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Dollar Firm, but Market Lacks Conviction

NEW YORK (BBH FX Strategy) -- The U.S. dollar is broadly firmer against the major currencies to start the week, but it remains well confined to ranges seen at the end of last week.

The market lacks conviction after shrugging off the disappointing European flash purchasing managers' index reports last week. Even though Italian and Spanish bonds are firmer Monday, outperforming Germany, we detect a deterioration of conditions in Europe and are concerned about a flare-up in tensions after the market gets through the quarter-end portfolio adjustments.

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Today's developments include a better-than-expected German IFO business-climate-index reading (109.8 vs. consensus 109.6) and an increase in Italian consumer confidence (96.8 in March, the highest since last July, from 94.4 in February). There are also signs that Germany will relent at the finance ministers meeting at the end of the week and allow the European Financial Stability Facility and the European Stability Mechanism to run simultaneously. The increase, however, will likely be temporary and once the EFSF expires in the middle of next year the available bail-out funds will be limited again to the money set aside for the ESM.

Asian shares were mostly lower, with the MSCI Asia-Pacific Index off about 0.5%, led by losses in Taiwan and India. While the decline in the former appears to be profit taking, the losses in the latter seem more significant as investors continue to be concerned about the direction of policy.

The Indian rupee itself is trading near 10-week lows against the U.S. dollar. European shares are more mixed, but of note Spanish shares are off sharply, extending the losses seen in the second half of last week and bringing the four-day loss to almost 6%. At the end of the week, the government will unveil the 2012 budget, with new austerity measures (the talk today focuses on electric utility hike and a cut in subsidies).

Four Observations

We share four important observations to begin this week, the last of the first quarter.

First, we expect politics to be a more important driver in Q2. This past weekend's developments are but a small taste of things to come. There were three electoral developments, two taking place in Asia. In Hong Kong, the election committee picked Leung Chun Ying as the next leader replacing Donald Tsang. China has promised Hong Kong direct leadership elections in 2017, so at least on paper this could be the last elite-picked leader.

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