Noticeable after a challenging few weeks is the creeping strength of the dollar over recent days. We are not talking about a huge move – so far, the dollar index is up by around 1% from last Tuesday’s low. This improved showing by the dollar in some part reflects the shifting weight of Fed opinion towards discontinuing quantitative easing once the current program runs out in a couple of months. Indeed, St Louis Fed President Bullard yesterday even suggested that QE2 could be abandoned beforehand because ‘the economy is looking pretty good’. It would be very surprising if the Fed took this course of action, not least because it would be very disruptive for markets. Furthermore, as enunciated by Fed Chairman Bernanke earlier this month, the FOMC wants to see “a sustained period of job creation”. As it turns out, overnight we had two Fed speakers who favoured continuing policy accommodation, although this would not rule out the ending of quantitative easing in June.
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On that front, there will be plenty of data to pore over this week, including payrolls on Friday and the ADP figures tomorrow. Yesterday, there was yet more evidence that the economy is on an improving path, with personal spending rising a greater-than-expected 0.7% in February. Fed officials will have taken note of the recent rise in core inflation contained within these figures – the personal spending deflator jumped 2.9% annualised in the three months to February, whereas six months ago this series suggested deflation was underway. Against the backdrop of very significant dollar short positions by fx traders right now, there is plenty of potential for a proper short-covering rally in the dollar if interest rate expectations continue to move as they have done recently.
Commentary
A Portuguese rescue – days, not weeks. It just can’t go on like this. Portuguese bonds were castigated once more on Monday, the 10yr yield reaching 7.94%, up 70bp in the past week. A major investment bank suggested that Portugal will call in the IMF/EU as soon as this weekend – to be frank, it should already have happened. One major reason that it has not is because of the political upheaval in the country and the inability of the previous government to gain parliamentary support for its austerity package. That said, the new caretaker government will likely accept the targets imposed by the Stability and Growth Pact, such that the IMF/EU can announce package details before the €4.3bn of government bond redemptions are due in the middle of next month.
These are the best of times for the Aussie. The cricket team may have seen better days but for the currency these are very much the best of times. In yesterday’s trading session, the Aussie broke through the narrow trading band that has existed over recent times to record a new post-float high of 1.0315. Among the drivers of this latest surge were reports of significant flows out of sterling related to insurance payouts for the Queensland floods, and claims of a frenzy of hedging activity now that the currency has cracked through the top of the trading range.
The GBP/AUD cross at one stage yesterday had fallen almost 10 big figures in just ten days from the 1.65 high registered on March 18th and is now not that far away from the recent low of 1.5141 seen on the first day of 2011. Also helping the Aussie was the defeat of PM Julia Gillard’s Labour Party in the New South Wales state elections, which makes it less likely that she will succeed in pushing ahead with legislation to tax carbon emissions and mining profits. The ability of the AUD to make further forward progress is especially noteworthy given the US dollar’s improved performance over recent days.
Trichet implies need for multiple rate hikes. Comments from ECB President Trichet on Monday claiming that inflation was potentially ‘durably’ above the Council’s inflation target throws open the possibility that the central bank is considering multiple rate hikes. Furthermore, it looks even more certain that a rate move is coming in April, as if there was much doubt. Certainly his remarks provided the euro with a small lift on a day when some of the PIGS were again under pressure. The euro has opened this morning with a slightly bid tone, aided by decent consumer spending figures out of France.
Is the ECB riding to Ireland’s rescue? One of the stories doing the rounds in the financial press on Monday concerned negotiations between Ireland and the ECB over a new liquidity facility. Ireland’s troubled banks are currently extremely dependent on central bank funding to survive, with some €100bn of outstanding borrowing with the ECB and an additional €70bn with the Irish Central Bank. According to a Market News story, the ECB is finalising a funding plan for Ireland’s banks which will replace the Emergency Liquidity Assistance (ELA) currently provided by their central bank, designed to wean these banks off unlimited, short term (three-month) funding. Once in place, this new funding facility would likely be used as the template for troubled banks in other eurozone countries, such as Portugal.
