BBH CurrencyView: Risk Off Trade Back On, Euro In No Win Situation

Highlights

The risk off trade is back on and the US dollar and yen are bid while the euro is in a no win situation at this point. There are renewed concerns over the situation in Dubai (ahead of Dubai holdings’ next repayments) and China while the EZ economic and social outlook is being questioned in the wake of the latest austerity measures (see below). Commodities currencies have lost momentum as oil prices eased back below the £75brl mark. The euro has fallen to its lowest level since late 2008, with downward momentum in place getting in the US session (see below).  White House Economic Advisor and ex Fed’s Chairman Volker’s doubts over the euro not helping sentiment, nor are press reports (later denied) suggesting that French President Sarkozy threatened to leave the euro at last week’s EU Greek bailout negotiations. Sterling is weak, approaching the $1.45 support. Possible disagreement with France and Germany over hedge funds regulation (which would be detrimental to London) is in the limelight and weighing on the pound ahead of next wk’s EU Fin min mtg. EMEA currencies are looking weak again as the risk off trade is back in fashion, with PLN and HUF (-1.8%) underperforming this morning. Elsewhere in EM, escalating violence in Thailand remains a concern, leaving the Thai Bath vulnerable. Hong Kong GDP close to expectations, at 8.2% y/y (from 2.5%). US April retail sales and industrial production main data releases to look forward today.

The Asia equity market was softer across the board overnight, with disappointing results from Sony Corp and renewed international jitters weighing on sentiment. The MSCI Asia Pacific index was down 0.8% on the session, with lower close seen on the Nikkei (-1.5%), the Hang Seng (-0.34%), the Shanghai SE (-0.43%) or again the S&P/ASX 200 index (-0.9%). European bourses are trading lower by mid-session, thin volumes in the Ascension long weekend context. The S&P future is called much lower at the open. Gold prices have moved to a new high of 1,249 per ounce.

A more uncertain equity mkt environment is helping the bond market, with 10 year JGB yields down 1bp (at 1.288%). The European bond market is bid, with 10 year bond yields trading down 6bp in France, Germany, Italy and Spain in early European session. Periphery bonds have lost momentum though, with 10 year Greek bond yields up 42bp by mid-morning. Portuguese yields up 10bp – note that Portugal announced fresh measures to narrow the budget deficit to GDP ratio to -4.6% in 2011 (vs initial target at -5.1%) vs -7.3% in 2010.

Currency Markets                                                                                       

The euro is in a no win situation at this point and there is significant downward momentum. The euro has fallen below the important $1.25 support very easily in European session, with further support found at $1.2455 and $1.2330. Options related sell orders are identified at $1.2450. In fact, there was not much news to inspire the market in terms of domestic data/releases in the Asia or in the European session and so international jitters have come back to haunt the market. In fact, at this point market jitters and associated euro weakness are more the result of a combination of factors/rumours than just one story.  In Asia, rumours that i) Dubai will face renewed repayment difficulties – nothing confirmed but a plausible scenario given the current environment and that  ii) China may tighten monetary policy sooner than expected in order to address a still very buoyant housing sector have been in the limelight. We remain of the view that further rises in reserve requirements are likely sooner rather than later, but actual rate increases and/or currency appreciation will not be on the agenda until later this year. However, all this will favour risk-off trades positioning, leaving the euro highly vulnerable.

In Europe, there is also concern that the much tighter fiscal stance in EZ periphery will have significant negative impact on the growth outlook, with potential serious negative social consequences. Yesterday, the Portuguese government has announced fresh austerity measures to narrow the 2011 budget deficit to -4.6% of GDP (from -5.1% previously) and to -7.3% in 2010 and this came after Spain announced public wage cuts in order to cut the deficit to -6% of GDP in 2011 from -11.2% in 2009. Meanwhile, France has announced that it will freeze state spending in line with inflation over the 2011-2013 period. All those measures have been welcome by the market and make economic sense, but a) should have been taken a long time ago and in a less drastic way and b) raise the risk of social unrest in the euro zone and this of major concern for the market. Note that Greece is presenting a deficit progress report to the EU today – expect positive progress at this point but the mkt impact will be limited and any euro bounce will be a good selling opportunity. Other factors are behind this euro weakness this morning, including various reports (later denied) from European papers suggesting that French President Sarkozy’s threatened to revisit his position on the euro should German Chancellor Merkel not agree on Greek bailout. Given that the market had been more worried about Germany’s euro exit risks, the French President reported attitude comes as a surprise and can only add to the euro bear sentiment.

Meanwhile, there should be good news from the US economy this morning. The US April retail sales are expected to confirm a positive contribution to economic growth from the consumer sector. We have a consensus at +0.2% and +0.4% m/m for headline and ex-autos sales, but this is adding to a strong 1.9% and 0.9% monthly outcome previously.  The steady improvement in the labour market is a central point in explaining a promising outlook for consumption, but the excellent Q1 earning season also has to be welcome. There will also be good news from the industrial sector, with April industrial production seen up 0.7% on the month (from +0.1% m/m previously). The May Michigan confidence index is expected at 73.5 from 72.2 and the March business inventories are expected up +0.4%. So the better tone in the US economy should provide fresh ammunition to US dollar bulls into the US session. In Canada, the March mnfg sales are seen at +1% m/m.

Upcoming Economic Releases                                                                       
America: US April retail sales, industrial production, May Michigan index, March business inventories, Canadian March manufacturing sales. Events: Fed’s Lockhart, Evans to give a speech, Greece to submit deficit-cutting progress report on EU.

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This was the BBH CurrencyView by Marc Chandler. Marc is the Global Head of Currency Strategy at Brown Brother Harriman. For more of BBH’s currency views, visit the BBH FX website here.

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