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Commentary for the week of 03/12/2010

The Australian dollar ended the week up 0.9% against the US dollar as risk aversion in light of a recovery in European sovereign credits (Greece, Spain and Portugal), higher commodity prices and despite firm data from China which in the past has sparked expectations of tighter PBOC policy and hence slower growth for the region (and a lower AUD). Officials from the Reserve Bank of Australia continued to talk up the economy and this is consistent with more rate hikes ahead. Employment rose 400 in February, well under expectations though full-time employment was up 11,400. The unemployment rate rose to 5.3% in February from 5.2% in January. Business and consumer confidence indexes for February and March respectively were up from the prior month.
In the coming week Australia releases economic data on housing starts and merchandise imports. The RBA's Edey and Debelle speak in the week and the RBA publishes minutes from the March policy meeting where rates were hiked. We reckon the AUD will move higher still against the USD in the week ahead in light of reduced risk aversion, higher commodity prices as expectations of a global recovery deepen and with the RBA expected to tighten more in coming months.

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The British pound benefited from a significant round of short covering Friday to end the week up 0.3% against the US dollar. Reduced risk aversion as confidence in Greek sovereign debt improved and polls showed the Conservative Party ahead in the polls (less chance of a hung parliament or no majority) helped the pound recover late in the week. Bank of England officials repeated there may be a need to restart quantitative easing ahead Gilt purchases) if necessary. The BOE reported inflation expectations rose in February to 2.5% (CPI 12 months out) from 2.4% in January (Bank targets 2%). The National Institute of Economic and Social Research said the economy grew 0.3% in the three months ending in February. January manufacturing output fell 0.9% month-over-month due largely to ice and snow storms. The trade deficit widened to GBP7.987bln in January from GBP7.010bln in December reflecting a 6.9% drop in exports. BRC (British Retail Consortium) reported retail sales in February rose 2.2% year-over-year after a 0.7% drop in January.
In the coming week the UK releases data on unemployment, budget deficit and industrial trends. Minutes from the March BOE Monetary Policy Committee meeting are released. Look for the pound to remain on the defensive next week in light of the uncertain political outlook, a fragile economic recovery and the risk the BOE will need to conduct more quantitative easing we think. Still the downside versus the USD should be limited by reduced risk aversion next week we think leaving the GBP down modestly versus the greenback.

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The Canadian dollar reached a 20-month high against the US dollar this week ending up 1.1% against the greenback. Strong Canadian economic data, firm commodity prices and a retreat in risk aversion combined to leave the CAD higher in the week. The unemployment rate in February fell to 8.2% from 8.3% in January while employment rose 20,900 in February. The jobs data fueled expectations the BOC will be forced to hike rates early in the second half of this year. Canada posted a larger-than-expected trade surplus in January helped by higher commodity prices. New home prices rose 0.4% month-over-month and were up 0.1% from a year ago in January. Capacity utilization rose to 70.9% in Q4 from 68.7% in Q3, the first substantial increase in 3 years. Housing starts rose 6.1% in February from January to a 196,700 per annum pace. BOC Governor Carney said sees low rates but not copying the Fed's approach to policy and rates noting it is appropriate to keep rates at a record low through June.
In the coming week, Canada releases economic data on productivity, manufacturing sales, wholesale trade, CPI and retail sales. Look for the CAD to move higher against the USD next week on elevated commodity prices, reduced risk aversion and signs of economic strength in Canada supporting an early second half of 2010 rate increase we believe.

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Waning concerns over Greece's fiscal condition, retreating risk aversion more generally and expectations the global economy is on the mend helped the EUR end the week up 1.0% against the USD. Euro Zone industrial production rose 1.7% month-over-month, the largest gain ever recorded (series started in 1990), and was up 1.4% year-over-year, the first annual increase since April 2008. Euro Zone sentiment index (Sentix) rose to -7.5 in March from -8.2 in February. ECB officials repeated rates are appropriate while stressing the need for fiscal adjustment ahead. Germany January industrial production rose 0.6% month-over-month after a 1.0% decline in December. Germany's trade surplus narrowed in January to the lowest level in about a year as exports slumped. European officials expressed confidence Greece's latest austerity measures will be enough to restore confidence in the nation's debt market and avoided hinting at any bailout for Greece from the EU.
In the coming week, data from the Euro Zone include figures on inflation, the current account and international trade. Germany releases data on PPI and economic sentiment. We expect the EUR to end next week higher against the USD as risk aversion retreats more and traders continue to cover a rather large one-way bet against the single currency and for the USD.

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With reports near daily that the Bank of Japan will consider more easing measures at next week's board meeting, the yen ended the week down 0.2% against the US dollar and was down considerably more against the EUR and AUD. Adding to the downdraft for the JPY was the tightening in European credit spreads for the riskier credits, especially Greece reflecting a broad decline in risk aversion. The yen largely ignored firm economic news from China this week which raised questions about the longevity of the risk or correlation trade (correlations are weaker). Japan's Q4 GDP was revised down to +0.9% quarter-over-quarter from +1.1% in the preliminary release. January industrial production was revised up to +2.7% month-over-month from +2.5% in the preliminary report. machinery orders fell in January from December. February wholesale prices fell 1.5% from a year ago highlighting deflation pressures. Bank lending fell for the third month in a row in February according to the BOJ. The coincident indicator rose to +2.5 in January from +3.5 in December.
In the week ahead Japan releases data on trade and CPI. The BOJ meets on policy and will announce its decision on Wednesday. No one expects a change (cut) in rates, but there is some risk of an increase in the amount of liquidity the BOJ is providing to the banking system. With the BOJ likely to signal a desire to do more to contain deflation by pumping more liquidity into the banking system next week, we think the yen will end next Friday somewhat lower against the USD and considerably lower versus the EUR and AUD. However, there is one caveat and it is related to fiscal year-end at the end of the month which often sees Japanese firms repatriate earnings from abroad to pad earnings and balance sheets with the added incentive of tax breaks on repatriated earnings.

