Dollar Better Bid; Will Consolidation Morph into Correction?

The US dollar is a little better bid today most of the major currencies, as the downside momentum seen last week has faded, and a consolidative phase has emerged. We suspect it will morph into a deeper correction.

The dollar does not seem to be reflecting some fundamental changes that are taking place. The euro maybe in a tight range, but it is near two year highs and is holding above the $1.3800 level, which had provided a cap since last October.

The apparent breakout was triggered by the ECB's decision to stand pat. If you expect banks to continue to pay down their previous LTRO borrowings, shrinking the ECB balance sheet; bank lending to continue to be constrained by both supply and demand factors, and for disinflation forces to increase the threat of deflation, then pressure is likely to mount on the ECB to take more action.

A German economic think tank that advises the government called for 60 bln euro sovereign bond buying program by the ECB. The IMF's chief economist Blanchard warned of the risk of long-term deflation in the euro area. The ECB's Constancio suggested that the market misunderstood Draghi last week if it thinks the ECB is on hold. It still has many options at it disposal. Many market participants thought the lack of action meant the ECB was finished. We demur.

Meanwhile, Russia is consolidating its control over Crimea. The Ukraine government had bases and armories in the Crimea and the Russians are neutralizing them as it prepares for annexation following the referendum this coming weekend.

In addition, the euro area is having problems agreeing on the terms of the single resolution mechanism (SRM) and hopes to have an agreement in place by the end of March to give the existing EU Parliament an opportunity to approve. Given the strength of anti-European voices, like Le Pen in France and the 5-Star Movement in Italy, the next parliament may be less cooperative than the sitting one.

Sweden's CPI was reported in line with expectations. This means that it is still experiencing deflation of -0.2% year-over-year. Consumer prices had fallen on a year-over-year basis in five months last year and have begun 2014 with two months of deflation. Riksbank officials are clearly not panicking. The repo rate is at 75 bp, giving plenty of scope to cut. A majority at the central bank appear concerned about the level of household debt and the impact of lower rates. Still, the April 9 meeting is likely to be live, in the sense that a rate cut could be delivered. The krona initially weakened on the report but remained within yesterday's range against the euro.

As widely expected, the BOJ left policy on hold. It is expected to remain so until the impact of the retail sales tax hike can be understood. This likely means Q3, but BOJ Governor Kuroda is giving no hints. He says the core inflation target of 2% will be achieved by early 2015 and that the economy is strong enough to absorb the tax increase. The BOJ's economic assessment upgraded capex and production and downgraded exports, where the weakness was thought to be due to temporary factors.

The UK offered a mixed industrial production report. The headline increase of 0.1%, was a little below expectations. However, the manufacturing component rose 0.4% compared with the consensus forecast of a 0.3% increase. Earlier, BRC retail sales reportedly fell 1% in February, whereas the market expected a 0.6% increase. The floods are thought to have distorted the data, but the take away is that the UK is still enjoying relatively robust economic activity Several BOE officials testify before the parliament, but their general stance is known, and barring a surprise, is unlikely to change the market's direction.

Sterling edged a bit closer to the $1.66 level and recorded is lowest level since February 24. A break of $1.6580 could open the door to another cent decline as the correction we anticipate unfolds. Technically, there is some risk that a double top has been carved out, in which case there is potential toward $1.6400.

Outside of second tier US data in the form of JOLT Job Openings and January wholesale inventories, there is a light US and Canadian economic calendar.