development was Moody’s rating downgrade of Spain’s debt to Aa2 from Aa1 with a negative outlook to boot. Euro zone spreads have flared up again after Monday’s downgrade of the Greece’s rating and this latest downgrade, adding pressure to periphery sovereign yields as European policymakers gather to discuss a permanent crisis rescue mechanism. As such, sovereign CDS prices are on the rise with the Greece, Irish and Portuguese 5-year reaching fresh highs. Core government bonds remain firm, with 10-year gilts outperforming bunds, despite the UK’s strong economic data, with 10-year gilts yields down 4bps. US Treasuries are mostly flat after yesterday’s strong auction results.

Currency Markets

After a largely quiet first half of the week, there are a number of noteworthy developments today. The most important of which is arguably Moody’s downgrade of Spain to Aa2 and maintaining a negative outlook. It is important because it took place hours before the Bank of Spain is to publish each bank’s capital needs. Spanish officials have indicated that it would not exceed en toto €20 bln or 2% of GDP. Moody’s says it could really cost up to €50 bln. The government seems livid. Greece, which Moody’s cut three notches earlier in the week is also irate, complaining to the EU and there has been some suggestion of legal action. The euro fell on the unexpectedly timed to almost $1.3800 where demand, purportedly from Middle East and sovereigns, emerged and lifted the single currency back toward yesterday’s lows near $1.3850. In addition Moody’s downgrades, note that reports over the past couple of days suggests the bank stress tests may not be as robustas hoped after last’s July’s disappointment and the compromise over the competitive pact is also an exercise is dilution–less surrender of sovereignty–which means less required action.

Two countries adjusted interest rates. The Reserve Bank of New Zealand delivered a 50bps rate cut. The market was largely divided between a 25 and 50 point move. After the initial drop, the New Zealand dollar has continued to trade heavily and appears capped near $0.7380. The rate cut is best understood as a temporary move that the central bank says will have to be reversed once the rebuilding begins. While it acknowledged the economy was under-performing its expectations even prior to the earthquake, central bank head Bollard suggested that he anticipated no additional rate cut unless the situation deteriorates further. Separately, aswidely anticipated South Korea hiked key rates 25bps to 3%. It is the second hike this year and comes after inflation surpassed the target for two consecutive months. Recall Thailand hiked rates earlier this week. Ironically, the South Korean won was the worst performing Asian currency, losing a little more than 0.5% against the US dollar. Although the Kospi’s 1% decline was in line with the other major Asian equity market losses, foreign selling pressure was particularly acute with almost $1.1bln in sales today, brings the week-to-date liquidation to $1.55 bln, compared with about $2bln liquidation in the year up to this week.

China unexpectedly reported a trade deficit for February. The $7.3bln shortfall is the largest monthly trade deficit in seven years. The consensus was for a surplus of around $5bln. While some observers may see in the data the long awaited shift toward internal/domestic led growth, such a conclusion seems premature. The data was skewed by the lunar New Year. Germany reported a smaller than expected trade surplus in January of €10.1bln about 30% smaller than expected. The key to the disappointment was that exports fell 1% on the month instead of the rise of 0.7% that the consensus expected. Another look at the data reveals the re-orientation on German exporters that is one of the important aspects of its economic prowess. Exports within the euro zone rose almost 19% from a year ago. Exports outside of the EU increased by nearly 31%. Yet if the net exports may weigh on German growth at the start of the year, France looks to have accelerated a bit. January industrial production rose 1%, twice what the market expected. Lastly, in terms of data, while the Australian dollar is trading heavily, it is not because of the jobs data. The headline loss of 10k jobs is misleading as there was a large shift from part-time jobs (-57.7k) to full-time (+47.6l). The rise in full-time jobs was more than twice the consensus forecast of total job creation.

Upcoming Economic Releases

The US data calendar is light again today with March 5^th initial jobless claims reported at 08:30 EST / 13:30 GMT (376k expected vs. 368k prior) followed by the trade balance (-41.5bln expected vs. -40.6bln prior). Canadian January trade figures (2.6bln expected vs. 3.0bln prior) at 8:30 EST / 13:30. Events: ECB speakers begin at 10:00 EST / 15:00 with Gonzalez-Paramo and Mersch both expected to speak, Axel Weber speaks in London at 10:00 EST / 15:00.