Dollar Snaps Back

The US dollar is broadly higher in Asia and Europe.  Comments by Greece's Papademos put the cat among the pigeons and the euro, and the foreign currencies more broadly, have been unable to recover.  We had anticipation a correction and although we got it, we had expected it to continue a bit longer and deeper.  The speed of the reversal is leaving many, including ourselves a bit off balance.  That said, the short-term momentum readings are stretched and it appears to require new negative news to keep the upward momentum intact. 

Few probably are as surprised as Papademos by the impact of his comments.  Essentially he seemed to say that a Greek exit is possible but disastrous, and acknowledged some preparation.  The alternative is years of austerity, he said.  The only exception we would take with that assessment is that austerity of some magnitude will be necessary even if Greece leaves the EMU and repudiates all of its debts, including to the official sector.   That is the point.  

When it came to sterling, we countered arguments that ongoing M&A activity was responsible for its relative strength, noting that mergers and acquisition take a period of time to be funded and that often it is for shares not cash and even when it is for cash, sterling is often borrowed rather than bought.  Yet today, news that Germany's SAP will pay $4.5 bln cash for US-based Ariba is thought to have added weight on the euro.

It is possible that with the new lows being recorded that the euro's drop to $1.2615 completes the down move.  However, the pace at which it fell and the fragility of sentiment warns of the risks of such a call.  It may be best now to wait for some technical confirmation that a near-term low is in fact recorded.  

Sterling itself has been undermined by two developments and they both point to increased likelihood of a new round of gilt purchases as early as next month.  First, the BOE minutes seemed to indicate that the decision not to extent QE last month was a close call--which gives more credence then to the new data.  And that has been favorable for QE, which brings us to the second development:  horrific retail sales.  The 2.3% decline in the month of April is roughly three times larger of a decline than the market expected and more than offset the 2.0% rise in March.  

Separately, note that Deputy PM Clegg indicated that the government is putting together a large state-backed investment program for housing and infrastructure.  Although it was suggested that this has long been part of the government's plans, it does seem to be parallel with the shift in tone in EMU as well.  

Sterling fell to about $1.5680, bringing this month's loss to about 3.8%.  Of note, the $1.5640 area corresponds to a 61.8% retracement of the rise off the mid-Jan lows.   The $1.5750 area now offers resistance and needs to be overcome to stabilize the technical tone.  

The Bank of Japan may have surprising some participants by standing pat.  There has been pressure on the BOJ to do more to support the economy.  We also noted the technical issue of the Japanese banks not allowing the BOJ to buy as much 1-2 year notes as it was committed to under its asset purchase plan.  This, we thought, increased the risk that it would extend the maturities it purchases.  Not.   

Separately Japan reported a JPY520 bln April trade deficit.  This was about 10% larger than the consensus.  However after seasonal adjustments it came in at JPY480 bln, which was considerably smaller than the JPY617 bln expected.  Exports rose 7.9% year-over-year, while imports rose 8%.  The year-over-year comparisons are flattered by last year's disasters.  Auto exports, for example, are up about 220% year-over-year.  

Moreover, Japan's export growth is function of a better US economy.  Consider that Japan's exports to the US rose almost 43% year-over-year.  Shipments to its largest trading partner, China, are off 7% and off 2.6% to all of Asia and off nearly 2% to Europe.  

The recovery of the yen seems to be mostly a function of the general risk appetite more than specific Japanese news, which taken together also seems somewhat supportive of the yen.