Dolar Bears in Control, but Finding it a Bti Tougher

The market’s focus has shifted away from the European debt crisis, where the news stream seems largely benign (for the moment), and toward the more negative growth impulses coming from the US. Even though the weakness in the June US jobs report appears largely concentrated in manufacturing, the recent string of economic data has shown a loss of momentum. This coupled with the safe haven demand have depressed US yields.

At the same time, the settlement of the ECB’s LTRO has not eased pressure in the European money market. Overnight deposits at the ECB stood at 246.4 bln euros yesterday, which is above the recent average. Overnight money market rates are about 10 bp above levels that prevailed just before the LTRO expiry. The amount of money the European banks are borrowing from the ECB’s emergency marginal rate (1.75%) is nearly double what it was before the weekend. The net consequence is that interest rate differentials have moved in the euro’s favor. The German two year yield is above the US two year yield for the first time since late March today. This is also reflected in the Euribor-Eurodollar spread. The differential on the Dec ’10 contracts stands at 40 bp, which appears to be the highest since early Feb. The next big event for the euro zone is the stress tests on the region’s banks. News that the ECB will host a meeting with top banks’ CEOs on 21 July, two days before planned publication of the bank stress tests drew interest today.

Many observers have targeted the $1.2700-$1.2750 area for the euro’s recovery. Short-term momentum traders appear to be turning a bit more cautious when the euro pokes above the $1.26 level, perhaps as a function of shifting risk-reward. Before the weekend the euro pushed through $1.2600 but finished a half cent lower and went down another three-quarters of a cent into early Asia before finding a good big that propelled it back above $1.26. A new high was not recorded. Initial support is seen near $1.2540, but only a break of the $1.2480 area would neutralize the generally favorable tone.

The markets have been closely monitoring developments in Switzerland. The SNB had aggressively sold Swiss francs in its version of quantitative easing. The Swiss franc strengthened through out its QE exercise as Switzerland’s safe haven appeal as well superior macro economic fundamentals (compared with most of Europe) overwhelmed the SNB’s efforts. Swiss officials declared victory in its fight against deflation and the Swiss franc strengthened sharply in response.

On both counts—deflation and intervention, the judgment may be premature. Last week, as the euro fell through CHF1.31, there was talk that the SNB again had made its presence felt. Today Switzerland reported that the June CPI surprised on the downside. The market had expected a flat reading on the month and a 1% year-over-year rise. Instead, Switzerland reported that consumer prices fell 0.4% on the month and the year-over-year increase was 1%, a little less than in May. The 4.6% decline in June transportation costs likely reflect the drop in oil prices. But the drop in oil prices and the decline in clothing prices (-1% in June) and the general softness in import prices also reflects the strength of the franc. Since 1 June, the dollar has lost nearly 10% against the Swiss franc. The marginal new low for the move was recorded today near CHF1.5064. The dollar needs to resurface above CHF1.0675 and ideally CHF1.07 to stabilize the tone.

The Reserve Bank of Australia is the first to meet this week, though the absence of a meeting did not prevent the Reserve Bank of India from surprising the market with a 25 bp rate hike before last weekend (repo rate now 5%). As widely anticipated the RBA left rates on hold at 4.5%. However, the accompanying statement was less dovish than the market had expected and this helped the Australian dollar to launch a strong after initially testing last week’s lows (~$0.8316).

The Aussie pushed to almost $0.8500 before stabilizing. A close above $0.8470 would be sufficient to point to a reversal price pattern and suggest a move toward $0.8600-50. Separately, Australia reported a larger than expected trade surplus. The May surplus stood at A$1.65 bln bln, more than 3-times the consensus forecast and the April surplus was revised to A$1.12 bln from A$134 mln. Exports rose 6% in May, with a 10% rise in coal exports and a 66% jump on non-monetary gold. Imports rose 4%. Consumer goods imports for 4%, while capital equipment imports rose 10%.

The New Zealand dollar has been pulled up by the Aussie’s gain. It also is positing an outside day and needs to close above yesterday’s high near $0.6940 to confirm it. That said resistance near $0.6975 may prove a more formidable obstacle. Since 21 June the US dollar has rallied about 5.3% , but appears to have run out of steam in the CAD1.0650-75 area over the last several sessions. Initial support is seen near CAD1.0550.