USD Firms Ahead of U.S. Retail Sales, FOMC

NEW YORK ( BBH FX Strategy) -- The U.S. dollar maintains broad firmness ahead of Tuesday's release of retail sales and the FOMC meeting. Even with the Greek PSI event risk out of the way, the focus on CDS payouts and the many central bank meetings this week should provide enough uncertainly to leave investors on edge despite the positive news on U.S. employment last Friday.

The euro is still holding up above the 50-day MA now at 1.3090, which has proved a formidable resistance level since late January. The dollar is weaker against the yen, down 0.3% to 82.23. Global equity markets are also mixed. The MSCI Asia Pacific Index was 0.7% lower, but European stocks pared their early losses and are currently flat on the day. Periphery sovereign yields are modestly higher with moves confined to a few basis points.

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International Swaps and Derivatives Association's determinations committee decided late Friday that the Greek PSI was a credit event, as was widely expected. The triggering of the Greek credit default swaps is important. Many are focusing on the net figure, which is a modest $3 billion according to reports, but the gross figure of almost $69 billion may be more indicative of the nature of the settlement process on March 19.

There is a heavy load of debt issuance this week, with Germany and France Monday, Italy, Belgium, and Netherlands on Tuesday, Italy on Wednesday, and Spain and France on Thursday. Ahead of that, European Union officials will meet Monday in Brussels to finalize the Greek aid package, which should be cleared after PSI deal was completed. EU will also meet with Spanish officials, who say any "misunderstandings" will be cleared up and expressed confidence that EU sanctions will be avoided.

Spain appears headed for an important confrontation with the EU. Spanish Prime Minister Mariano Rajoy cannot reverse the unilateral aspect of his announcement that Spain would see a 5.8% of GDP budget deficit vs. 4.4% agreed upon with the EU.

The fiscal compact has just been signed and promises greater fiscal discipline. If the EU backs down, it loses credibility and calls into question the fiscal compact itself. All this uncertainty should limit euro upside and keep markets on track to test the 1.2974 February low.


With the Greek PSI out of the way, developments in the U.S. are likely to be front and center this week. Strong U.S. jobs data Friday helped the dollar rally, so perhaps we are back to the good old days where fundamentals matter. That is, good U.S. data is good for the dollar.

February retail sales are due out on Tuesday, with market looking for 1.1% month-over-month (0.7% ex-autos). However, auto and chain store sales point to the risk of a stronger-than-expected gain. The headline figure may also be inflated by higher gasoline prices, but the market will likely focus on the core measure that excludes autos, gasoline and building materials used in GDP calculation.

Firm data lessens the chances of further quantitative easing from the Fed. FOMC meets Tuesday and no action is expected. Besides the Fed this week, we also have policy meetings at Bank of Japan Tuesday, Norges Bank Wednesday, and Swiss National Bank Thursday. No action is expected from any of them.

In our explanation of the euro-dollar exchange rate, we often understand the two-year interest rate differential to embody many of the key forces that drives investor behavior. The spread is close to its widest level since mid-2010 as the U.S. pays about 14 basis points more than Germany.

As the premium Germany offered began to fall from last spring, we became more confident in our negative euro view. At first the driving force was the European debt crisis that saw investors park funds in the short end of the German curve. However, more recently this has changed. It is the backing up of U.S. rates that is responsible for the last widening of the spread.

As recently as late January, the U.S. two-year yield was near 20 basis points. It now stands near 32 basis points, the highest since last August. German two-year yield at 16 basis points is just above the record low set in January of 13 basis points.

The focus in the emerging markets space is China. The trade deficit for February came in at -$31.5 billion vs. an expected -$5.3 billion. The combined January-February data showed that imports rose 12% year-over-year while exports rose only 9%. Oil and copper imports were particularly strong, with the latter posting the second highest import print on record.

People's Bank of China Governor Zhou Xiaochuan confirmed our view that there is "lots of room" for reserve requirement ratio cuts but that they should not be seen as monetary policy easing. Consistently, stocks were little changed on the day but SHIBOR rates came down as the 14-day SHIBOR rate fell below 3% for the first time since May 2011.

The data also supports our view that the underlying dynamics for CNY are changing. We still expect appreciation to continue, but mostly through the real exchange rate given higher inflation and especially wage growth in China vs. its trade partners. We do not expect any material appreciation this year, but we also doubt CNY will be allowed to depreciate much either, staying basically flat in nominal terms.

USD/CNY fixed almost 0.25% higher overnight, the largest one-day move this year, but is still trading within recent ranges.
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