Currencies Pull Back Into Weekend

NEW YORK ( BBH FX Strategy) -- The U.S. dollar is broadly higher paring some of its losses seen Thursday as asset reflation bumps up against fleeting technical momentum and mixed economic data.

The euro is currently trading below 1.322 after steadily declining from 1.332.

The dollar is rallying against the yen, up 0.5%, after Bank of Japan Governor Masaaki Shirakawa repeated the bank's commitment to achieve its 1% inflation target. Yet, he also noted that liquidity alone cannot defeat deflation.

Sterling edged higher against the euro amid a combination of corrective euro action and underlying sterling support following a firm construction purchasing managers' index print. Asian stocks posted modest gains, leaving them close to seven-month highs with the MSCI Asia Pacific index up 0.3%. The EuroStoxx 600 is flat; banks shares are up 0.5%.

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Spain unemployment claims increased 112,269 in February, with total registered unemployed reaching 4.7 million and the pace of claims picking up. This comes after a pretty ugly fourth-quarter jobless rate of 22.9%, and points to further deterioration ahead.

What is more important to us is that European Union leaders have told "member states under scrutiny" that they should be ready to pursue other austerity measures if needed. In other words, despite recession risks in much of the eurozone, members are being told to tighten their belts again.

Spain is not unique, and given that it is going to have to revise its budget targets for this year in light of slower growth, so too will others. The debt crisis is by no means over given the negative growth/budget deficit dynamics in play, but the Long-Term Refinancing Operation appear to have bought the eurozone some time as Spain and Italy 10-year yields remain below 5%.

The European Central Bank reported that overnight deposits surged to a record 776.9 billion euros on March 1, up from 475.2 billion euros a day earlier. This would appear to reflect hoarding of the 529.5 billion euros in three-year liquidity that was provided by the ECB earlier this week. However, balance sheet mechanics suggest this does not represent hoarding of LTRO cash since banks taking LTRO funds are different than the ones parking money at the ECB.


Over the past week CAD was the best performing currency in the G10 against the USD, also outperforming many EM currencies. CAD has also been one of the best performing currencies over the course of February. We consider this a function of two important drivers.

First, as we recently highlighted, CAD is highly sensitive to oil prices and with Brent prices increasing nearly 12% over the past month it is not surprising that CAD has risen in kind. The rise in oil prices is still consistent with an improvement in demand, rather than a pure supply side shock that was seen during the Arab Spring. That should be less negative for growth. As a result, the terms of trade are positive for CAD.

Second, CAD is also outperforming due to its economic and trade links with the U.S. The U.S. economy continues to grow above trend and is likely to continue to grow at a decent clip. Given that nearly 75% of Canadian exports are destined for the U.S. market, this dynamic should remain supportive for Canadian growth.

On the domestic front, today we will get the fourth-quarter reading of Canadian GDP. The Bloomberg consensus is for a 1.8% quarter-over-quarter reading, well below the 3.5% print seen previously. However, despite the potential for a deceleration in the economy we continue to expect the Bank of Canada to remain on hold at next week's policy meeting and retain its neutral posture.

Consequently, we expect CAD to continue to outperform, but we would recommend waiting for a pullback to 0.995 to position for further outperformance in the medium-term.

Emerging Markets

There are two important political events this weekend in the emerging markets world: the presidential elections in Russia and the yearly Chinese National People's Congress and Chinese People's Political Consultative Conference.

In China, one possible tangible outcome of the meetings would be a more explicit shift toward a looser approach to housing, in line with our view. Some local news reports overnight noted a sharp increase in real estate lending by China's for big banks, while others mentioned a proposal to be discussed at the CPPCC for as much as a 30% discount on mortgages for first-time homebuyers. Consistently, the Shanghai index closed 1.5% higher led by gains of nearly 4% in the real estate sector.

In Russia, the protests did little to undermine Vladimir Putin's chances of winning the elections, but they may have a medium-term positive impact for the country as it pressures authorities to increase accountability.

In the short term, however, the most likely outcome is that Putin will meet public discontent with increased fiscal spending. With oil prices still elevated and Russian fundamentals mostly on the strong side, we are inclined to view any selloff in Russia assets caused by post-elections protests as a buying opportunity.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.