Currencies Firm Despite Market Stricken with Rate Cut Fever

The economic reports and official comments have heightened expectations for rate cuts by the ECB, Reserve Bank of Australia, and possibly the Norges Bank. However, the respective currencies have recovered from the initial weakness. Their resilience may be an important tell that the US dollar is set to trade heavier.

Following yesterday's disappointing PMI data, Germany's IFO confirms that the euro zone's largest economy has lost its mojo. The much-watched business climate component of the IFO survey fell to 104.4 from 106.7 in March. The Bloomberg consensus was for a 106.2 reading. The expectations and current assessment measures both fell more than expected. ECB President Draghi's comments at the press conference earlier this month, followed by BBK President Weidmann's comments and now the poorer data fan speculation of a 25 bp cut in the main refi rate (currently 75 bp)at the May 2 ECB meeting.

Officials clearly recognize that such a rate cut will have little material impact. The key rate in the euro area is not really the refi rate cut the deposit rate. It is at zero and there is no indication that the ECB is seriously contemplating bringing this into negative territory. It is that zero deposit rate which is the anchor of EURONIA, which is just above zero.

Nevertheless, the prospects for a rate cut, the EC extending times frames to reach 3% deficit targets, positive developments in Italy's political situation, and confirmation of that Greece will get delayed aid tranche, continues to support investor sentiment. In addition, while the data continues to show Japanese investors have been net sellers of foreign bonds, there remains strong expectations that they will eventually--perhaps after the Golden Week holidays--buy euro-area bonds. After posting strong rallies in recent sessions, European bonds are consolidating today.

If the euro area has moved from crisis to response to complacency and back to crisis, it appears to moving back to complacency since the Cyprus events proved a catharsis. During those complacency phases, there is a virtuous cycle of sovereign bond rallies in the periphery, narrowing premiums over Germany, helping support the banks, who are large holders of sovereign bonds.

The euro has tended to rise during such periods. However, the euro fell to new 2 1/2 week lows today. It's recovery is impressive and to solidify the potential reversal, a close of the North American session today above $1.3030 would be helpful.

Separately, but on the same theme of rate cut expectations, Australia's tame Q1 CPI report, in the current context of softer China data, weaker commodity prices, the recent rise in unemployment and a tightening in credit conditions, help bring back rate cut expectations. The RBA meets on May 7. The market appears to be pricing in about a 40% chance of a cut. Unlike the euro, the Australian dollar haled above yesterday's lows when it was initially sold in Asia. A move a above $1.0310 would lift the tone and signal a near-term move toward $1.04.

There is also increased speculation that the Sweden and Norway's central banks could cut rates soon too. The next string of reports will be important for the outlook for the Riksbank following the recent news of a jump in unemployment. The weakness of the German economy signals a headwind for Sweden. Meanwhile, the Norges Bank meets May 8. Governor Olsen yesterday warned that inflation was "disturbing low". Adjusted for taxes and energy prices, CPI slipped below 1% in February. The Norwegian krone extended its recent losses against the euro. At almost NOK7.7 earlier today, the euro was at its strongest level against the krone since January 2012.

The data feature of the North American session is the March durable goods orders report. The risk seems to be to the downside of the consensus forecast of a 3% decline. Boeing orders are volatile and often drive the headline. Weaker orders were reported. Just as important, after missing the economy's strength earlier in the quarter, economists adjusted their forecasts just as the economy lost momentum. The recent string of data has come out below expectations. That said, the durable goods orders report is the last piece of data for economists fine tuning Q1 GDP forecasts. The US releases its first estimate on Friday. The Bloomberg consensus is for an above trend 3% after a the economy nearly stagnated in Q4 (0.4% annualized).