THE FORCE BEHIND THE DOLLAR RALLY
For anyone trading the 3 major currency pairs – EUR/USD, USD/JPY and the GBP/USD, it was a good day to be long U.S. dollars. The greenback rose to a fresh 10 month high against the euro, is at the cusp of breaking its 10 month high against the British pound and reached a 2 month high against the Japanese Yen. Troubles in Europe prevented the European currencies from participating in the risk rally triggered by the persistent rise in U.S. equities. Investors around the world shrugged off Bernanke’s concerns about the strength of the U.S. recovery and focused instead on the glowing earnings reports by Best Buy and reports that the U.S. government plans to unload its holdings of Citigroup. The rally in the commodity currencies, which do not share the same sovereign risks as Europe confirms that Bernanke failed to spook the markets with his cautionary comments.
Force Behind the Dollar Rally – U.S. Yields
Although the rally in the dollar against the euro was triggered by ECB President Trichet’s criticism about the IMF’s involvement in a Greek bailout, the dollar’s rally against the Yen was driven by the sharp rise in U.S. yields. Ten year yields rose to the highest level since June, extending Tuesday’s sharp move. The main catalyst for the jump in yield was yesterday’s exceptionally weak 2 year bond auction. Today’s 7 year note auction saw stronger results, but it failed to make up for the difference. Weak demand for U.S. bonds is normally a bad thing but with the 10 year swap spread turning negative for the first time ever this week, the U.S. recovery has encouraged investors to park their money in corporate bonds. Some may argue that this is a reflection of concerns about the U.S. government’s finances, but we believe that investors wouldn’t be willing to put their money in higher yielding corporate bonds over lower yielding U.S. bonds if they did not feel more comfortable about the outlook for the U.S. economy. The following chart illustrates the strong correlation between the U.S. 10 year bond yield and USD/JPY. If the 10 year bond yield hits 4 percent for the first time since October 2008, it could push USD/JPY above 94.00.
No Surprises from Bernanke
Fed Chairman Ben Bernanke failed to deliver any surprises in his much awaited testimony on exit strategies. Instead of telegraphing the central bank’s next steps, Bernanke spent more time talking about the weakness in the U.S. economy and constraints that lie ahead than about exit strategies. He stressed that the economy still needs accommodative policies and failed to signal an impending discount rate hike. He also noted that the unemployment situation is very weak, which suggests that any job growth this month could be temporary. Bernanke was also worried about the housing market as he expressed concern about the significant number of foreclosures this year, which could drive down prices. The one thing that he alluded to was possible asset sales. He noted that the Fed wants to reduce the balance sheet to under $1 trillion and they felt uncomfortable holding all of their assets to maturity. Even though Bernanke did not lay out his full exit strategy, his comments are in line with the overall cautiousness of the central bank. The Fed wants to ensure that the economy is on a sustainable growth path before taking any harsh measures. At the same time, his dovishness is not a game changer for the dollar because everyone knows that additional easing is not needed and the next step the Fed will take will still be to tighten monetary policy. Their speed may be not as quick as everyone had hoped, but they are moving forward.
Economic Data Review and Preview
Jobless claims was the only U.S. data released this morning and according to the report, the number of people filing for first time unemployment benefits fell from 456k to 442k, the lowest level in 6 weeks. Continuing claims also decreased to 4.65 million, the lowest level since December 2008 while the four week moving average fell to 453,750, the lowest level since September 2008. There is no question that unemployment remains high and it is still very difficult for people to find work, but the latest data indicates that the pace of layoffs has moderated significantly. This report supports the improvement that everyone expects for the labor market this month. The final release of fourth quarter GDP and the University of Michigan consumer confidence index are due tomorrow and no major revisions are expected.
EUR/USD: COLLAPSES AS TRICHET DISAPPROVES OF EU PLAN
EU leaders have come to an agreement on a financial aid mechanism for Greece but based upon the price action in the euro, investors are not satisfied. The euro fell to a fresh 10 month low against the U.S. dollar as people continue to dump the single currency. We suspect that short euro positions have returned to their record levels following the latest move in the currency. The problem is that the plan fails to have the blessing of ECB President Trichet, whose judgment is extremely respected by investors. He was adamantly opposed to IMF involvement from the very beginning and after the initial details of the bailout plan was released Trichet said that seeking aid for a euro area nation from any outside group such as the IMF is “very very bad.” It is not only an embarrassment for the region as a whole but it also shows that members of the Eurozone are very reluctant about helping each other out when the times get tough. Although the involvement of the IMF is negative for the euro, it is positive for the Eurozone as a whole that a plan has actually emerged because up until the 11th hour, France and Germany were still reluctant to support Greece. The plan involves a combination of bilateral loans and money from the IMF. Although an EU official said the IMF will only have a small part in the Greek pact, a German official said there will be substantial IMF involvement. Euro members will pay based upon their stake in the ECB which means that Germany and France will shoulder most of the burden. The EU will still have coordination controls and officials stressed that is a standby deal that would only be used as a last resort. Based upon the comments from Prime Minister Papandreou, the Greeks appear to be satisfied with the plan. ECB President Trichet also announced that the central bank will hold off tightening lending rules until 2011 to ease pressure on Greece, a step that suggests that they will also keep monetary policy loose for longer than otherwise. In the meantime, the deep sell-off in the EUR/USD puts the currency pair at risk of a short squeeze but in absence of that, there is no major support until 1.30.
