Dollar Heavy, Sterling Leads Charge

A shift in the news stream, with more disappointing US economic news and some positive developments in Europe seemed to have begun weighing on the dollar and that shift has been solidified today. Although the dollar extended yesterday's pullback in Asia, it was the stronger than expected UK GDP pushed it through support.  

The UK is the first G7 country to report Q1 GDP.  The market had been prepared for a +/- 0.1`% and the upside surprise of a 0.3% expansion sent sterling a almost $1.5450, the highest since Feb 20.   This area also corresponds to a retracement objective of sterling's slide since the start of the year.   That said, the failure to finish the North American session today above $1.54 will be disappointing and would fail to confirm the upside breakout.  

Many observers will see in the UK's GDP report evidence that it has avoided a triple dip.  This is, we think, not a very helpful way to conceptualize what is happening in the UK, after all the two-consecutive quarterly contraction is a rule of thumb, and frankly is not even the definition used in the United States.  For all practical purposes, the UK economy has essentially stagnated.  It remains in a trough.  Output is about 2.8% below the Q1 2008 peak. 

The stronger than expected GDP figure, which offsets the 0.3% contraction in Q4, may buttress the UK government's resolve to stay the austerity course over increasing pressure from the IMF to do otherwise.  It also means that BOE Governor King, having been outvoted on the MPC, may not win over many converts to his desire to resume gilt purchases.  

The dollar has continued to hold below the JPY100 barrier. Pullbacks have been shallow and the greenback is spending more time above JPY90.  Japanese investors continue to sell foreign bonds, according to the latest weekly MOF report.  Last week they sold JPY862 bln of foreign bonds, bringing the April sales to JPY2.335 trillion.   Ironically, this appears to be more than sum of the new purchases suggested by major Japanese life insurance companies that have reported their new investment strategies.  

Separately, foreign investors sold Japanese equities for the first time in four weeks.  The JPY28 bln sales followed the record buying of JPY1.568 trillion the previous week.  Japanese equities have drawn ~$64.2 bln of foreign inflows this year, more than double last year's pace.  

There are two important events in Japan tomorrow.  First, the latest CPI figures will be reported.  The headline March CPI is expected to be -0.8% after -0.7% in February.  The core-core, which excludes fresh food and energy is expected to be essentially the same, though compared to -0.9% in February.  Tokyo CPI, which will be for the month of April is expected to posts a -0.8% headline rate and a -0.7% core-core rate.  

The data will illustrate the challenge facing the BOJ.  While it is unlikely to take fresh measures at the conclusion of its meeting tomorrow, it is expected to update its inflation forecasts.  Nevertheless, this should be understood as a signaling tool.  It is the core-core rate that is most important and will exclude the impact of the 2014 and 2015 sales tax hike.  The BOJ will anticipate the success of its program and lift the FY14 forecast to something around 1.5% and for FY15, will likely introduce a forecast of near 2%.  

Note that OECD updated its forecasts earlier this week and projects 0.5% core-core CPI in Q4 14.  The OECD did its forecasts for Japanese growth to 1.4% this year and next form 0.7% and 0.8% respectively.  

Separately, we note that the South Korean economy reported that Q1 GDP expanded by 0.9%, which is a bit stronger than the market expected and is the strongest performance in two years.  Of note, exports  rose 3.2%, after falling 1.1% in Q4.  This is important because of the potential trade friction that may be caused by the decline of the Japanese yen.   The main economic challenge Korea faces may lie within the country as household consumption fell 0.3%.