Consolidative Tone Emerges

There are some observers who are suggesting that the negative swap rates in the US (from fixed to floating) is undermining the dollar just as it undermined sterling. This seems mistaken. The strongest major currency against the dollar over the past five sessions has been sterling. But even more to the point, the dollar’s recent pullback, like its strength through Q1, appears to be more a function of developments outside the US than in it. Specifically, the European debt situation and Greece in particular weighed on the euro. As Europe closed ranks, at least papered over differences, the euro found better support. We expect another leg of support for the dollar to grow and that leg is about positive developments in the US. In particular, interest rate differentials are moving in the US direction. This is changing the incentive structure. The whole US coupon curve is now above Germany’s—for the first time since mid-2007. Although Europe will be largely closed on Friday and the US equity market will be closed, the US will be reporting the March jobs figures. It is expected to mark an important turn with the consensus looking for around 200k increase. The data may be skewed to the upside by weather, other seasonal factors, and census workers. The underlying trend looks to be 50-100k. Suspicions that the European debt problem is not really resolved and the near-term strength of the US economy may limit the dollar’s downside.

While much attention in Europe is focused on Greece, reports that the Irish government is going to take a larger stake in its top banks, also seems to be weighing on the euro. Reports suggest the government’s share in Allied Irish will rise to 70% from 25% and to 40% in the Bank of Ireland from 16%. In addition, reports indicate that the tens of billions of euros of toxic assets will be transferred from five Irish banks to the National Management Agency. Irish bonds have taken it well with 10-year yield, rising a single basis point. The yield is up 4 bp over the past 5 sessions. ECB President Trichet told the European Parliament last week Ireland could be Greece role model, but we demur. The situation in Greece seems more problematic and would note that the difference in rating would support this view. Trichet was likely implying that Greece should have Ireland’s resolve and determination. With nearly 70% of Greek bonds owned by foreign investors, the demand placed on Greece cannot be so heavy that it makes default a reasonable alternative.

Japanese data was rather disappointing after the spectacular retail sales reported on Monday. February industrial output fell nearly twice what the market had expected. The 0.9% decline was the first drop in a year. Nevertheless, with the Asia-Pacific region growing and Japanese exports growing, we suspect the weakness of this report is exaggerated. Mitigating factors include the sharp 2.7% rise reported in January and the early lunar new year this year. Perhaps more worrisome was the unexpected 0.5% decline in overall household spending. The consensus was for more than a 1% gains. Still, with unemployment holding at a 10-month low (4.9%) and the job-to-applicant ratio ticking up, the real take away story is that the Japanese economy is also enjoying a fragile recovery. The Tankan Survey (April 1 in Tokyo) is expected to underscore the message with a marked improvement.

With corrective forces gripping the foreign exchange market, yesterday’s US personal consumption figures may have been lost in the shuffle. However, the 0.3% increase, is the fifth consecutive monthly increase and, assuming consumption is 2/3 of the economy, it could be contribute 2 percentage points, if not a little more, to Q1 GDP. Disappointingly, cyclically sensitive durable goods purchases fell, with non-durable expenditures rising 1.6% and services (including utilities) increased by 0.5%. There are two sources fueling the consumption. First, wages and salaries are increasing; 0.4% over the past 3 months compared to 0.2% the previous 3 months and -0.9% in the three months before that. In addition to higher wages and salaries the second source of funds to finance consumption appears to be coming from savings. Personal savings as a percentage of disposable income has fallen form 4.9% in June last year to 3.1% in February. This data series is volatile, but is suggestive of an underlying trend.