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The Mexican peso ended the week up 0.7% against the US dollar as data from Mexico pointed to an earlier rate increase and risk aversion was broadly lower. Inflation rose to the fastest pace in 5 months in February reaching 4.83% year-over-year up from 4.46% in January. Gross fixed investment rose for the third straight month in December from November (+0.19%). Industrial production fell 0.2% in January from December. Mexico asked the IMF to renew its $48bln credit line to protect against possible market turmoil when developed nations start removing stimulus from their respective economies.
In the coming week Mexico there are no major economic releases. However, the Bank of Mexico holds a policy meeting Friday and is widely expected to leave rates unchanged at 4.50%. With our belief that risk currencies are likely to continue to outperform next week as confidence in the global recovery improves, look for the MXN to strengthen some more against the USD in the week ahead.

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Reduced risk aversion in the wake of the Greek budget measures and firm energy prices left the Russian rouble up 1.6% against the US dollar in the week reaching a 14-month peak. The Russian central bank moved the floating rouble band (limits rouble movement against a basket of USD and EUR) twice on Friday in the face of large RUB demand and intervention reaching $700mln ahead of each change. The trade surplus widened in January from a year ago. The budget deficit was 3.2% of GDP for January and February.
In the coming week Russia releases data on industrial production, PPI and unemployment. Look for the RUB to end next week higher against the USD in our view as risk aversion slips more and lends commodity prices and risk currencies like the rouble support.

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The Swedish krona ended the week up 0.9% against the US dollar tracking the EUR against the greenback as risk aversion waned and confidence in the global recovery improved. Sweden's economic data lifted expectations some of an earlier rate hike by the Riksbank. CPI rose 0.6% month-over-month in February and was up 1.2% year-over-year which was above expectations though still under the Riksbank's 2% target. The unemployment rate rose to 9.5% in February from 9.4% in January. Retail sales rose 0.8% month-over-month in January revised from +1.7% in the preliminary report and after +0.4% in December. Industrial production in January fell 0.2% from a year ago but was up 1.6% from December. In Iceland, the voters rejected a government bailout for UK and Dutch depositors leaving the IMF-Nordic loan program in doubt.
In the week ahead Sweden releases economic data on employment. Look for the SEK to end next week modestly up versus the USD as risk aversion slips more, confidence in Europe's recovery and fiscal outlook improves some and markets discount a July rate hike by the Riksbank we think.

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The Swiss franc ended the week up 1.5% against the USD despite the Swiss National Bank reiterating its determination to limit CHF appreciation versus EUR (saw new CHF high versus the EUR). Lower risk aversion and increased confidence in the Swiss economy helped support the franc. The SNB left rates on hold (0.25%) while lifting its forecast for GDP in 2010. CPI rose 0.9% year-over-year in February after 1.0% in January. There were reports of the SNB buying EUR for CHF after the central bank policy review but they were never confirmed by the central bank.
In the coming week Switzerland releases data on PPI, international trade, industrial production and economic sentiment. We expect the CHF to end next week higher amidst waning risk aversion and growing confidence in the outlook for the European and global economy which should see investors move more capital out of "risk-free" currencies like the USD and JPY.

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Large short covering in euro and British pounds left the US dollar lower at the end of the week with the USD index down 0.7%. Of the major currencies, only the yen ended down versus the dollar as the market contemplated press reports the Bank of Japan would consider easing policy more at its monthly meeting next week. Reduced concerns over the outlook for Greece's fiscal condition helped put some wind in the sail of the EUR. The USD closed at near a 1-month low versus the EUR and a 2-week low versus GBP. Some of Friday's USD weakness was attributed to reports that the San Francisco Fed President Janet Yellen would be named to succeed Donald Kohn as Fed Vice Chairman as Yellen is widely seen as an inflation dove. With the FOMC meeting next week based on press reports it would appear the Fed is going to repeat its pledge to keep rates low for an extended period and acknowledge signs the recovery is continuing while gradually picking up some pace. US retail sales in February were up 0.3% from January surprising many who expected snow storms would depress sales and helped lift expectations for Q1 GDP. However January sales were revised to +0.1% month-over-month from +0.5%. The University of Michigan index of consumer sentiment in March fell to 72.5 from 73.6 in February. Jobless claims in the latest week fell 6,000 to 462,000 which is still considered at a level consistent with falling non-farm payrolls. The trade deficit in January narrowed 6.6% from December to $37.3bln as imports fell more than exports. Business inventories were unchanged in January from December while sales were at their highest level since October 2008. The budget deficit in February was a record $220.91bln.
In the week ahead the US releases data on capital flows, industrial production, housing starts, import prices, PPI, CPI, jobless claims, leading indicators, current account and Philadelphia Fed business index. The FOMC meets on Wednesday and is seen leaving policy on hold. With risk aversion in retreat in light of diminished worries over Greece's fiscal outlook and the Fed's March FOMC meeting March 16 likely to leave the low rate pledge ahead in the language of the statement, we again think the USD index will end the next week lower. That said the Fed is likely to signal its desire to remove liquidity measures ahead that have been in place since 2008 to keep the banking system afloat and there is some risk that as markets perceive less liquidity in the banking system ahead deflating asset prices, the USD could see some strength in the later half of the week we believe.

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