US Dollar Struggling to Avoid Collapse through Risk, Rate Speculation
- US Dollar searches for direction through unstable risk trends and policy forecasts
- Fed surprises rate hawks by keeping its vow to maintain rates at an “exceptionally low” level for an “extended period”
- Does a late reversal in the US dollar set up a true revival for the currency’s sidelined bull trend?
- Fed surprises rate hawks by keeping its vow to maintain rates at an “exceptionally low” level for an “extended period”
- Does a late reversal in the US dollar set up a true revival for the currency’s sidelined bull trend?
The lynchpin to the dollar’s ability to span both extremes of the risk spectrum is the interest rate outlook. The United States is already considered to be ahead of the curve for economic recovery; however, the implications expansion has for yield (or expected returns on capital invested in the US) requires tangible results. On this front, the forecast for monetary policy has improved considerably over just the past few weeks. In fact, overnight index swaps from Credit Suisse are pricing in approximately 88 basis points worth of rate hikes over the coming 12 months – the most hawkish forecast in a month and notably more bullish than the outlook for the ECB or BoE. This establishes pace; but establishing a stable role for the dollar at the upper echelons of the yield curve is the timing of the first rate hike. This past week, the Federal Reserve discouraged rate hawks by maintaining its warning that rates would remain “exceptionally low” for an “extended period.” However, this does not necessarily put the dollar at a disadvantage. The removal of this phraseology would likely set expectations for the first tightening of the Fed Funds rate to a time frame of two to four meetings following the announcement. This matches up reasonably well with the remarks being dropped at the April gathering given Fed Fund futures have priced in approximately a 50 percent probability of a hike in September and a 67 percent chance of rates rising to at least 0.50 percent by November. In the meantime, the FOMC continues to tighten the policy reins in other areas. Lending facilities established to support liquidity through the financial crisis are scheduled to expire at the end of the month and speculation is running high of a follow up hike to the discount lending rate.
While rate speculation develops in the background, the dollar will remain especially sensitive to large swings in sentiment trends. Looking ahead to next week, there are potential catalysts for the UK (the 2011 budget release) and Euro Zone (the deadline for a Greek bailout plan). Beyond these known events, it would not be out of the question to see an unexpected progress report from China on its asset bubble, the US on its deficit fight or one of the credit rating agencies. Given the capital markets’ rise to new highs recently, the scene is ripe for a bolt of uncertainty to shake unabashed speculative build up. In the meantime, the US docket itself is light. The Chicago Fed’s National Activity Index is notable for its scope; but it lacks market moving impact. The same can be said about the durable goods and home sales figures – though all this data should be mentally processed for its impact on growth expectations. - JK
Euro Will Struggle to Develop a Trend with Greece Back in the Headlines
Fundamental Forecast for Euro: Bearish
The Euro was far and away the worst-performing G10 currency through the past week of trade, suffering once again due to continued struggles with the Greek fiscal crisis and questions on the stability of the European Monetary Union. Whether or not the EMU, International Monetary Fund, or individual Euro Zone countries will offer Greece a lifeline has been the topic du jour and the cause of great consternation. On the one hand, European Central Bank President and French President Nicolas Sarkozy have spoken candidly in favor of a Euro Zone-brokered agreement to assist Greece. On the other, Germany’s Angela Merkel has almost-vehemently cast aside the possibility of any such move. Continued political indecision and a Greece economy mired in fiscal problems may continue to hound the Euro and force further declines into the coming week’s trade.
Euro traders have long awaited a concrete plan of action that solves lingering fiscal crises, but current deadlock suggests markets may have to wait yet longer. Whether or not Germany—a source of many of the most fervent Euro skeptics—can agree to any plan involving European funds may be of chief importance. ECB President Jean Claude Trichet essentially laughed off suggestions that a Euro Zone country would depend on assistance from the International Monetary Fund. The fact that the United States is the largest stakeholder in the IMF could single-handedly rule out any such bailout—especially as it would implicitly imply that the US holds leeway over the European institution. The alternative—an EU bailout—looks likewise untenable if the union’s largest economy has openly refused to any such deal. Financial markets want answers and resolution, and the lack of compromise could force further Euro losses through upcoming trade.
We would otherwise be remiss to completely ignore upcoming economic data, but it will take large surprises to force substantive moves surrounding the second-tier economic releases. The possible exception is German IFO business confidence survey data. IFO indices have steadily trended higher through recent months, and it will be interesting to watch whether fears over EMU unity will be enough to shake the relatively sanguine outlook for economic growth. The fact that even the Reserve Bank of Australia based its own outlook for domestic economic conditions underlines the interconnectedness of the global economy. Given Germany’s literal and figurative proximity to Greece and other debt-stricken economies, we can only assume that any contagion would be of great importance to German businesses. - DR
Japanese Yen Outlook Clouded as Yields, Risk Compete for Influence
Fundamental Forecast for Japanese Yen: Neutral
- Japanese Large Manufacturer’s Survey Points to Jobless Recovery
- Bank of Japan Leaves Rates Unchanged, Doubles Bank Lending
- All Activity Index Outperforms in January on Service Sector Sales
Japanese Yen price action may remain indecisive for a second week against the US Dollar as the currency is pulled in opposing directions by its relationships with investors’ appetite for risky investments and the yields on US government debt.
