Euro rallies as global asset rally continues, but dollar remains stable
27/Feb/2012 • Currency Updates•
Nearly all risk assets rallied last week, on a continuation of the global asset reflation theme we have been seeing over the past weeks. The S&p 500 index of US stocks reached a new high in this economic cycle. Last week, however saw a significant breakdown in the correlations that we had been witnessing in the FX markets. Whereas the common currency rallied sharply on news that a second Greek bailout seems to have been agreed upon, Sterling and Yen sold off sharply, and the dollar remained range bound in trade-weighted terms. It is remarkable that correlation among currency performance has dropped sharply. We are moving away from the “risk-on, risk off” trading theme. Idiosyncratic factors, such as monetary policy and macroeconomic performance, are increasingly driving FX moves.
Main news of the week was the more dovish than expected minutes from the February Bank of England minutes. Two members of the MPC voted for 75 billion GBP of further purchases, rather than the 50 billion finally agreed to. No members argued for less that 50 billion. Sterling did not react well to these dovish release, and failed to join the Euro in its sharp rally, ending the week down over 2% against the common currency and flattish against the dollar. Macroeconomic data continue to paint a murky picture. Output data (manufacturing and services output) are coming in generally stronger than expected, while on the expenditure side, business investment was the weakes part of GDP in the fourth quarter. Overall, we expect a flat or slightly down print for the first quarter of 2011, and another increase of 50 billion GBP in the Bank of England purchase target. We are not surprised by the failure of Sterling to rally against the dollar, though we still expect it to outperform the Euro in the medium term.
Grim news continued to leak out of Europe last week. The PMI business confidence index fell back to 49.7. This masked the usual divergence between Germany and the periphery, where the index is well below 50 and continues to indicate contraction. Expectations for European growth by official institutions continue to be ratcheted down, and our view of a double dip recession in the Eurozone as a whole in 2012 is now the consensus. there wer modestly better news in Germany, as usual. Retail sales for November and December were revised from a sharp fall to a modest decline. With the second round of Long term refinance operations by the ECB in sight, and the new Greek bailout agreed to by the current Government, fears about event and liquidity risk are giving way to more medium-term concerns about the disastrous macroeconomic situation in the periphery. This may well change in the run up to Greek parliamentary elections in April, where left parties calling openly for a return to the Drachma are doing quite well on the polls. For now, the short position in Euro continues to clear out and the Euro rose a sharp 2.5% against the dollar, breaking fabove 1.34 for the first time since December.
It was a very light week for US macroeconomic and policy news. The most timely indicator of US labor market developments, weekly claims for unemployment benefits,continues its reassuring trend downwards. However, rising energy prices are becoming a head wind for US consumer spending. Geopolitical concerns around Iran are keeping oil prices higher than demand alone would justify, and the resulting increase in US gasoline prices will act as a tax on the consumer. We are still sanguine about this risk. Outside of energy, inflation pressures are weak. However, the worrisome trend in oil prices bears watching and an Israeli or Western attack on Iran would lead us to revise our positive outlook for the US economy.