Consolidation in FX

The US dollar is narrowly mixed as a consolidative tone emerges. Technical pressures for a more serious bout of profit-taking on long dollar positions had been cut short by heightened concern about Greece’s ability to raise capital. Although the Greek debt market is calmer today, the issue has not gone away. That may help explain why the euro has hardly benefited from the stronger than expected service PMI (54.1 vs consensus 53.7), which is now at a two-year high. On the other hand, sterling was punished for a weaker than expected CIPS service PMI (56.5 vs 58.0 consensus). The Canadian dollar continues to march higher, moving above parity convincingly for the first time since mid-08. A recovery in Feb building permits, and healthy rise in the IVEY PMI will underpin expectations that the Bank of Canada will be the first G7 central bank to raise interest rates (June/July).

There are three points to be made about the debt market. First, Greek bonds are firmer, but have given back much of their earlier gains. The 10-year yield is down a single basis point, while German bund yield is off 2 bp. Greece’s 2-year yield is off 33 bp, having been down 45 bp or so earlier. It is a relatively small markets and probably made much thinner by banks likely using their Greek paper as collateral with the ECB. Second, US Treasury yields have eased from the highs, when the 10-year poked briefly through the 4% level. Yields are 1-2 bp lower today ahead of the 10-year note sale. Third, China announced it will sell 3-year bond tomorrow, the first sale since mid-08 and there is increased speculation that China will either raise rates as soon as this weekend or, some suggest move on their currency.

Initial euro support is seen in the $1.3350 area. A break could spur a move toward the recent low just below $1.3270. On the upside a move above $1.3410 could see another half a cent advance before sellers re-emerge. Sterling dropped .almost a cent on the disappointing data, but may find support ahead of $1.5150.

Greece’s financing woes, and Europe’s ability to decisively deal with the issue of the weaker credits in the euro zone in general, weighs on euro sentiment. Greek officials said last week and have reiterated it this week: April’s financing needs have been met. It can be a little patient and not have to rush into the market to raise more capital. Over the past six months, Greece has had three main choices in addition to its own austerity measures. It could seek aid from its European partners. Despite “no bailout” clauses in treaties, there are a number of ways and channels that assistance could be made, if the political will was there—which it apparently is not. Second, it could go to the IMF. The press reports suggest that Greek officials were surprised on the onerous demand the IMF would likely make in order to get access to concessionary funding. More details may emerge in the coming days as an IMF team will be in Greece, ostensibly offering technical assistance. Third, Greece could default. With some 70% of Greek bonds owned by non-residents, a default would share Greek’s pain more broadly. The fluid conditions alter a cost-benefit analysis, but the heavier the burden on Greece the more attractive a default may become. Those emphasize fiscal discipline and moral hazard arguments may need to contemplate the consequences of a Greek default more seriously.

There are two general developments from the Asia-Pacific region to note. First, China short-term debt sales planned for tomorrow will mop up liquidity. In anticipation of this the 7-day repo rate rose 8 bp to 1.7% and the 12-month non-deliverable forward prices for the yuan rose for the ninth day and now is at an 11-week high, pricing in about a 3% appreciation. This speculation helped underpin the Asian regional currencies. There is speculation that Korean officials intervened buying $1-$1.25 bln dollars to step the won’s rise against the dollar. Korea is one of the countries believed to be use the Federal Reserve’s custodial services and the settlement from this week’s Treasury auctions, plus the intervention proceeds are likely to boost the much watched Fed’s custody holdings in next week’s report, not tomorrows.

Second, New Zealand’s milk auction saw prices surge. The average selling price rose 21% and is now almost 120% above last July’s lows. Fonterra, New Zealand’s milk co-op is the country’s largest company, accounting for about 1/14 of the country’s GDP. This should help underpin the New Zealand dollar. Meanwhile, Australian financial journalists debate whether the RBA hikes rates next month, for their third meeting in a row. Of course, the RBA’s decision is data dependent and we side with those looking for unchanged policy next month.