Dollar Mixed, 4 Drivers Discussed

The US dollar is narrowly mixed as participants continue to digest the significance of the disappointing US jobs data and await full participation to return from what for many is a long holiday weekend. Asian equities were lower for the fourth consecutive session and the MSCI Asia-Pacific Index was off 0.6%.

The Nikkei’s 1.5% decline set the pace as the yen’s recovery and diminished chances of a near-term easing by China, following the somewhat higher than expected March CPI reading (3.6% vs 3.3% consensus). The Shanghai Composite lost nearly 1%. US equities are expected to open broadly lower ahead of the formal start of the earnings season on Tuesday.

We share four observations at the start of the week.

First, no matter how one slices and dices the US jobs report it was disappointing. Yet that disappointment should be mitigated by a broader appreciation of the state of the labor market. The fact that weekly initial jobless claims continue to gradually fall and other part of the national figures, including the increase in earnings and hours worked caution against exaggerating significance of the report. That said, the real test of the labor market is still to come. In particular, as others have noted, the seasonal adjustment factor has been tailwind and with the May report, the seasonal adjustment will begin subtracting jobs rather than adding them. Numerous Fed officials will speak this week and investors will likely learn that the employment data did not change the essential views.

Second, the European debt crisis is moving back into an elevated state. The immediate cause appears to be the weak economic data that will make it more difficult to reach deficit/GDP ratios. Neither Greece’s debt restructuring and default, nor the Spanish budget, nor the increase in the euro area fire fall has closure been achieved. Spanish bond yields are near 4-month highs and Italian bonds yields are approaching 2-month highs. German 2-year yields made record lows last week and 10-year bund are at the lowest for the year and quickly returning to the record lows set last September. Italy’s bond auction on April 12 will draw much attention this week after Spain’s disappointing sale last week.

The euro has approached the lower end of the trading range against the dollar that has prevailed since late January in the $1.2970-$1.3000 area. This area may be difficult to break without some significant deterioration in the news stream. However, the economic risks of additional weakness in the reports in the coming days and political risk ahead of the upcoming French and Greek elections continue to favor an eventual downside break.

Third, the Bank of Japan’s two-day meeting ends tomorrow amid high hopes that it takes additional measures to increase the likelihood of achieving its 1% inflation goal. While it could take some small steps, it seems too soon following the JPY10 trillion increase in the asset purchase plan in mid-Feb to do expect more QE. The recent news stream has been poor for in the sense that the Tankan survey was weaker than expected, including capex plans, deflation continues to grip as the Tokyo March CPI illustrated, the money base contracted for the first time in two years, and the yen’s downtrend has been halted. The BOJ will offer it more comprehensive economic assessment on April 27.

The increased tensions in the euro zone and the weaker US jobs data are renewing speculation in some quarters of QE3 (again) are spurring a recovery in the yen. Separately, earlier today Japan reported a somewhat better than expected current account surplus of JPY1.178 trillion in February. This reflected the recovery of the trade surplus after the Lunar New Year distortions and the a modest increase in the investment income account. Technical indicators warn of a near-term test on the JPY80.60-80 area. A break could see the first sub-JPY80 move since Feb 22. The euro is testing similar support near JPY106. A break could spur a move toward JPY104.30-50.

Fourth, China’s CPI increased 3.6% in March from 3.2% in February and more than the consensus 3.3%. Speculation ahead of the weekend of a cut in the required reserve ratio proved for naught and the inflation figures will have the market waiting longer. The breakdown reveals, though, that food prices remain the main culprit, with a 7.5% increase year-over-year compared with a 1.85 increase in non-food items. China reports other economic data this week, including the March trade balance (expected to be in deficit as exports and imports slow considerably).

New yuan loans are expected to be reported before the end of the week and they are anticipated to show more than a 105 increase from the CNY710.7 bln reported in February. The main weight on the Australian dollar presently appears to be coming from increasing expectations of a rate cut next month by the RBA, but China’s news is unlikely to be helpful. The A$ descent is appears to be slowing ahead of the $1.02 area. The Australian dollar may also find some support in front of JPY83.30.