Global Briefing: Dollar Rallies as Rate Cuts Loom in Europe

The U.K. and European central banks contemplate easing.
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Global capital markets are off to a slow start, with many financial centers, especially in Europe, still on holiday. There are three factors that require the market's attention: Japan's tankan survey of business sentiment, the likelihood of rate cuts in Europe and the subdued U.S. jobs data released before the weekend.

Japan's tankan survey showed the smallest improvement imaginable. Sentiment among large manufacturers rose to minus 47 from minus 49. This means that among large Japanese manufacturers, there are 47% more pessimists (who expect conditions to worsen) than optimists (who expect conditions to improve). Among large nonmanufacturing concerns, sentiment rose to minus 34 from minus 39. Sentiment among small manufacturers rose to minus 53 from minus 56 and among small nonmanufacturers, sentiment rose to minus 38 from minus 43. While this marks the first improvement in seven quarters, the improvement is too modest to be very meaningful. If the deterioration has been arrested, Japan's economy remains in the trough.

Like most other key releases, the tankan report was somewhat below consensus expectations.

Japan also reported its leading economic indicators for February and household spending figures. Both figures show the rot continues. The preliminary estimate of February's leading economic indicators fell to 42.9 from 44.4 in January. Meanwhile household spending fell 3.8% on a year-over-year basis in February, reversing the 2.2% rise in January. It represents the largest year-over-year decline since last March and is the 10th decline in the past 12 months.

The yield on Japan's benchmark 10-year bond was unchanged on the session. Uncertainty ahead of Wednesday's sale of 20-year bonds offset the favorable impact of the weak economic data. Japan will auction 600 billion yen (around $5 billion) of 20-year bonds.

During the first quarter, investors in Japan's 20-year bond lost 7.3% (assuming the currency was not hedged), compared to a 0.4% total return on Japan's two-year bond. The volatility of issues with long maturities and the near-zero yield of short-dated obligations continue to force fixed-income investors into the intermediate sector. The yield on the 20-year bond is hovering just below 2.5%. The last time the government sold 20-year paper, the coupon was 2.6% and regarded as disappointingly low.

The Nikkei erased most of its early gains, which had carried the index to new highs for the move.

However, the inability to sustain the gains warns of a further setback in the days ahead. In addition, momentum indicators are flashing a bearish divergence. A move toward 15,500 over the next week or two, from the current levels around 16,330, would not be surprising. Much of the foreign demand for Japanese stocks that was related to the quarter-end portfolio allocation adjustment appears to have been satiated.

The dollar advanced sharply from the 118.40-yen area seen last Wednesday and Thursday to 121.75 yen earlier today.

The dollar has not finished a session above the 121-yen level in nearly a month. A convincing close above it today, say above 121.20 yen, would encourage traders to look for the dollar to retest the March high near 123.50 yen.

Europe's lingering holiday mode should not distract us from this week's agenda, the highlight of which is the potential for several central banks to cut interest rates. The

European Central Bank

, the

Bank of England

and the

Danish Central Bank

all are likely candidates for rate cuts this week. Norway and Greece are also possible candidates. The case for an ECB rate cut rests on three legs: downward revisions to growth forecasts throughout the eurozone, more dovish comments from ECB officials and increased political pressure for lower rates, emanating from the U.S., the


and the



The three-month futures contract on eurodeposits has rallied 25 basis points in the past month so that the implied yield is now 20 basis points below the ECB's 3% repo rate. So while a rate cut has largely been priced in, the contract sheds little light on the timing of such a move and cannot, for example, distinguish between a move this week or a move at the following meeting in the third week of April.

The case for an ECB rate cut sooner rather than later is largely based on the potential risks of waiting.

For example, at the start of April, Germany hiked taxes on energy, which will filter through and lift April's cost of living (inflation) by 0.4%-0.5%. In effect this will nearly double Germany's rate of inflation on a year-over-year basis. While this is largely a statistical phenomenon, it puts the most hawkish and independent central bank in the world in an awkward position to cut rates shortly after such data is released.

In addition, around the third week of a month, the ECB reports money-supply figures. The growth rate remains somewhat above the ECB's reference range. While excessive money-supply growth will not stand in the way of an easing, a cut too close to the release may not give the appearance that the ECB seeks to maintain.

The Bank of England's monetary policy committee meets Wednesday and Thursday.

The outcome will be known on Thursday, probably prior to the outcome of the ECB meeting. Currently U.K. base rates are at 5.25%. Soft economic data and subdued price pressures give the BOE scope to cut rates again. A 25-basis-point cut would likely encourage speculation that at least another cut of the same magnitude is in the pipeline, while a 50-basis-point cut would likely be seen as a signal that policy will be on hold at least for a couple of months.

Denmark could also announce a rate cut on Thursday. Its key two-week CD rate stands at 3.40%. Many look for a 20-basis-point rate cut. The strength of the Norwegian krona gives officials there an opportunity to reduce interest rates to help the flagging economy. The key deposit rate stands at 7% and a 50-basis-point cut cannot be ruled out. Greek officials would like to reduce rates, but the key is whether market conditions, given the impact of the war in Kosovo, are favorable. There is a chance that Greek officials will use Wednesday's inflation report as cover for a rate cut.

The March U.S. jobs data were reported somewhat below market expectations and suggest a further string of subdued reports.

The loss of jobs in the manufacturing and construction sectors, for example, points to soft industrial production and construction spending. The decline in aggregate hours and the small rise in earnings suggest personal income may not match the recent increases.

This said, many market participants are concerned that poor weather distorted the data. However, the situation will not be clarified for several weeks. In the meantime, the June U.S. bond futures probably have put in a near-term low. Look for a retest on the March high of 122-20 and then potential toward 123-20.

Marc Chandler is an independent global markets strategist who writes daily for At the time of publication, he held no positions in the currencies or instruments discussed in this column, though positions may change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at