Three Surprises Leave Dollar Softer

The US dollar is generally softer in rather quiet turnover. The greenback's gains against the yen were initially extended in early Asia to about JPY99.65 before some profit-taking kicked in pushed it back to JPY98.70. Although there are some reports of Japanese institutional sales of yen, we see the bulk of the move being non-Japanese leveraged accounts anticipating what Japanese institutions are likely to do now that the BOJ is displacing them from the new JGBs.  

While we expect that at the start of the new Japanese fiscal year, institutional investors may increase their foreign allocation, seasonal patterns are not as clear as one might expect.  Japanese were net buyers of foreign bonds in both February and March last year and last April, for example, Japanese investors were net sellers of foreign bonds in two of the four weeks for net sales of more than JPY2.5 trillion.  

In contrast, the MOF's data shows Japanese investors were net sellers of foreign bonds consistently this year in the face of yen depreciation.  Of the 13 weeks of data reported this year, Japanese investors were net buyers in only three weeks.  The next report is Thursday and while we expect to learn that Japanese investors were net buyers of foreign bonds in the first week of April, we suspect those who think the yen has been weakened by a tsunami of money leaving Japan will be surprised.  The key players, like Japanese insurance and pensions, are unlikely to react instantaneously to the BOJ announcement last Thursday.  

There have been three data surprises today.  First, China's March CPI came in at 2.1%, down from 3.2% in February and lower than the consensus of 2.5%.  On the month prices fell 0.9%, offsetting the bulk of February's 1.1% increase.  Food prices are 2.7% above a year ago, while non-food prices are up 1.8%.  It helps ease pressure to tighten monetary policy..  That said, there is a slew of economic data in the coming days, including trade figures, new yuan loans and aggregate financing figures.   

Second,  the divergence between Germany and France were highlighted by their respective trade figures.  Despite a surprising large fall in exports (-1.5% vs consensus -0.3%), Germany's trade surplus swelled to 16.8 bln euros from 13.6 bln in January and 10% larger than the consensus estimate.  We note that three of Germany's four largest trading partners (UK, US, and China) are outside of the euro area.  

France's reported a 1.9% drop in exports.  Exports have fallen for two consecutive months and in three of the past four months.  Imports also have fallen for two consecutive months and have only risen once since last August.  Yet, France's trade deficit widened to 6.01 bln euros from 5.65 bln in January (revised form 5.82 bln).  Typically, one would expect that the under-performance of the French economy would help correct the trade imbalance.  

Third, the UK surprised twice.   February industrial production and manufacturing output figures were stronger than expected.  The 1.0% rise in industrial production was less by a 0.8% rise in manufacturing.  While this was essentially twice what the market had expected, the downward revisions to the January series, especially in manufacturing (-1.9% vs 1.5% initially) steals most of the good news. 

The other surprise was on the UK's trade balance.  It swelled more than expected.  The trade deficit grew to GBP9.4 bln from GBP8.2 bln.  Trade with non-EU partners accounted the bulk of the deterioration.  Imports rose and exports fell. 

Turning to the price action, sterling has traded within yesterday's range, which in turn was within last Friday's range.  It appears a potential bullish flag pattern is being carved.  A move above $1.5365 could signal a move toward $1.5425 initially and then $1.5600.  Provided the euro holds above the $1.2970 area, we look for a move to $1.3120 and then $1.3220.  The Australian dollar is extending yesterday's recover, but we expect it to stall ahead of the $1.05 cap pending tomorrow's employment data.  A small decline in jobs is expected after the outsized 71.k increase in Feb (due to 53.7k part time jobs).  

Lastly, the increased volatility of the yen and the Nikkei prompted the CME to raise margin requirements.  Three month implied volatility reached almost 13.6% earlier today, the highest since the 2011 tsunami/earthquake and nuclear accident.  As the dollar pulled back, volatility slipped, but it remains above the 12.8 highs, which capped it in Q1, prior to "quantitative and qualitative" easing announced last week.  In the current environment, higher vol is associated with a stronger dollar.  The short-term market has its sights set at JPY100 and then the 2009 high near JPY101.50.  Beyond that, there is talk of JPY105.50, a key retracement objective of the yen's advance since the crisis began in 2007.