Dollar Rally Stalls Ahead of U.S. Data

NEW YORK ( BBH FX Strategy) -- The U.S. dollar is mixed as the broad dollar rally loses steam into the North American open, highlights of which will include the U.S. weekly jobs numbers, the producer price index and the Philadelphia Fed survey.

The euro is currently flat after rallying from overnight lows of 1.300 following the encouraging auction results from Spain. An eventual downside break of 1.30 sets up an eventual test of 1.26, the January low.

Sterling is the weakest performer in the G10 against the dollar, thanks in part to Fitch's move to place the UK's outlook to negative. The dollar is losing steam against the yen as well after breaking 84, driven again by the rise in U.S. yields, continuing to move up 4 basis points to 2.305%.

Global stocks are mostly mixed, with the MSCI Asia Pacific up 0.3%, though stocks in China closed lower on the day. The EuroStoxx 600 is flat, with banking shares down 0.2% on the day.

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The eurozone is on the back burner for now. Despite what we see as an unsettled solution to the Greek saga and ongoing risks in Spain, eurozone governments were able to place a heavy load of debt issuance this week at lower yields.

Thursday, Spain placed 3 billion euros of debt. While below the EUR3.5 billion maximum, demand was strong as bonds maturing in 2016 saw an average yield of 3.37% vs. 3.75% previously and a bid-cover ratio of 4.13% vs. 2.21% previously.

Similarly, French yields declined and bid-covers rose at its bill auctions Thursday. That suggests much of this current leg of the dollar rally is due more to the improved U.S. side than from what we see as a still-worrisome eurozone side. In that regard, Greek unemployment rose to 20.7% in the fourth quarter from 17.7% in Q3, while Spain house prices collapsed 11.2% year over year in Q4 vs. a drop of 7.4% in Q3.

Indeed, the recent backup in U.S. yields over such a short time period has been astounding. Even with the Fed seemingly intent on anchoring the short end of the U.S. curve, the two-year Treasury yield continues to march higher and is now around 40 basis points, up 15 basis points year to date. On the long end, the 10-year yield has risen 43 basis points to 2.3% and the 30-year by 53 basis points to 3.43%.

As note before, higher U.S. rates have been a big part of the story behind recent dollar strength, as interest-rate differentials continue to move in the dollar's favor. As dollar/yen rose today to a new high for this move above 84, the two-year U.S.-Japan spread rose to an intraday high around 30 basis points, the highest since July 2011, before falling back to 27 basis points.

Similarly, the two-year U.S.-German spread is now around 16 basis points, the highest since June 2010. While the 60-day correlation with EUR/USD has been weakening steadily since mid-January, the 30-day has been rising back to positive territory in recent days, and is one of the factors we see as dollar-supportive.

U.S. data Thursday for March could give the dollar rally another boost.

Fitch late yesterday followed Moody's in placing the UK outlook to negative on its AAA, implying a one-in-two chance that it will downgrade within a two-year time frame. Chancellor Osborne will deliver the 2012-13 budget next Wednesday and he has also already made clear that there will no unfunded spending increases. Osborne will likely stress supply-side reform and other initiates as the best means to boost demand next week.

Our own model puts the UK at AA, and so we think a downgrade is long overdue. Sterling is likely to remain under pressure against both the dollar and euro. EUR/GBP has likely bottomed near-term and likely to move higher as sterling outperformance ebbs. This pair is now pushing up against near-term resistance at the 50-day moving average (0.835). Support is near recent lows around 0.830.
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