Dollar-Bloc Stays Bid, Euro and Yen in Well-Worn Ranges

Sterling and the dollar-bloc currencies are firm, but the euro and yen remain confined to well-worn ranges. The US dollar is vulnerable to poor economic news in the form of a negative year-over-year CPI print, especially given that Fed hike expectations have not been rebuilt in response to Yellen's testimony.  

We understand her testimony to having indicated that barring a significant surprise the FOMC statement next month will drop the forward guidance of "patience".   We do not think that this will lead to an April rate hike, but continued labor market improvement will set the stage for a June hike.   That said, of course, we recognize that the Fed waits a bit longer, as they did with the tapering.  From a long-term investor vantage point, a June or September hike may not be a significant difference. 

While headline CPI may be negative, the core rate is stickier and is expected to be unchanged at 1.6%.  Yellen was clear in her testimony.  Headline inflation is weighed down by the fall in energy prices, and this is spilling over into the core rate.  This seemed to be a clear signal that soft inflation will not prevent the first rate hike. 

Separately the US reports durable goods orders and weekly initial jobless claims.  Durable goods orders are expected to bounce back after a weak December report.  The consensus calls for a 1.6% increase after a 3.4% decline.  The internals are also expected to have improved.    Weekly jobless claims have been trending lower.  As of last week, the four-week moving average stood at 283k, the lowest since last October.  Next week's national number are of more significant for investors, but the weekly initial jobless claims have fallen between the January survey week and the February survey week. 

There are four major central bank meetings next week (RBA, BOC, BOE, and ECB).  The market is on the fence about an RBA rate cut.  The OIS shows a little more than a 50% chance of a cut after the disappointing capex data.  The 2.2% decline in Q4 was more than the market expected (-1.6%) after Q3 was revised to 0.6% from 0.2%.  The disappointment was also due to the fact that the non-mining sector capex also fell and that plans for the new year remain soft.  Nevertheless, the relatively high yield, especially for a triple-A credit has helped underpin the Australian dollar.  It extended its recent gains to $0.7910, its highest level since late January.    We suspect the market will turn more cautious as the $0.8000 area is approached.  

Following Bank of Canada Poloz comments suggesting that the January rate cut was to buy time, which the market thinks mean more than two months, has seen rate cut ideas for next week scaled back and this, coupled with firmer oil prices, have helped the Canadian dollar recover.  The greenback is now near the lows for the month.  Support is seen in the CAD1.2350-60 area.  Canada reports January CPI figures today as well.  The headline is expected to be halved from 1.5% to 0.8%.  However, the core rate remains firm.  It is expected to ease to 2.1% from 2.2%. 

Following next week's ECB meeting, its bond buying program its expected to be launched.  Ahead of it, the Irish 10-year yield has broken through the 1% level yesterday and is now below 90 bp.  Germany sold a 5-year bond yesterday with a negative yield for the first time.  Today, German rates are negative through seven-year, and the 10-year yield is below 30 bp.  Portuguese bonds also continue to rally strongly and the 10-year yield has fallen through 2%, with a 72 bp decline year-to-date.  It is second only to Slovenia (-89 bp to 1.11%). 

Today is an anniversary of sorts for EMU today.  The last LTRO repayment is due today.  Yesterday the ECB provided a next injection of 35.7 bln euros in the 91-day operation to help smooth the transition.  There is around 83 bln euros remaining to be repaid today.  This will suck away some of the excess liquidity, but at around 115 bln, it will roughly match the prevailing level prior to the TLTRO in December.  Recall that the new tranche of TLTRO funds will also be made available next month (March 19) as well as the new asset purchase scheme. 

Ironically, even before the asset purchases, the eurozone has been reporting better real sector data and financial numbers.  Money supply growth which began last year carried through January.  M3 growth was 4.1% year-over-year in January.  This is the strongest pace since 2009.  Lending to households and companies was 0.1% lower than a year ago.  It had contracted 0.5% in December.  Bank lending has contracted since May 2012. 

Separately, Germany reported unemployment in February fell twice what the market expected (-20k).  This is more than the 3, 6 and 12 month moving averages and is consistent with the cyclical recovery story after the slow patch in the middle of last year.