Currencies Look Past Moody’s Downgrade

BBH CurrencyView

The US dollar is broadly mixed against the majors and EMs after the market appears to have shrugged off Moody’s downgrades of European sovereigns. The euro is currently flat after giving back some early session gains following the better than expected results from euro zone debt auctions in Italy, Greece, Spain and Belgium. The euro should remain confined to recent ranges ahead of tomorrow’s Eurogroup finance ministers meeting. The surprise in the Asian session was the move by the BoJ to ease policy by boosting asset purchases and defining a 1% inflation target. As a result, the yen is the weakest performing currency in the G10 against the dollar, down 0.6%. Sterling rebounded from Asian session lows of 1.568 to highs near 1.580. January inflation fell to 3.6% y/y as expected but the near-term focus for sterling should be tomorrow’s inflation report. The Australian dollar is currently flat after losing steam in the Asian session following positive business confidence data. Global equity markets are mixed with MSCI Asia Pacific index down, 0.4%, while European shares are currently higher with tech shares leading gains the EuroStoxx 600.

Central banks ability to surprise the market remains intact, even in these trying times. It was the Bank of Japan’s turn today. It surprised the market in two ways. First, it expanded its asset purchase plan by JPY10 trillion ($128 bln). Second, it set an inflation goal of 1%. As noted yesterday, the BOJ has come under more pressure locally to do more to arrest deflation in light of the weak performance in Japan and the more assertive action taken by the Federal Reserve and European Central Bank. It is the first expansion of its asset purchase program since October. Previously the BOJ had defined price stability as between 0 and 2%. It now suggests 1% is the goal. This still a bit ambiguous. For the record, Japan’s CPI has not risen by 1% in any year since 1997. Stil,l the surprise was sufficient to lift the dollar above its 200-day moving average against the yen for the first since mid-April 2011 (~JPY78.05). Nevertheless, the dollar needs to convincingly break the upper end of the 4-month range that extends toward JPY78.50. Although it is highly unlikely this is where BOJ intervention in the foreign exchange market would likely be more effective. It has the wind to its back and the intervention would reinforce the easing of monetary policy via asset purchases.

On the data front, the main focus today is twofold: euro zone industrial production and US retail sales. EZ industrial production dropped 1.1% m/m in December following a revised 0.0% m/m outturn for November. This reinforces our expectations for a negative Q4 GDP to tomorrow. However, this backwards-looking data is being overshadowed by the February German ZEW survey, which showed a sharp improvement in expectations. The data underscores that Germany remains the bright spot in the euro zone and that activity for Q1 is beginning to improve after the contraction in Q4 last year. Since the ECB’s LTRO in December, Bloomberg’s European financial conditions index has improved by nearly 2.5 standard deviations, indicating the potential for a pickup in the growth outlook as pressures ease in the bond and money markets. An improvement in euro zone growth picture should provide near-term support for the euro, especially given that short euro positions are still very prevalent. For example, CFTC data shows that net shorts at roughly 141k. Near term support for EUR/USD is seen near 1.298, with resistance expected to come in near the recent high of 1.332. US retail sales should be supportive of risk appetite this morning with the advanced figure for January seen improving to 0.8% following the disappointing 0.1% in December. In particular, both auto sales and chain store improved ahead of this morning’s reports, suggesting at least some of the slowdown in the consumption growth at the end of last year may prove temporary.

Chile central bank holds policy meeting. Markets are split but most expect rates to be kept steady at 5.0%. After the surprise 25 bp cut in January, it seems to us that the central bank could wait a month before cutting again. Price pressures continue to ease, but remain elevated at 4.2% y/y in January and still above the 2-4% target range. Exports came in stronger than expected in January while retail sales and IMACEC GDP proxy came in stronger than expected in December. For USD/CLP, the next key level is 459, the September low. In Hungary, today’s much higher-than-expected CPI print serves as reminder of the fundamental problems the Hungarian economy is facing. CPI accelerated to 5.5% y/y in January from 4.1% y/y in December, against expectations for an increase of only 5.0% y/y. The surprise was due to pass-through from the VAT hike and the weaker HUF late last year. However, both factors were expected by the central bank and likely to somewhat overstate the intensity of price pressures. Without a resumption of depreciation pressure on the forint, we do not expect the bank to continue hiking rates, especially after last week’s soft industrial data. Still, tomorrow’s 4Q GDP numbers will be an important data point to watch as markets re-focus in economic fundamentals. The 290 level in EUR/HUF has held the pair from moving lower over the last few session, but it should break if risk appetite gets another leg higher.