In Becalmed Markets, Sterling Shines

The widening interest rate premium is helping to lift sterling, in an otherwise subdued Monday foreign exchange session.  A Sunday Times piece is suggesting that the BOE's Quarterly Inflation Report this week will signal an earlier rate hike may also be encouraging the sterling bulls.  The intra-day technical readings, however, warn that the recovery may have nearly run its course. We peg  nearby resistance beginning in the $1.6915 area.  

 The UK 2-year yield is up a few basis points to stand at its highest level since July 2011.  In the 10-year space, at about 126 bp the UK premium over Germany is the highest since the late 1990s.    These interest rate developments and the anticipate divergence of monetary policy between the BOE and the ECB has pushed the euro to its lowest level against sterling since early last year.   The break of GBP0.8160 suggests potential of another 1.0-1.5% decline in the coming period.   

Japan reported the March current account figures ahead of the Q1 GDP estimate later this week.  The surplus was considerably smaller than expected at JPY116.4 bln.  The Dow Jones survey found a consensus forecast of JPY294 bln and the Bloomberg consensus was for JPY347 bln surplus.  This is only the second time over the past ten years that the surplus did not grow in March from February, and now the seasonal factors point to deterioration in both April and May.  

Many observers are attributing the disappointing data to import demand ahead of the tax increase. While this makes sense, the trade component of the current account was a minor miss; only about JPY8 bln larger trade deficit than projected.  The miss on the current account was much larger.  

The market will not put much stock into Q1 data as the retail sales tax increase change everything.  Officials are unlikely to put much stock in the Q2 data, where weakness is expected, following the tax increase.  The key to policy is how the economic momentum at the end of the quarter and into Q3.  This will determine, we suspect, if the BOJ will do more than tweak its QQE policy and/or if the Abe government will offer another supplemental budget for the second half of the fiscal year.  

The immediate outlook for the yen will be influenced by two considerations.  First, a backing up of US bond yields would be dollar supportive.  Second, sustained gains in the S&P 500 after last week's pullback, would also aid the dollar.  Initial resistance is seen in the JPY102.20 area.  

China reported rebounding broad money supply (M2 to 13.2% from 12.1%) and a stronger than expected aggregate financing, which appears to be largely a reflection of the shadow banking system that officials are struggling to rein in.  Aggregate financing rose CNY1.55 trillion in April.  The Bloomberg consensus was for CNY1.475 trillion, which is down from CNY2.071 trillion in March.  The miss was not due to yuan bank loans, which were reported at CNY775 bln rather than CNY800 bln the consensus expected.  The prospect speed up some infra-structure spending and implementing reforms that appeared to have been already announced may have helped lift Chinese shares.  Separately, Indian shares also rallied in anticipation that a new government will be more pro-market now that the election is over.  

For its part, the euro has trading quietly in a little more than a quarter cent range.  The news stream is light.  There is some interest in how the EU and the US will respond to the weekend referendum in two regions in East Ukraine.  While the referendum was not legal, there is a sense that they do reflect the wishes of the more pro-Russia region.  On the eve of the vote, Putin had appeared to want to call it off, but the tactician likely realized his call would be ineffective, but sufficient to create some divisions among his adversaries, like the claim that Russian troops would move away from the Ukrainian border, which could not be independently verified.  

Peripheral European bond yields are rising for the second or third session, and the premiums over Germany are edging higher, as well.   Portugal's 10-year yield is up 6 bp today despite Moody's decision before the weekend to upgrade its credit worthiness to Ba2 from Ba3 and S&P is revising the outlook to stable from negative.  We suspect the backing up of peripheral yields would be euro negative.  Note that Moody's will review Ireland's credit rating at the end of this week, and an upgrade from Baa3 is likely.  Earlier today, Ireland reported that its April construction PMI rose to 63.5 from 60.2, which represents a 10-year high.  The yield on Ireland's 10-year benchmark bond remains below the UK's.