US Dollar On The Defensive

The US dollar is coming under broad pressure against the major currencies for no apparent reason. There is some talk about $130 bln US bond maturity and coupon payments over the next two weeks or so and is a well known event in the middle of every February. It is not a very useful fact in explaining the abrupt price action that has lifted the euro more than a cent off yesterday's lows.

Sterling's gains, extending yesterday's rally, are more understandable. Simply put, the market is pricing in risk that the BOE hikes rates earlier than BOE thinks, though the debt market is consolidating after big moves yesterday. There is a relatively wide premium over German on 10-year bonds. The BOE and CBI have revised higher growth forecasts.

The 3-year high set in late January just below $1.6670 is within spitting distance, but short-term technicals suggest the market is stretched and, even if a new high is made. It may not be sustainable before, at the minimum, some consolidation is seen, perhaps after the US retail sales report which is the main event in the North American session. Yellen was to testify before the Senate today, but due to the winter storm, it has been delayed.

Perhaps in this vein, the dollar's pullback against the yen is also comprehensible. The dollar had recovered from the JPY100.75 area seen last week, but has ran out of momentum. In the past four sessions, the dollar approached stalled in front of the JPY102.80 area, which is a technical retracement target and the 20-day moving average that is seen near JPY102.65. Although US shares recovered yesterday, the Nikkei lost 1.8% and the S&P 500 is off almost 0.5%. US Treasury yields are lower. The US dollar sees support in the JPY101.50-70 band and while the US retail sales report poses some headline risk, we suspect that the dollar's low is in place or nearly so.

The Australian dollar is the main exception to the generalized US dollar heaviness. The Aussie is being punished for a simply dismal employment report. Instead of gaining 15k jobs the consensus forecast, Australia reported a net loss of 3.7k jobs, which understates the case. There was a loss of 7.1k full time jobs. Adding insult to injury, the December series was revised to show a 23k job loss, a little more than initial estimated. The unemployment rate jumped to 6.0% from 5.8%, which is the highest in a decade, and the participation rate was unchanged.

The market was caught leaning the wrong way. The recent neutral RBA statement ironically spurred some speculation about the timing of a rate hike. We don't think that any thing like that was signaled. Nevertheless, Aussie had advanced nearly 4.5% since the lows on January 31 through yesterday's high. That high near $0.9065 will take on greater technical significance and is just shy of the year's high set a month ago near $0.9085. The initial retracement object neat $0.8925 has been approached. There is potential toward around $0.8850 in the coming days as sentiment readjusts.

It is really the euro's gains that are the least obvious. Yesterday's pullback was sparked by the ECB's Coeure using the strongest words to date to play up the possibility of a negative deposit rate, saying that the ECB was "seriously thinking" about it. The ECB's Coene did seem to play it down, but Coeure's comments fan expectations that the ECB will take fresh action in a few weeks. This is only by the fact that the March ECB meeting will see updated staff forecasts, which will include 2016 for the first time.

Some observers have argued that the 2016 forecasts could be used to justify a policy shift,but today's ECB's monthly report contains a strong hint that such speculation may prove for naught. Specifically, 2016 HICP (harmonized inflation measure) projection by professional forcasters in the ECB survey estimated 1.7%, seemingly supporting the official claim that deflation is not a threat. It will underpin a decision not to take a potentially highly disruptive act of a negative deposit rate. The survey did see this year's 1.5% forecast made in Q4 cut to 1.1%.

The euro has made a marginal new high since late January, but appeared to run into some profit-taking as it entered the $1.3680-$1.3700 band of resistance. Short-term technical indicators warn of the risk that the euro is range-bound. Stops are thought to be stacked above $1.3700, but beware of stops being triggered only to see the euro quickly reverse, which is what happened on January 24.

In addition, a shroud of uncertainty hangs over Italian politics, largely because of a split between head of the government coalition, of which the PD is the senior partner, and the PD leadership. A survey found a nearly 2/3 majority of Italians are opposed to a Letta-Renzi switch. Renzi is not even a member of parliament and yet, if he formally seeks to oust Letta, President Napolitano would most likely ask Renzi to try to put together a new government. It would be the third consecutive government that would not have been elected.

If Renzi does take office like that now, the risk is that he discovers that the disappointingly weak economic recovery that he will be associated with, is not simply a function of the poor leadership, but institutional constraints on strong leaders. It could weaken his position (and the center-left) when elections are held, under the rules that Renzi negotiated by Berlusconi.

This is hardly causing much of a stir in the market. Italian stocks are off, but holding up slightly better than Span and the FTSE MIB is still up more than 5% year-to-date, making in the best performer with in the G7. Italian bonds are under mild pressure. The 10-year yield is up about 4.5 bp to 3.77, but the Treasury has been busy with new sales and today sold a near 3-year bond at record low yields.

The risk to US retail sales is to the downside. Auto sales were disappointing and chain store sales appears soft. The measure used for GDP calculations, which excludes autos, building materials and gasoline, jumped by an outsized 0.7% in December should be expected to slow. Business inventories risks are slightly on the downside too. The preliminary estimate of Q4 GDP of 3.2% is likely to be revised down (Feb 28) as inventory growth appears somewhat softer and the US trade deficit, somewhat larger.