GBP/USD: UK RETAIL SALES A WASH
For the third trading day in a row, the British pound weakened against the U.S. dollar despite stronger than expected retail sales in the month of February. Consumer spending rose 1.6 percent last month, the strongest jump in demand since May 2008. Excluding the drag from energy costs, retail sales rose 2.1 percent, close to 3 times market expectations. The improvements in the labor market have boosted both consumer confidence and consumer spending. However, part of the reason why the British pound failed to rally on the numbers is because of the sharp downward revision to January figures. Retail sales were originally reported to have fallen by 1.2 percent but after the revision, we learned that consumer spending actually contracted by 2.1 percent that month. With the revisions, it was basically a wash. January was a particularly tough month for U.K. retailers because of the weather and the reversal of the VAT tax cut, but we are still encouraged to see that at least spending did not fall in February. For the Bank of England the retail sales numbers are not strong enough for them to drop their easing bias. The U.K.’s Debt Management Office doesn’t expect the country to be downgraded despite their plans to increase gilt issuance. With no major economic data on the calendar tomorrow, the British pound will be at the whim of the market’s sentiment towards all things Europe.
NZD/USD: STRONGEST GDP GROWTH IN 2 YEARS
The performance of the commodity currencies were completely mixed today with the Australian dollar slipping against the greenback, the New Zealand dollar appreciating and the Canadian dollar ending the North American session virtually unchanged. New Zealand was the only country that released economic data over the past 24 hours. According to their latest report, the economy expanded by 0.8 percent in fourth quarter, the fastest pace of growth in 2 years. Improvements in consumer spending, manufacturing and construction helped to spur growth and Prime Minister Key believes that the expansion will continue thanks to upcoming personal and company tax cuts. Trade balance numbers are due for release this evening and a rise in imports is expected to boost the country’s surplus. Even though there was no economic data released from Australia, comments from Reserve Bank officials suggests the central bank is still pretty optimistic about the outlook for the Australian economy. Spare capacity is limited and business deleveraging is coming to a close. It will be interesting to see if RBA Governor Glenn Stevens, who is scheduled to speak this evening, shares the same sentiment.
USD/JPY: JAPAN'S HOPES STILL ALIVE ON EXPORTS
Japanese Yen crosses fell across the board as repatriation flows dwindle, risk appetite improves and the recently expanded QE puts pressure on the currency. CAD/JPY rose to a highest level since October of 2008. Plagued by fears of a further deflationary spiral, the Bank of Japan may continue to expand its credit program. According to BoJ board member Hidetoshi Kamezaki, “The central bank will implement policy proactively if necessary, and last week’s monetary easing was based on such a stance.” Japan’s current recovery was mostly manifested by exports, and with the Yen weakening considerably over the past month, better circumstances for exporters may be ahead. Deflation remains one of the country’s biggest problems as the Corporate Service Price continued to fall. Yet, the most telling piece of information will come later this evening with the release of inflation figures. Deflation will likely moderate in February as key forecasting components showed better situation for prices. Domestic CGPI, Bank Lending, Industry production, Consumer Confidence, Tokyo and Nation Department Sales, Supermarket and Convenient Store sales printed a much better outcome suggesting that deflationary pressures are beginning to ease.
USD/JPY: Currency in Play for Next 24 Hours
USD/JPY will be the currency in play for the next 24 hours. The Consumer price index will be released from Japan at 23:50GMT or 7:50PM EST. U.S. Gross Domestic Product will be announced at 12:30GMT or 8:30AM EST tomorrow morning followed by the U. of Michigan Consumer Confidence Index at 13:55GMT or 9:55AM EST. With an incredible momentum USD/JPY is advancing deeper into the Buy Zone which we determine using Bollinger Bands. The pair has its eyes set on breaking its next level of resistance which is represented by a swing high at 93.75. Having recently breached the 200-SMA, this moving will now act as a level of support. If USD/JPY breaks back below 91.55 the uptrend will be broken.
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