Oil soars on Middle East unrest but dollar fails to rally
28/Feb/2011 • Currency Updates•
The unrest in the Middle East, and in particular the threat of full-fledged civil war in Libya, took front and centre in financial markets last week. Oil spiked upwards on fears of supply disruption, and a barrel of Brent closed above 112 dollars, having reached nearly the 120 dollar level during the week. Risky assets dropped moderately in response. In FX markets, correlations in general appear to be weakening, and while the dollar rallied against emerging market currencies, it failed to do so against the euro, in spite of the general flight to quality. This is a noteworthy development and should it continue over the next weeks it would indicate a regime shift in G10 FX markets.
Two main events of the week for sterling were the publications of the minutes from the last Bank of England meeting and the release of the first revision to the fourth-quarter GDP numbers. As expected, the minutes revealed that a third member has joined the camp that wants to increase rates right away. However, a spate of speeches by those who voted against hikes revealed that they are further from being swayed by the hikers than markets assumed. Further gloomy news for sterling came in the form of a downward revision to last quarter growth, which shrunk even more than had been expected and generally downbeat retail news. Overall, expectations of BoE hikes were pushed further into the future, and sterling dropped 1% against the dollar and 1.5% against the euro. We are increasingly confident that the massive fiscal tightening in the UK has not been properly factored into expectations for growth and BoE hikes, and maintain a bearish stance with respect to the pound.
The sentiment indices out of the Eurozone confirmed the optimistic outlook of core Europe’s companies, coming out higher than expected in both manufacturing and services. In the absence of tape bombs from peripheral countries, thes news and the hawkishness of ECB officials were enough to buoy the euro vs. the dollar in a week where geopolitical concerns should have supported the greenback. The moderate widening of the short-term interest rate differential between the Eurozone and the United States also helped the common currency, which ended the week up 0.5% against the USD.
The macroeconomic news flow out of the United States turned more negative last week. The very volatile durable goods orders came in better than expected, though the more stable core orders for capital goods ex-defence and aircraft was quite weak. The first revision to fourth-quarter GDP numbers lowered growth to 2.8% SAAR from 3.3%. Growth in domestic demand was revised down to a still very healthy 6.7%, though this release adds to the general sense that consumption in the US is losing some of the momentum it had finished last year with. It is somewhat surprising that the US dollar turned in a rather mediocre performance (down slightly in trade-weighted terms) in a week where flight-to-quality bids should have helped it outperform significantly.
Inflation in Japan came slightly higher than expected in January (i.e. less negative), driven mostly but higher food and energy prices. This is not the kind of inflation that the BoJ wants to see. The yen, however, continued to ignore domestic development and rose against most currencies on the back of flight-to-quality in financial markets and lower US rates. The heretofore tight correlation between JPY and US rates, like many other FX correlations, continues to weaken, and geopolitical concerns are driving the yen more than rate differentials. The yen closed the week nearly 1.8% higher against the dollar.
Dollar bloc FX trading was dominated by news of the terrible Christchurch earthquake in New Zealand. NZD quickly dropped on the news, and continued to lose ground as the full extent of the damage was revealed and expectations for further RBNZ hikes were removed; the curve there is pricing a significant chance of a 50bp cut at the next meeting, as the earthquake hits what already was a weakening economy. Not surprisingly, the Kiwi lost 1.5% for the week. The Australian dollar, however, was impervious to this news and to the general negative tone in financial markets and rose nearly 1%, while the Candian dollar was flat.
The Norwegian currency withstood the bout of risk aversion better than the Swedish kroner. Buoyed by the spike in Brent oil prices, it managed to end the week unchanged against the euro, while the Swedish krona lost over 1%. Our bullish view of the NOK / SEK cross rate has proven prescient, and we expect further NOK outperformance on the back of higher oil prices.
The Swiss franc performed true to form last week as the quintessential safe-haven currency. It rose nearly 1.5% against the euro, and 2% against the dollar. The Swiss National Bank cannot be happy with these developments and therefore the market pushed expectations for SNB hikes even further into the future.
Next week will be dominated by the ECB rate setting meeting and the US job market report for February. Also important will be the UK sentiment indices and Swiss and Swedish GDP numbers. The RBA also meets next week.