Earthquake Sends Yen Higher, Dollar Continues to Recover

There are two main features in the foreign exchange market as North American participants return to close out the week. The first is a continued recovery of the US dollar in a backdrop of widening peripheral European bond spreads, the continued reversal of the global equity market rally and the ongoing MENA tensions and within the context of market positioning which has amassed a sizeable short dollar position in recent weeks, judging from the IMM data, the dollar's steady decline and proprietary information. The second feature is the strength of the Japanese yen in the wake of an earthquake that may have been near 9.0 on the Richter scale.

The typical expectation, based on past experience, is for Japanese investors to repatriate funds. This, of course, was very unlike the market response to the recent earthquake in New Zealand, when the local dollar was sold off. Two key differences: Japan's net international investment position is in surplus. It has funds it can repatriate. And judging from the margin trading figures, retail in Japan, which industry estimates suggests could be in excess of 25% of the Japan's foreign exchange turnover, had built a large long dollar position.

Market talk suggest the liquidation of these dollars and may have been a key factor driving the dollar from above JPY83.20 to JPY82.00 and in the process adding to the weight on other major currencies as short-term cross positions are forced to unwind. Below JPY82.00, there is additional chart-based support near JPY81.60 and JPY81.00. In terms of the euro. it has slipped through the 20-day moving average (~$1.3760) for the first time since Feb 22. Initial support is seen in the $1.3730-40 area and a break could spur another 1% drop.

In the euro zone, Portugal has announced additional spending cut measures, worth almost 1% of GDP and has brought forward to next year when its budget deficit will return to 3%. Nevertheless, the market has sold off Portuguese bonds today. Pressure is most acute in the short end of the coupon curve, with 2-5 year yields up 12-15 bp, while the 7-10 year yields are up 5-9 bp. There are some reports suggesting EU pressure may be build on Portugal to accept aid. Portugal, of course, wants to hold out. The government claims that average yield on its debt stock is 3.6%-3.7%.

Even assuming 4% yield on bills and 7% on all bonds, the government estimates that the average yield on its debt stock would still be below 5% in 2013. It has become quite obvious that the assistance packages to Greece and Ireland have not stabilized their interest rates and the terms of the assistance is not particularly attractive to Portugal. The dynamics are changing. Germany seems more sympathetic about extending the duration of Greek (and by implications, it would seem, Ireland). Moreover, the new spending cuts today also may be understood as a precondition for assistance.

A package for Portugal is possible from the weekend summit, I suspect March 24-25 summit is a more likely venue. However,  I continue to resist the idea whenever it is forthcoming that aid to Portugal is no more a bailout than the pakcage Greece and Ireland received.  They have not been bailed out. Those countries are more indebted than they were before. Interest rates are higher. The EU/IMF funds are used primarily to keep private sector banks, often foreign to boot, whole.

China, the world's second largest economy, reported a slew of economic data. The key take away is that activity appears to be leveling off and price pressures may have begun stabilizing. One of the key issues has been inflation and Feb CPI came in at 4.9%, the same as in January and a bit higher than the "leaks" in the local press. The other key is retail sales which rose 11.6% on a year-over-year basis, matching the slowest rate since March 2006. That said, industrial production and investment were reported stronger than expected and this would seem to point to only a modest slowdown and one in which the Lunar New Year may obscure. We continue to expect China to raise interest rates in the coming months.