Dollar Under Pressure at Month End

The US dollar is finishing the week, month and quarter on the defensive. The euro appears poised to challenge the $1.34 area that capped it earlier in the week, while sterling is trading above $1.60 for the first time since last November. Demand from short-term players as well as asset managers. Sterling has been particularly resilient over the past week or so amid M&A reports. The greenback is also sporting a softer profile against the yen, with a marginal new low for the week recorded in early Europe with a dip below JPY82.00.

The US dollar’s weakness is broad based, with the dollar-bloc currencies, Scandis and emerging market currencies all gaining today. Equity markets are mostly higher. The MSCI Asia Pacific managed to close marginally higher, though the Nikkei traded heavily after the unexpected decline in February industrial output (-1.2% m/m vs consensus of +1.3%), but of note the Shanghai Composite gained about 0.5%, for the first gain since the start of the week. India’s equities were the strongest with a nearly 2% increase.

Gains were widespread and sufficient to reverse the week’s earlier losses. European bourses are also fully recovering from yesterday’s slide, following the recovery in US markets yesterday. There is talk of Q2 portfolio allocations. European peripheral spreads are mostly tighter.

The focus now ahead of the weekend is three-fold. First, Spain is set to unveil its 2012 budget. Full details will not be available until it is presented to parliament next Tuesday. However, the overall savings is what investors are most interested in. The market is looking for more than 20 bln euros in new savings on top of the 15 bln euros of savings announced at the end of last year. To get ahead of the curve of market expectations savings in excess of 30 bln euros may be needed.

Recall that Spain overshot last year’s 6% target, delivering a 8.5% shortfall. This year’s new target is 5.3% vs the initial 4.4% EU agreement and the 5.8% initial Rajoy proposal. The Jan-Feb deficit came in at 20.7 bln euros, which represents a modest increase from the year ago period. Spain’s 10-year benchmark yield rose 40 bp in Q1 and alongside the 5.7 bln euro current account deficit, the government reported that 5 bln euros of portfolio capital left Spain in January.

The second focus is on the European finance minister two-day meeting that begins today. The idea of a larger firewall until the middle of next year has main issue, but should Spain or Italy need assistance the firewall is likely to prove insufficient. There may also be some agreement on personnel changes, including Juncker’s replacement (likely Germany’s Schaeuble).

We remain concerned that below the surface, the situation the euro zone is actually deteriorating. It is not only a matter of a deeper economic downturn, but several policy developments are worrisome. An example of this deterioration today is the report out of Germany that the Bundesbank has indicated that it will no longer accept government-backed bank bonds as collateral from Greece, Portugal or Ireland.

The ECB meets next Wednesday rather than Thursday dues to the Easter holiday. Although earlier today France reported its first increase in household consumption in four months (Feb 3.0% m/m vs 0.2% consensus), while Germany reported an unexpected decline in Feb retail sales (-1.1% vs expectations of +1.2% following a 1.2% decline in January), the firmer CPI flash figures may have the ECB see upside risks to inflation, even as the real economy stagnates or worse.

The third focus today is on the state of the US economy. February personal income and consumption data are expected to be firm. A 0.6% rise in PCE would be the strongest since last September. PI is expected to post a healthy 0.4% increase. However, the March Chicago PMI may come in softer, perhaps foretelling a moderation in next week’s national figures. Moreover, the risk seems to be on the downside for next week’s report of March auto sales and non-farm payrolls.

Before the markets open on Monday, Japan will report the Tankan Survey. A modest increase in the diffusion index for large manufacturers to -1 from -4 is expected and an anticipation of a positive reading in June. Capex plans are likely to remain cautious, with a rise of about 1%. In addition, China will report official manufacturing PMI. In the past, when the Lunar New Year falls in February, the March PMI has tended to rise. A reading above 50 might ease some concerns about the pace of the slowdown in the world’s second largest economy and help support regional currencies and commodity producers. There is also some talk that China will cut reserve requirements this weekend as the government has declared both Saturday and Sunday working days with Monday through Wednesday next week as official holidays.