Yen Pushes Euro Out Of The Spotlight; Brazil and Singapore Also In View

Highlights

The US dollar was mostly softer vs. the majors, but EUR/USD was sidelined for a day as the yen was the big mover on political uncertainty (see below).  We believe the euro bear trend remains intact, but that the pace of weakness has eased since mid-May.  ECB reported that overnight deposits there stood at EUR316.4 bln, a record high, which shows European banks remain fearful.     Yen was softer across the board and underperformed the buck and so dollar/yen rose to its highest level since May 18 above 92.  EM FX was mostly firmer.  Biggest gainers on the day vs. USD were CAD, MXN, BRL, AUD, and NZD, while biggest losers vs. USD were KRW, JPY, CLP, TWD, and RUB.  CAD posted an outside down today, and so will try to build on recent gains against USD.  US data was stronger than expected, with pending homes sales up 6.0% m/m in April and vehicle sales at 11.64 mln annual rate in May.  Fitch raised outlook on Peru’s BBB- rating to positive from stable.  Our model has Peru at BBB+ and so an upgrade is expected.

US equity markets were higher, as DJIA, S&P, and NASDAQ ended up 2.2%, 2.6%, and 2.6%, respectively.  European markets were down, though, with Euro Stoxx 50 falling 0.2%.  Asian equities are likely to open up today as Asian ADRs were higher during N. American trading Wednesday.  Nikkei futures point to an up open for Japan, and the softer yen should help Japan exporters.

US bond market was lower, as 2- and 10-year yields were up 4 bp and 8 bp, respectively.  European bond markets were mixed, as 10-year yields in UK, France, and Germany were down 3 bp, up 2 bp, and down 2 bp, respectively.  Greek 10-year yields rose 17 bp, Portugal rose 12 bp, Ireland rose 4 bp, Italy rose 8 bp, and Spain rose 10 bp.

Currency Markets
Dollar/yen made fresh 3-week highs above 92.  If at first in response to the resignation of Prime Minister Hatoyama the yen was sold on political uncertainty, it may continue being sold because uncertainty appears to be diminishing and the more likely successor as prime minister is a person who is vocally in favor of a weaker yen.  It will be recalled that even before becoming finance minister, Kan advocated a weaker yen in general and not in the context of a particular move in the foreign exchange market.  Kan is also a strong advocate of the BOJ to take more measures to combat deflation.  Here too a decline in the yen is desired.  Some observers will attribute some of the blame of Hatoyama’s resignation on the US government which pressed Hatoyama to abandon his electoral pledge about moving the Us Marines Corp base off of Okinawa.  Kan, as prime minister, might be willing to overrule any objections the US may have for intervention. Kan may find a sympathetic air from some Europeans.  Rather than dollar-yen being the source of frustration for Japanese investors and businesses, it is the euro-yen rate which has been more costly.  In addition then to the political certainty (with a yen devaluationist likely coming to the helm) and uncertainty (yet another prime minister that couldn’t last more than a year), and the (marginal) increase in intervention risk, the risk of a rating downgrade seems more likely because it is more difficult to envisage the will for strong fiscal actions.  The dollar is testing the JPY92.30 area, which is a retracement objective of the two day decline in early May that saw the dollar fall from almost JPY95 to a low just below JPY88.  A move above the JPY92.30 area would give immediate scope for another big figure increase toward JPY93.30.  While the euro is up almost 1% against the yen today, it has not decisively taken out Tuesday’s high (~JPY112.85).   A move above the JPY115 is needed to stabilize the downtrend. 

Brazil central bank meets June 8/9, and median market forecast is for a 75 bp hike to 10.25%.  Of the 19 analysts surveyed by Bloomberg, all look for 75 bp except 2 (100 bp hike).  The weekly central bank survey still shows that the market expects a year-end rate of 11.75%, same as last week.  That implies 225 bp of further tightening in 2010.  Trend growth for Brazil is thought to be around 4-4.5%, so with growth expected near 6.5% this year, the case for more aggressive tightening is there.  Price pressures have picked up, with mid-May IPCA inflation at 5.3% y/y, the highest since mid-May 2009 and above the 4.5% midpoint of the bank’s 2.5-6.5% target range.  Central bank report just issued sees inflation moving back to the 4.5% midpoint in 2011.  Brazil is not as concerned about the global growth outlook as others in EM, such as the export-dependent Asian nations.  As a result, Brazil’s central bank is one of the few that are likely to be tightening aggressively this year even though uncertainty regarding Europe continues.  Officials are saying GDP growth in Q1 is likely to come in at a 7.5-8.5% annualized pace.  BRL has held up OK during the intensification of the European crisis, down 3% so far in Q2 compared to PLN (worst EM performer, down 15% in Q2) and putting it in the middle of the EM pack.  We believe USD/BRL will remain largely in the 1.75-1.9 range near-term, with the risk tilted towards the upside.  We remain concerned about developments in Europe that will ultimately determine overall risk appetite and affect EM currencies, and even rates in excess of 10% will be no protection for BRL against these swings in sentiment.  While Brazil fundamentals remain solid, we think that appreciation (not only for BRL but for EM as a whole) will be very limited in the coming months.

Singapore May PMI came in stronger than expected at 52.2 vs. 51.9 in April, signaling continued expansion in its manufacturing sector.  This also supports our long-held fundamental view that the Asia macro outlook remains the strongest amongst the EM regions.  The headline PMI remained above the 50 boom/bust line for the thirteenth straight month.  Looking at the PMI components, new orders rose to 54.1 from 53.7, new export orders rose to 55.4 from 54.8, and production rose to 54.9 from 52.5.  The electronics sector subcomponent jumped to 53.7 from 51.8 in April, and forward-looking components there remain extremely encouraging for that segment of industry worldwide.  Electronics new orders rose to 56.5 from 55.2, while electronics new export orders rose to 58.9 from 56.7.  Given Singapore’s position as a regional bellwether, markets should feel even more confident about the Asian economic outlook as forward-looking indicators point to a strong Q3.  Due to its having the strongest fundamentals in the region, SGD remains the best performer in Asia quarter-to-date, down only 0.8% vs. USD compared to KRW (down 8.4%), INR (down 4.4%), PHP (down 1.6%), and TWD (down 1.6%).  Only the pegged CNY and HKD have done better than SGD in Q2.  We think SGD should continue to outperform during this ongoing period of heightened uncertainty, as Singapore fundamentals remain stellar.  And despite already tightening in April, the MAS remains in hawkish mode, warning in May that inflation may become “steep” in the coming quarters as an tightening labor market leads to higher wages that are then passed on to consumers.  MAS boosted 2010 growth forecast to 7-9% from 5-6.5% previously.  We continue to focus on cross-EM plays in this environment, as EM vs. USD is going to be driven largely by swings in general market risk appetite.  We continue to believe due to fundamental divergences, cross-EM plays that favor Asia over EMEA are the best way to play EM in the current environment and initiated a buy recommendation last week for SGD against CZK.  For similar reasons, long TWD/short CZK is another play.

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