Sunday will see US lawmakers voting on legislation to overhaul America’s health-care system, a proposal that is projected to cost $940 billion dollars over the next 10 years by the Congressional Budget Office (CBO). The same projection also suggests that the measure – through various spending cuts and new revenue – will cut the fiscal deficit by $138 billion over the same period. However, the actual measure being voted on has been changed since the CBO’s assessment to help secure enough votes for passage. Further, even the previous cost/savings assessment assumes that Congress will actually do what it tells the CBO will be done, which is often not the case for politically unpopular things like excise taxes and reduced spending. On balance, the passage of the bill will likely create uncertainty about the degree to which it will compound the US’ already considerable fiscal shortfall. If markets perceive the headline CBO reading to be rosier than is realistic, long-term borrowing costs may see upward pressure on expectation that government will now need to issue more debt than previously expected. The short-term (20-day) correlation between USDJPY and the yield on benchmark 10-year US Treasury bonds stands at 0.72, hinting that such as outcome will pull the currency pair higher at least in the near term.
On the other hand, renewed escalation of the debt crisis in Greece has seen a return to risk aversion across financial markets. Greek PM George Papandreou has said that his country will be able to deal with their 2010 shortfall of 53 billion euros – 20 billion of which are needed by April and May – only if it is able to borrow on “reasonable” terms, otherwise turning to the IMF for help as a last resort. The comment was designed to prod the EU to offer something more concrete beyond broad statements of support for Greek austerity efforts, which have failed to meaningfully narrow the spread between the yields that Greece must pay to its lenders versus those required of Germany (the region’s benchmark). Policymakers will meet in Brussels next week to discuss a mechanism for offering Greece “coordinated bilateral loans” to stave off a default, calm markets, and bring down borrowing costs. However, reaching agreement will be all but impossible without support from Germany, the region’s top economy. Such support became suddenly remote last Thursday after an official inside the Berlin administration said that “in the case that the Greeks get into really serious problems, [Germany] would support an IMF solution.” Any involvement from the IMF would likely have negative implications for the EU and risk appetite at large, showing that the world’s largest economy is unable to keep its own house in order. This means that anything short of a decisive outcome in Brussels ought to bode ill for carry trades, a good deal of which are funded by borrowing cheaply in the Yen, meaning that any return to risk aversion is likely to put upward pressure on the Japanese unit as traders unwind their yield-seeking FX exposure.
British Pound Loses May Continue As BoE Weighs Options
Fundamental Forecast for British Pound: Bearish
- U.K. Jobless claims fell by 36K in February, the most since 1997
- BoE Continues To See Downside Risks
- Mortgage approvals slip to 48K from 49K
The British Pound sharply fell to end the past week as BoE member Andrew Sentence warned that the U.K. was still at risk for a double dip recession. Sterling saw across the board losses as the comments from the traditionally hawkish MPC member added weight to the potential for additional QE. The dovish rhetoric erased gains generated by a better than expected labor report, where jobless claims fell by 36,000 against forecasts for a rise of 6,000. The biggest drop since 1997 in the number of unemployed had brightened the outlook for growth fueling speculation that he central bank would bring an end to their asset purchase program at their next meeting. Minutes from the last meeting revealed the committee voted 9-0 to remain on hold for a consecutive month, as there was ``little evidence to suggest'' a change in the economic outlook. Some members did see an increase in upside inflation risks which helped fuel speculation that an end to quantitative easing was imminent.
Mortgage approvals unexpectedly declining for a third straight month should have been a red flag for sterling bulls. The six largest banks in the U.K. continue to tighten lending standards which led to a decline in new loans to 48,000 from 49,000, against expectations for an improvement to 54,000. The BoE’s concerns that restrictive lending could derail the recovery continue to be proven valid and a continuation of the current trend may force further action to provide liquidity to the market. Additional measures would be a bearish sign for the economy and could lead to accelerating pound losses. At the time of release the mortgage report was overlooked as markets focused on a smaller than expected budget deficit for February. Public net borrowing increased by 12.4 billion but missed forecast for 14 billion. Nevertheless, the overall deficit continues to grow and considering the concerns over Greece’s credit troubles, risks that the U.K. could see their AAA rating at risk may also fuel bearish sentiment.
The central bank has forecasted that inflation will eventually be dragged lower by existing slack in the economy. Therefore, the upcoming consumer price report could present major event risk. Economists are looking for inflation to have decelerated to 3.1% from 3.5% but remain above the BoE’s 30.0% threshold. Therefore, we could see another letter from Governor Mervyn King explain the breach and actions intended to bring price growth to the 2.0% target. A greater than expected decline in prices would allow the MPC to maintain easy policy which could be bearish for the pound. A positive retail sales report may help bring an end to the sterling slide as domestic demand is expected to improve by 0.6%. The improvement in the labor market supports a rosier outlook for consumer spending and the economy. -JR
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