Dollar Consoldiates After Big Week

The North American market will put the finishing touches on what has been a generally constructive week for the US dollar. Ironically, the one notable currency that it slipped against is the Japanese yen.  Many had come away from the G20 meeting thinking it gave a green light to sell the yen. 

We read the G20 statement a bit differently. We did not see a significant change from the G7 statement earlier and the draft of the G20 statement. Japanese officials have already moved back into compliance with the general rules of foreign exchange engagement as they have evolved since the Plaza and Louvre Agreements by refraining from offering bilateral targets. Under the rules, countries are indeed allowed to use monetary and fiscal policy to pursue domestic goals. 

For the better part of three weeks now, the dollar-yen rate has been in a range. The 20-day moving average, which has supported the dollar since the mid-Nov election announcement in Japan has been successfully tested again yesterday and earlier today, coming in just below JPY93.00. Local press reports suggest that Japanese exporters are reviewing their internal budget rates and are revising from JPY75-80 to JPY85-90. 

There have been several notable developments in Europe.  The most important is that the European banks are prepaying a much smaller than expected amount of the second LTRO.  Banks are returning 61.1 bln euros next week.  Surveys found consensus expectations near 125 bln euros.  This means that the passive tightening in the euro area financial conditions is not as great as the market had discounted and the euro returned to yesterday's lows. Euribor rates have eased a few basis points and the 2-year interest rate differential between the US and Germany, which we argue continues to track the euro-dollar exchange rate has move more in the US favor.  At eleven basis points it is the most since mid-Jan. 

The German IFO sentiment survey was stronger than expected, though perfectly consistent with other surveys, like the ZEW and PMI which show Europe's largest economy is recovering after a dismal Q4 when it contracted by 0.6%.   

The EC revised its forecasts and now see the euro zone contracting by 0.3% this year.  Of particular interest, France's forecast was cut to 0 from 0.4%.  This will add pressure on the government to slash its 0.8% forecast.  The key is whether it is given another year to meet its deficit target, as it seems to want or whether Germany, Austria, Slovakia and Finland's arguments that it would undermine the EMU's credibility if it did not make the 3% target this year.  

The other country that is on the edge is Spain.  The EC calculation show Spain  having run a budget deficit of 10.2% last year, the most in three years.  It projects a deficit this year of 6.7%, which seems a Herculean task.  There has been some suggestion that Spain could be given more time to reach its deficit targets, but given the lack of progress last year and some backtracking this year,  it too may undermine credibility.  

The uncertainty surrounding the weekend Italian election may have lent Spanish bonds some support (they have fared better than Italy's for example in recent weeks), but pressure may return after the political uncertainty in Italy eases, even if it take a bit more time.  Although there is an official poll ban, the informal ones show the center-left PD (Bersani) recovering from some recent slippage, Berlusconi's right coalition largely flat.  Monti, who in the run-up to the vote has been critical of the PD, appears to be slipping. Grillo's protest movement is holding its own, though below 20%.   Meanwhile, the graft scandal in Spain sees the King Carlos son-in-law and palace guard testify today.

The Reserve Bank of Australia's minutes were not as dovish as the market had anticipated and Governor Stevens' comments earlier today along similar lines.  The take away is that the RBA is content in a wait and see mode, which means that, barring any significant surprises,  a rate cut in March and April seems unlikely.   

The April 24 release of Q1 CPI may be the most important data point for a Q2 rate cut. Regarding the Australian dollar itself, Stevens acknowledged it was over-valued, but not hugely, and was surprised it was not lower.  The tenor differed by the RBNZ which had a greater sense of the over-valuation of the Kiwi and brandished its intervention option.  Further afield, note that Stevens' term expires shortly after the Sept 17 election. 

The Aussie has fallen four cents over the past four weeks.  It appears to have found a near-term bottom--and a double one at that in the $1.0220 area.  The key now is the $1.0370-5 area.   A move above there would confirm the double bottom and signal scope for another 1.0-1.5 cent recovery.