Dollar Remains Soft, Sterling in Charge

The US dollar continues to sport a soft profile, even as the political and economic risk in the euro zone is escalating.  Downside data surprises in the US have not help the greenback's case.  Sterling has led the move against the dollar with a 1.5% advance.   The yen has been the weakest of the majors, off nearly 1%,  perhaps as a function of stabilizing equity markets, cross rate adjustments (yen sales vs sterling and euros), and expectations the BOJ will ease monetary conditions next week. 

While the euro is pushing through the $1.3200 level for the first time this week, I want to fade the advance.  However, the euro has remains largely confined to a range$1.30-$1.34, with some minor exceptions since late January.  From a risk management point of view, the euro is at the center of that range, which compromise risk/reward calculations.  To navigate these waters, I am going to be patient and wait for a technical sign that the advance is exhausted. 

Sterling has pushed through the $1.61 barriers today with the help of a much stronger than expected retail sales report.  The 1.85 rise in March was more than three times more than expected and recoups the 0.8% drop in February with aplomb.  The Olympic and Jubilee impact still lies ahead. 

While the UK economy has proved more resilient than we had expected, today's headline exaggerates the fact.  Two considerations that take off the shine.  First, there was a 4.95 jump in fuel demand and this seems less related to underlying demand and more to preparation for a delivery strike.  Second, the retail sales price deflator--analogous to the US PCE deflator--rose to 2.5% from 2.4%. 

What this means about the UK: The first estimate of Q1 GDP is out next week (April 25).  It is likely to show a modest expansion of about 0.2-0.3% on a quarter-over-quarter basis, leaving the economy essentially flat over the past six months after a 0.3% contraction in Q4 11.  One has to go back to the middle of 2010 to find to UK quarterly GDP reports in the same direction.  Since then it has been alternating between expansion and decline.  A small expansion in Q1 '12 keeps that pattern intact.  

Prices are proving stickier than expected in the UK as well.  Of the major economies, stagflation appears to characterize the UK economy perhaps more than anything elese.  With the minutes of the March BOE meeting underscoring, the MPC is unlikely to extend its gilt purchases next month when the current operation is completed.  

Early this week, Germany reported a stronger than expected ZEW survey.  Today it has followed suit with a firmer IFO survey.  The improvement in the overall climate was more a function of expectations than an assessment of current conditions.  The surveys simply confirm what the market already knows.  The German economy continues to churn along, but not fast enough to lift the depressed region, where even the core Dutch economy is expected to contract this year. 

The Australian dollar is the only other major currency that has lost ground against the US dollar this week.  The conviction that the RBA will cut rates in May has been bolstered this week and today's terms of trade pushes even further in this direction.  The key is that export prices fell a whopping 7% in Q1.  Expectations centered around a 2% decline.   Imports prices also fell (1.2%). 

This also means that next week's Q1 CPI report that the RBA highlighted will likely show a meaningful decline to around 2.2% from 3.1% in Q4 11.  The underlying rate tends to be less volatile, but is liekly to fall to around 2.3% from 2.6%.