Weaker-than-expected European data helped push the dollar to new highs for the week, but market participants are hesitant to be too aggressive ahead of the next batch of U.S. economic data and the G7 meeting this weekend, which TheStreet.com previewed Thursday.
reported that fourth-quarter GDP slipped 0.4%, marking the first quarterly contraction in three years. On a year-over year basis, the economy's growth slowed to 1.9% from the third quarter's 2.7% rate. The weaker-than-expected
survey of business confidence for January gives little hope of a strong rebound here in the first quarter. The January IFO slipped to 91.1 in January, a 2 1/2-year low, after a 91.4 reading in December. A poll by
Market News Service
found a median expectation for a slight rise to 91.5.
The bad news was echoed in France, which issued a disappointing manufacturing report. Not only did manufacturing decline a greater-than-expected 0.7% in December, but the November series was revised sharply lower to boot. Originally France reported that manufacturing rose 1% in November, but today it revised this to show a 0.1% decline.
European bonds have found little comfort in the poor economic data.
The yield on the benchmark 10-year German bund, for example, is near 3.92%, just off the highest level for the year and some 30 basis points off the low set in late January. The flatness of the European yield curves encourages investors to keep durations short, which has the opposite effect of the relatively steep yield curve in Japan. With call money trading around 0.10%-0.11% in Japan, investors are being forced to extend their durations to lock in better yields.
The chief international financial adviser to German Chancellor
forecast that the
European Central Bank
, which kept rates on hold yesterday, will shave 30 basis points off the repo rate this year. Yesterday, the IFO warned that the ECB may not reduce rates at all this year. Looking at the three-month euro-deposit futures contract, the market appears to have discounted about a 20-30-basis-point cut in the repo rate. However, in the near term, the currency rather than interest rates or fiscal policy will likely bear the burden of adjustment.
Official blessing for a weak euro is subtle and comes in the form of attributing recent weakness to fundamental factors, as the governor of the
Bank of France
said earlier today. This said, note that technical indicators, like momentum studies, are flashing warning signals as the dollar's highs against the mark and Swiss franc have not been confirmed by new highs on the relative strength index. This suggests that the dollar may consolidate, or even correct lower, before resuming its climb against European currencies.
Japanese government bonds rose for the fourth consecutive session, with the yield on the benchmark bond dropping another 13 basis points.
The yield now stands at 1.755%. The
Ministry of Finance
ended its two-month freeze on purchases of government bonds by stepping into the market (through the BOJ) and bought 100 billion yen worth of bonds. The MOF is committed to buying another 300 billion yen in government bonds before the end of the fiscal year on March 31. While the decline in Japanese bond yields is a welcome development, there is a danger that yields have fallen too far too fast to ensure a healthy reception at next Tuesday's 1.4 trillion-yen auction of 10 year bonds. With Japanese officials still talking the yen down, foreign investors will not be large buyers of Japanese stocks or bonds.
The January CPI and November trade balance will compete for mindshare at the start of the U.S. session today. The consensus calls for a 0.1% rise in the headline CPI and a slightly larger rise when food and energy are excluded. After filling the gap at 124-11 that we have been monitoring all week, the March bond contract reversed course and finished sharply lower. Support is now seen near 123. It will be difficult for the March bond to regain any meaningful upside momentum in the current environment.
The November trade deficit is expected to widen to around $15.5 billion, according to a
Market News Service
poll, from a $13.6 billion shortfall in October. The wider U.S. trade deficit reflects in part the fact that the U.S. economy was accelerating while those of most of its trading partners were slowing. And given that U.S. growth has been systematically underestimated, the risk is for a wider-than-expected deficit. Given the technical condition of the market, the dollar could be more vulnerable than usual to the data.
Ties to the U.S., codified in Nafta, are helping to insulate Canada and Mexico from the vagaries of the international economy.
The Canadian dollar is trading at its best levels in more than half a year against the U.S. dollar. The impact of weak commodity prices has been mitigated by ideas that the strength of the U.S. economy will spill over and put a floor under the Canadian economy. Canada also offers among the highest interest rates in the G7.
Meanwhile, Mexico has fully recovered from the shock of the Brazilian crisis. The Mexican economy is expected to be one of the few in Latin America not to contract this year. Foreign investors are attracted to its high nominal and real yields. This week's auction produced a 27% annual yield on the 28-day T-bills known as cetes. The government forecasts a 13% inflation rate this year. After the recent large moves, look for the Mexican peso and yields to consolidate in the week ahead.
Marc Chandler is an independent global markets strategist who writes daily for TheStreet.com. 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