Dollar Under Pressure at Start of the Week

The foreign exchange market has responded to the EU/IMF deal by reducing short euro positions. The latest IMM data showed that as of as of last Tuesday, March 23rd, the next speculative position was record short euros. The short-covering rally began before the weekend, with the euro recording a fresh low for the move just below $1.3270. The rally to $1.3425 on Friday has been surpassed by a full cent today. Additional position squaring seems likely over the next couple of days. The next target is near $1.3550-70. Dips to $1.3400-20 will likely be bought.

Despite polls still showing the likelihood of a hung parliament, sterling is also benefiting from the unwinding of long dollar positions. Sterling briefly poked through the $1.50 level where it hit a wall of sellers. Provided initial support in the $1.4950 area holds, sterling can make another run toward $1.5025 and maybe even $1.51 over the next day or two.

Meanwhile cross rate pressures and ideas that Japanese repatriation ahead of the fiscal year end is complete may have emboldened some yen sales. Japanese retail sales rose 0.9% in Feb for a 4.2% year-over-year pace. This is the fastest since 1997, but failed to trigger yen buying. Dollar support is seen in the JPY92.20-40 area and resistance seen last week in front of JPY93.00 may be vulnerable in the next couple of days.

The fact that the EU/IMF came up with a backstop for Greece has some other implications. For one, it showed a victory for the politicians over the central banks. Both the ECB and BBK seemed to back down from their opposition to a more substantive role for the IMF. Trichet’s opposition and climb down is well documented. Less appreciated is the BBK’s stance. In its monthly report released on March 22, the BBK noted: “The IMF’s mandate stipulates that it may only use its foreign currency reserves to bridge short-term balances of payments deficit.” Solving structural problems doesn’t have a foreign exchange component.

Second, what began as a Greek debt issue, morphed into a more serious institutional threat to EMU, which very well may require treaty modifications and greater institutional capacity.

Third, some fissures have appeared in the German government, not just between the CDU and its smaller coalition partner the FDP, but also within the CDU. The schism between Merkel and Schaeuble may reflect a deeper debate about Germany’s future role in Europe.

Fourth, Fitch’s downgrade of Portugal last week and today S&P reaffirmation its negative outlook for the UK (thought maintained the AAA rating) suggests that Europe’s debt problems will likely continue to hang over the market.

US debt concerns have also risen in recent sessions. While it is tempting to dismiss last week’s soft auction results as a one-off related to the proximity of the end of the quarter and fiscal year end, but there are a number of worrying signs that also may be encouraging the profit-taking on long dollar positions. Due to falling payroll taxes due to high unemployment means that Social Security will likely have to pay out more in benefits than it receives to the tune of almost $30 bln. A deficit was not expected until 2016.

The other big issue in the US debt market is fact that the 10-year swap rate fell below the 10-year Treasury yield. This is seen as an unintended consequence of the huge supply of US Treasuries. The key economic report this week is the March jobs data. The consensus is near 200k. On top of that auto sales figures are expected to be strong as well (12 mln unit pace from 10.36 mln in Feb). The combination of a stronger jobs market and healthy consumption figures may make for a difficult environment for US bonds, but could give the dollar better support in the second half of the week. Separately, note that the swap rates in the UK have been below gilt rates since January. It is near -20 bp from around -10 bp prior to last week’s budget.