For Ireland, the prospect of more medium to long-term funding from the ECB for its distressed banks would be a significant shot in the arm and a victory for the new Irish PM, who has been pushing hard for this over recent weeks. It would also allow the ECB to lift the refinancing rate with relative impunity, without being constrained by the knowledge that doing so would only worsen the plight of Ireland’s already blighted banks. An announcement on this new liquidity facility is likely very soon, because the outcome of stress tests on Ireland’s banks is due on Thursday. Interestingly, the Irish Independent reported on Saturday that these stress tests would show that the amount of capital required by the Irish banks would be less than the €35bn set aside in the EU-IMF bailout.
More sterling sufferance. Sterling was the main loser amongst the major currencies on Monday, cable slipping below the 1.60 level for a time, and EUR/GBP also moving higher through 0.88. This negative tone carries on from the weakness seen through most of last week. Since the budget last Wednesday, sterling has consistently lost ground against major currencies, with the exception of the Swiss franc. As we have pointed out, this contrasts with the last budget in June, when sterling reacted positively to the fiscal tightening that was announced. Even so, most of the weakness we are seeing right now appears to be more related to concerns on the economy, more particularly the limited signs that the weakness seen in Q4 (which was to a large degree weather-related) is reversing in the current quarter. We’ve had further comments from MPC members over the weekend and on Monday, both from the arch-dove (Posen) and also the hawk (Sentance). Indeed, Posen has said he will not seek a second term on the MPC should his calls for further QE prove to be unwarranted. If the economy fails to recover the loss in output seen in Q4 (revised figures are released tomorrow), then the MPC could find it very difficult to raise rates when the economy has effectively ground to a halt over a six-month period. This would be an uncomfortable scenario for the pound.
Looking Ahead
Tuesday: IT: Business Confidence, March (expect 102.5, previous 103); UK: GDP, Q4 final (expect -0.6%, previous -0.6%); Net Consumer Credit, February (expect – £0.1bn, previous – £0.3bn); Mortgage Approvals, February (expect 46.8K, previous 45.7K); US: Case-Shiller Composute-20 House Prices, YoY (expect -3.2%, previous -2.4%); Consumer Confidence , March (expect 64.8, previous 70.4).
Wednesday: JPN: Industrial Production, February (expect -0.1%, previous 1.3%); EC: Business Climate Indicator, March (previous 1.45); Eurozone Consumer Confidence, March (previous -10.6); UK: CBI Reported Sales, March (previous 6); US: MBA Mortgage Applications; ADP Employment Change, March (expect 210K, previous 217K).
Thursday: UK: GfK Consumer Confidence, March (expect -29, previous -28); Hometrack House Prices, March (previous -0.2% MoM and -2.7% YoY); Nationwide House Prices, March (expect -0.2%, previous 0.3%); GER: Unemployment Change, March (expect -24K, previous -52K); Unemployment Rate, March (expect 7.2%, previous 7.3%); EC: Eurozone CPI, March (expect 2.3%, previous 2.4%); US: Jobless Claims (previous 382K); Chicago PMI, March (expect 70.0, previous 71.2); Bloomberg Consumer Comfort (previous -48.9).
Friday: JPN: Tankan Large Manufacturing, Q1 (expect 6, previous 5); IT/FR/GER/EC/UK: PMI Manufacturing, March (expect 58.0/56.6/60.9/57.7/60.9, previous 59.0/56.6/60.9/57.7/61.5); EC: Eurozone Unemployment rate, February (expect 9.9%, previous 9.9%); US: Change in non-farm payrolls, March (expect 190K, previous 192K); Unemployment Rate, March (expect 8.9%, previous 8.9%); ISM Manufacturing, March (expect 61.0, previous 61.4); Total Vehicle Sales, March (expect 13.2m, previous 13.38m).
Source: Bloomberg
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