US dollar ends flat as risky assets and commodities bounce back
28/Mar/2011 • Currency Updates•
Stocks and commodities rallied strongly last week. Investors chose to ignore a variety of bearish developments, including the escalating war in Libya, the fall of the Portuguese government, the deepening economic impact of the Japanese earthquake and the lack of improvement in the Fukushima nuclear emergency and the softer tone of macroeconomic releases in the developed world. In FX markets, the US dollar put in a mixed performance, rising against European currencies but falling against commodity currencies, reaching post-float lows against the Australian dollar.
Another, month, another nasty surprise in British inflation. February CPI rose a higher than expected 0.7%. More worryingly, core inflation came in at 3.4% YoY against consensus expectations of 3.1%, which makes it more difficult to blame spikes on international commodity prices for the persistent inflation overshooting. However, the minutes for the latest Bank of England meeting showed the same split as the previous one, six to three for keeping rates unchanged and eight to one for keeping the size of the balance sheet constant. It bears noting, however, that the MPC members did not have access to the inflation numbers released last week.
Expectations for BoE hikes went sharply up after the CPI release, but, somewhat surprisingly, spent the rest of the week retracing their post-inflation move and ended the week not far from where they started. GBP got some support from higher UK rates, but quickly gave up all its gains, trading dismally all week and ending down nearly 1.5% against the greenback and 0.5% against the euro. Sterling under-performance on the face of high domestic inflation is a somewhat new reaction, and ones that bears watching as it is not a good omen for GBP.
Although it ended the week somewhat lower against the dollar, the common currency traded rather well given the negative peripheral news hitting the tape. On Wednesday, the Portuguese government fell as the new austerity package prepared in response to the failure to achieve the fiscal target was rejected by Parliament. This brings Portugal one step closer to requesting a bailout. The next day, most Spanish banks were downgraded by Moody’s. However, the euro held its own and only retreated somewhat on Friday. An important development this week was that Spanish and Italian debt appeared to decouple somewhat from the other peripherals, holding their own even as Portuguese and Irish yields rose to new highs. We are sceptical of this development, as we think that Spain has failed to clean up its banking system and that this is a major reason behind its continued dynamic of job destruction and its failure to post GDP growth. However, these developments will affect the medium term prospects for the common currency, and in the short term the trend appears to be towards somewhat tighter spreads.
A spate of second-tier macroeconomic releases confirmed the softer tone out of the US economy in the third quarter. Home sales (both existing and new) and home prices surprised to the downside, pushing further into the future any expectations for a revival of the US housing sector. Durable goods was also soft, which is surprising given the very low interest rate environment and the high profitability of the US corporate sector, whose investment is still well below the 2007 peak. The market, however, is more focused on monetary policy and the Fed’s exit strategy. Last week the message from Fed officials turned distinctly hawkish, and this helped the dollar maintain a good bid in spite of the less positive macroeconomic background. The dollar ended the week nearly unchanged in trade-weighted terms, up against the European currencies but down against the commodity block.
Neither the upwards revision in the damage from the Japanese earthquake, nor the sense that the problems with the Fukushima nuclear plant are far from over had any visible impact on yen trading last week. In the absence of intervention, the Japanese currency reverted to old form and traded essentially in line with US yields. As hawkish Fed officials brought forward expectations of Fed hikes, JPY weakened to end the week down 1.1% against the dollar.
Both the Australian dollar and the New Zealand dollar moved higher almost in lockstep last week, buoyed by higher risk appetites and commodity prices. The Canadian dollar, however, lagged significantly, weighed by the political crisis in Canada and the call for new elections for May 2nd. AUD and NZD ended the week up an astounding 3% against the greenback, while CAD was up less than 0.5%.
A fairly uneventful week in Scandinavian currency trading. The Norwegian kroner traded in a narrow range, to end up essentially unchanged against the euro, while the Swedish krona bucked the positive trend in asset prices to end up down 1% against both NOK and EUR. For its part, the Swiss franc traded off in line with the increase in risk assets, to end down over 1% against the euro.