Nervous Market: Key Developments

The market is  becoming a little skittish ahead of tomorrow’s ECB.  Although the euro’s recovery off the $1.3460 low yesterday was impressive,   follow through buying has not materialized.  The spread between US and German short-term rates, that is doing a good job of tracking the euro-dollar exchange rate, has stabilized and correcting the sharp move against the US.   

Many are wary of comments by Draghi that could either dangle the possibility of a rate cut or in other ways signal displeasure at tightening of financial conditions in the euro area.       Recall that in December there were many on the ECB that wanted to cut rates, but in January apparently no one did.   There is also some apprehension ahead of Spain's bond auction tomorrow, which is the first since the latest scandal broke, and more importantly, since the LTRO funds were repaid. 

In addition, part of the euro’s recent advance has been sparked by appreciation that the ECB’s balance sheet is shrinking and the Fed’s is growing.  Yet this too is being called into question.  The German paper Die Welt reports that Ireland and Portugal are pressing their case for triggering the ECB’s OMT, under which it would buy short-term coupons in the secondary market.  This would of course expand its balance sheet.  There appears to be resistance to this effort.  The threat of OMT may be more potent than its actual use. 

Provided that the $1.36 level is not overcome, the we continue to see risk of the euro slipping toward $1.3400.      

Hollande’s call for a EMU currency policy and a medium term target for the euro will provide fresh fodder for talk of currency wars.  However, this is an articulation of the traditional French stance, but to appreciate that means that the fascination with currency wars is misplaced.  The foreign exchange market has always been an arena that conflicting national interests are expressed.  The military metaphor also confuses words with actions.  There is no evidence that the “currency wars” are spilling over into increased trade tensions.     Seeing the world through the lens of currency wars also forces strange conclusions, like last July before Draghi uttered his famous words (whatever it takes), Europe was winning the “currency wars” as the euro approached $1.20.

 

The dollar was pushed above the JPY94 level, encouraging strong gains in the Nikkei.  News that BOJ Governor Shirakawa  will step down a few weeks  early, in line with the end of his deputies’ terms, is seen as bringing forward the time of more aggressive monetary policy.      In addition, the IMF’s Lipton (formerly at the US Treasury) endorsed the new 2% inflation target.  The G20 meet Feb 15-16 and the push back against Japan is likely to be limited.    Japanese officials appear to have already backed away from citing price targets and this will also help keep the focus on Japanese policies rather than rhetoric.  Initial support for the dollar is near JPY93.50, while many have their sights set on a test on JPY95 before the week is out. 

The Australian dollar is the biggest mover today and that is to the downside, following disappointing retail sales that fell by 0.2%, rather than increase 0.3% in December.   Adding insult to injury the Nov series was revised to a 0.2% decline rather than 0.1%.  Retail sales fell every month in Q4, after posting declines only twice in the previous nine months.  The Australian dollar fell to its lows since mid-Nov near $1.03.  We look for additional near-term losses toward $1.0260 and $1.0160 in the coming weeks.   News of a 2.4% increase in dairy prices underscored the divergent news stream between Australia and New Zealand.  While the RBA will likely cut rates next month, the RBNZ is on hold with a tightening bias.  The Aussie/Kiwi cross fell to 2 ½ year lows.  The NZD1.20-NZD1.21 is a reasonable near-term target.