US Dollar Strengthens on Greek Worry

The U.S. dollar is broadly higher against most of the major and emerging market currencies amid concern that the Greek PSI will not see sufficient participation to avoid the triggering of the collective action clauses or worse.

At the same time, the downgrade of China’s growth forecasts and the softer service sector Purchasing Managers Index, released Monday, continue to take a toll. The strength of JPY and USD appear to reflect short-term participants bracing themselves for disappointing developments in the coming days.

Consistent with this theme, global equities are lower, extending the first real correction of the year. The MSCI Asia-Pacific Index was off about 1.25% and is now off more than 3.5% since the Feb. 29 multi-month peak. Of note, the Malaysian bourse bucked the trend to post gains for the fifth consecutive session, the longest in nearly a month, lead by consumer service and basic material.

European equities are under pressure as well with the Dow Jones Stoxx Europe 600 off almost 1.5% near midday in London. Industrials are off about 2.25% following confirmation that the eurozone economy contracted 0.3% in fourth quarter and amid expectations that it is also contracting in the current quarter. Financials are off 2% on profit-taking spurred in part by concerns over the Greek PSI.

The anxiety is also evident in the debt markets. Core bonds in Germany, the UK and the U.S. are firmer, while peripheral bonds are weaker. Of note, Italian 10-year yields are moving below Spanish yields. The U.S.-Germany two-year spread is at its best level since June 2010. Although the correlation has weakened, we suspect, as we argued last week, the interest rate differential is sending the true signal and that the euro will catch up by depreciating.

The euro has broken through the uptrend, drawn off the Jan. 16 and Feb. 16 lows and catching Monday’s low as well. In so doing, it has retraced more than 61.8% of the rally since the Feb. 16 dip below $1.30. While some bids are expected to be seen around $1.3100, the downside risk extends to $1.3050. We note that the 5-day moving average is crossing below the 20-day average, reflecting the erosion of the recent uptrend.

While there has been much speculation that Long Term Refinancing Operation funds will be used in Europe as either a liquidity cushion or to buy local sovereign debt, there is increasing talk that some of the funds are being swapped into dollars. This left U.S. banks, often the other side of the swap, long euros and there is some speculation that those euros are being hedged or otherwise offset.

Sterling is posting an outside down day. This means that it has traded on both sides of Monday’s trading range and a close below Monday’s low (~$1.5786) would be a reversal pattern. The break of the $1.5780 area warns of the risk of a deeper setback. Initially the $1.5720 area may prove sticky, but there is near-term potential extends toward $1.5600 to $1.5640. Last week, sterling closed above its 200-day moving average for the first time since last August, but this proved, with the benefit of hindsight, a bridge too far. This area, roughly $1.59, will likely serve as resistance.

The dollar is at three-day lows against the yen and this seems to reflect cross-rate adjustments more than a dollar move. In particular, Japanese investors have reportedly been keen sellers of the Australian and New Zealand dollars today.

The Reserve Bank of Australia left its cash rate on hold at 4.25% as widely expected. Its statement read much like last month’s, with rates currently appropriate and global risks emphasized. The Australian dollar is trading below $1.06 for the first time since the start of February. The softer Chinese official service PMI reading and the lower official growth forecasts appear to have encouraged a bout of profit-taking on the Australian dollar, which had been looking a bit tired after being unable to make much headway above $1.08 after repeated attempts. The dollar found support near JPY80.80. The JPY81.20 to JPY81.40 area may now act as resistance.

There are no U.S. economic reports today, but Canada reports the IVEY PMI. The consensus calls for a bit of slippage from the 64.1 reading in January. The Canadian dollar is softer, but holding up better than the other dollar bloc currencies today. Still, the Loonie is trading near parity for the first time in about a week. Dollar spikes toward CAD1.0050 may be sold as investors take a more constructive view of North America.

The early call is for a third consecutive month of 200,000-plus U.S. non-farm payrolls on Friday.

Brazilian Q4 GDP came in close to expectations rising 1.4% year over year, down from 2.1% last quarter. Still, 2012 data suggest a bit of a pickup ahead. Previous rate cuts and credit easing measures seem to be having some effect.

As such we see no need for the central bank to accelerate its pace of easing from an economic perspective, but we recognize the political pressure for doing so. The bank meets March 6 and 7. Analysts are split between 50 and 75 basis points, while the swaps market is pricing in a significant chance of a 75-basis-point cut. So it would seem that regardless of the Monetary Policy Committee’s decision, someone is going to be surprised.