FX Spin

The US dollar's gains have been extended against most currencies today, with the Japanese yen as a notable exception. Global equities have followed the slide in North America yesterday.  Bonds, even in the periphery of Europe, are mostly firmer, with the exception of Italy, where there is a certain amount of anxiety ahead the weekend election.  

Turning to the price action, serious technical damage on the foreign currencies is being inflicted.  The euro is falling through the uptrend drawn off last July (Draghi-induced) lows.   It comes in just below $1.3200 today.  The next technical target is near $1.3070-80.  Sterling has been pushed well through our $1.53 target and is now trading at 31 month lows. It has bounced off $1.5130 area, but the $1.5250 area looks set to cap corrective upticks.  

The Canadian dollar is no match for the greenback.  A trend line drawn off the 2011  and 2012 high comes in near CAD1.0230 now.  A push through there can see an accelerated move.  The Australian dollar saw this week's losses extended, but support was again near $1.0225 (seen on Feb 12 too).   The dollar is heavier against the yen and has generally failed to sustain post-G20 gains.  It has not traded below its 20-day moving average since the election was called in mid-Nov.  It comes in now near JPY92.80.  

There are several considerations at work.  The market direction was already mostly in place before the FOMC minutes were released, but the hawkish read of them accelerated market moves.  We disagree with the general interpretation that the minutes increased the likelihood that QE ends early. 

Many voices that were picked up in the minutes are not voting members.  It has been well documented in speeches and dissents that a few regional presidents are not strong advocates of QE and would have been quite content had it not been resumed.  With the drag from government becoming more pronounced (see already agreed action and pending sequester), the US economy is likely to expand well below potential.  This warns of the risk of some backing up in the unemployment rate.  We expected QE to continue through Q2 and probably Q3 before possibly tapering off toward the end of the year. 

Actions by the People's Bank of China have also spooked the market and sparked a 3% drop in the Shanghai Composite.  It drained CNY910 bln from the money market, well more than expected and a little bit larger than what would have been achieved by a 25 bp hike in required reserves.  It drained via a long-term repo operation, something not seen since last June.  Some observers see this as a tightening of policy and the financials were among the weakest performers.  

However, we suspect the PBOC is being vigilant and draining the excess liquidity in the aftermath of the Lunar New Year holiday and evidence that sales were softer than usual.  Separately, efforts to curb housing loans and limit price increases though the local governments have been extended.   The fact that the government is using specific action targeted to the housing market supports our content that the blunter tool of monetary policy is not being tightened despite the drain. 

The euro zone flash PMI was poor.  The manufacturing index slipped to 47.8 from 47.9 and the service index fell to 47.3 from 48.6.  The composite then fell to 47.3 from 48.6.  If there is a bright spot and underscores our recent point about the inability to deduce changes in export performance from short-term/medium term currency fluctuations.  The export component rose to 51.7 from 49.5, which is its best level since May 2011. 

Evidence of a slow recovery in Germany continues to mount.  Both of its PMI readings are above the 50 boom/bust level.  Manufacturing improved, but services did not.  In contrast, which is one of our key European themes, the French economy appears to be contracting.  The manufacturing PMI did rise, but is still weak at 43.6 (from 42.9) and the service sector PMI fell to 42.7, the lowest since early 2009 (from 43.6).  

Clearly the risk is that the EC  cuts its French growth forecast from the already stagnation level of 0.4% tomorrow when it updates is forecasts.  France has acknowledged its will likely overshoot the 3% deficit target this year.  It seems its preferred course of action is to be granted another year grace.  However, several countries appear to be pushing against this with Germany in the background.  They include Slovakia, Austria and Finland. 

Japan's Prime Minister Abe visits US President Obama.  There may be two may issues on Abe's agenda.  First and foremost beef up regional security.  Second, access US shale.  What has been called the "Asian pivot" and the recent actions by North Korea, means there is much common ground on security issues.  The Abe government is increasing defense spending for the first time over a decade.  Obama may press Abe to participate in the US-led Pacific area trade agreement (TPP).  China is also proposing a regional trade bloc that excludes the US.