Currency Market Update

The foreign exchange market appears to have entered a consolidative phase as it waits for fresh incentives. Slightly firmer short term rates in the euro zone and UK appear to be helping cap the US dollar, while ongoing concerns about the European debt crisis and the potential stagflationary conditions in the UK deter enthusiastic buying for the euro and sterling.

Market talk suggests Asian reserve managers continue to diversify some of their recent dollar purchases into euro, but of course this is difficult to verify. Sterling's advancing streak extended into its ninth consecutive session yesterday, but is struggling today to maintain the upside momentum. The CBI trends survey for January was much weaker than expected (-16 vs consensus -2) and tomorrow's report of December retail sales may similarly drive home the point of weakening growth despite the price pressures.

The greenback has also steadied against the yen after yesterday's dip in North America below JPY82.00. Japanese official rhetoric about the yen's strength has increased a notch and some observers are suggesting that the recent cabinet reshuffle was also designed to signal an escalation of its concerns. Japanese export offers, rumored to be placed in the JPY82.40 area, may be limiting the dollar's recovery.

Since the US dollar topped out on Jan 10, the dollar-bloc currencies have been the weakest, with the Canadian dollar off about 0.5% the New Zealand dollar flat, and the Australian dollar is up a few ticks (0.02% at $0.9955). Canada and Australia, in particular have seen interest rate hike expectations get scaled back at the same time that ECB and BOE rate expectations have been heightened, to say the least. When the move since Jan 10 is exhausted, and we suspect it could be in its final phase, look for the dollar bloc to enjoy better traction.

Talk of Greek debt restructuring just won't go away. Despite the denials by German and Greek officials, many remain skeptical that given likely growth trajectory that Greece is going to be able to stabilize the critical debt-to-GDP ratios. In fact, the seeds are being planted. In particular, the first step, which is for the EU and IMF to extend the repayment schedule of Greek borrowings continues to work its way through the various channels. Greece's finance minister confirmed this yesterday. The ostensible cause of extending the maturities is that they are lumped into 2014-2015 posing a difficult funding challenge.

The veneer is removed when one considers the length of the extension. There is talk that the extension could be for as long as 20 years. At the end of last year there had been talk that some advisers to the Greek government were talking with Greece's private sector creditors (banks) to see if those obligations can be extended to be more in line with what the IMF/EU are likely to do. Those reports were denied, of course, but earlier this week a couple of government ministers reportedly endorsed such a strategy.

Today's focus on the periphery is on Spain, where the reports indicate that the government is preparing a 3 bln euro bond issue to inject capital into the cajas (local savings banks) and may ultimately raise as much as 30 bln euros. Separately, the press is also giving column space to yesterday's report form Moody's on Portugal and its concerns about "debt affordability" (ie high interest rates) and the sustainability of its recently improved exports.