Markets Brace for Poor Developments

The US dollar is broadly higher against most of the major and emerging market currencies amid concern that the Greek PSI will not see sufficient participation to avoid the triggering of the collective action clauses or worse. At the same time, the downgrade of China’s growth forecasts and the softer service sector PMI released yesterday, continues to take a toll. The strength of the yen and dollar appear to reflect short-term participants bracing themselves for disappointing developments in the coming days.

Consistent with this theme, global equities are lower, extending the first real correction of the year. The MSCI Asia-Pacific Index was off about 1.25% and is now off more than 3.5% since the Feb 29 multi-month peak. Of note, the Malaysian bourse bucked the trend to post gains for the fifth consecutive session, the longest in nearly a month, lead by consumer services and basic materials.

European equities are under pressure as well with the Dow Jones Stoxx 600 off almost 1.5% near midday in London. Industrials are off about 2.25% following confirmation that the euro zone economy contracted 0.3% in Q4 and amid expectations that it is also contracting in the current quarter. Financials are off 2% on profit-taking spurred in part by concerns over the Greek PSI.

The anxiety is also evident in the debt markets. Core bonds in Germany, the UK and the US are firmer, while peripheral bonds are weaker. Of note, Italian 10-year yields are moving below Spanish yields. The US-Germany 2-year spread is at its best level since June 2010. Although the correlation has weakened, we suspect, as we argued last week, the interest rate differential is sending the true signal and that the euro will catch up by depreciating.

The euro has broken through the uptrend, drawn off the Jan 16 and Feb 16 lows and catching yesterday’s low as well. In so doing it has retraced more than 61.8% of the rally since Feb 16th dip below $1.30. While some bids are expected to be seen around $1.3100, the downside risk extends to $1.3050. We note that the 5-day moving average is crossing below the 20-day average, reflecting the erosion of the recent uptrend.

While there has been much speculation that LTRO funds will be used in Europe as either a liquidity cushion or to buy local sovereign debt, there is increasing talk that some of the funds are being swapped into dollars. This left US banks, the often the other side of the swap, long euros an there is some speculation that those euros are being hedged or otherwise offset.

Sterling is posting an outside down day. This means that it has traded on both sides of yesterday’s trading range and a close below yesterday’s low (~$1.5786). The break of the $1.5780 area warns of the risk of a deeper setback. Initially the $1.5720 area may prove sticky, but there near-term potential extends toward $1.5600-40. Last week sterling closed above its 200-day moving average for the first time since last August, but this proved, with the benefit of hindsight, a bridge too far. This area, roughly $1.59 will likely serve as resistance.

The dollar is at three day lows against the yen and this seems to reflect cross rate adjustments more than a dollar move. In particular, Japanese investors have reportedly been keen sellers of the Australian and New Zealand dollars today. The Reserve Bank of Australia left its cash rate on hold at 4.25% as widely expected. Its statement read much like last months, with rates currently appropriate and global risks emphasized. T

he Australian dollar is trading below $1.06 for the first time since the start of February. The softer Chinese official service PMI reading and the lower official growth forecasts appear to have encouraged a bout of profit-taking on the Australian dollar which had been looking a bit tired after being unable to make much headway above $1.08 after repeated attempts. The dollar found support near JPY80.80. The JPY81.20-40 area may now act as resistance.

There are no US economic reports today, but Canada reports the IVEY PMI. The consensus calls for a bit of slippage from the 64.1 reading in January. The Canadian dollar is softer, but holding up better than the other dollar-bloc currencies today. Still the Loonie is trading near parity for the first time in about a week. Dollar spikes toward CAD1.0050 may be sold investors take a more constructive view of North America. The early call is for the US to report its third consecutive month of 200k+ non-farm payrolls.