Euro Higher, but News Remains Negative

NEW YORK ( BBH FX Strategy) -- The dollar is mixed, with most of the losses coming against the European currencies. The euro made a new high for this move vs. the dollar on Tuesday but so far has been unable to build on it. Support appears to be building for a larger European Financial Stability Facility/European Stability Mechanism firewall ahead of this week's eurozone finance ministers meeting.

The Irish referendum is now set for May 31 and the latest polls indicate it will pass. Italy had a well received T-bill auction, but Prime Minister Mario Monti's support is flagging in latest polls and suggests difficulties ahead in pushing through labor reforms. Near-term resistance expected to come in near 1.34 and then 1.348, while support lies around 1.33.

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Sterling is broadly weaker, declining the most in five weeks against the euro after UK fourth-quarter GDP contracted a worse-than-expected -0.3% quarter over quarter. The dollar is flat against the yen, trading to a recent low of 82.61 before recovering back above the 83 level.

The Antipodeans are leading the selloff against the dollar, consistent with the drop in Asian shares. SEK is doing well despite NIER cutting this year's GDP forecast to 0.4% from 0.6%.

Global shares are mostly down as Asian stocks took their cue from Tuesday's decline on Wall Street. The MSCI Asia Pacific Index is down 0.5%, led by losses in China. The EuroStoxx 600 is flat, with banks down 0.6%.

Strains to the System

Numerous eurozone developments Wednesday are worth mentioning. All in all, we think the news stream underscores the same elements still weighing on the eurozone, as weak growth and strains in the financial system keep the debt crisis alive.

The euro so far has been unable to sustain Tuesday's break higher and may test support around 1.33. Headline eurozone M3 growth picked up in February to 2.8% year over year from 2.5% in January. However, private sector loans were weaker at 0.7% year over year vs. 1.1% in January.

This underscores a major problem for the eurozone. The European Central Bank's Long Term Refinancing Operations have flowed into bonds and helped lift money supply, but it has not reached the end users. This in part is the money multiplier problem, as the high-powered money that the ECB creates is not reaching the real economy.

And it's not just the ECB. To differing degrees, the Bank of Japan, the Fed, and the Bank of England are all facing a similar dynamic, though recent U.S. data suggests loan activity is finally picking up.

France fourth-quarter GDP revision saw its quarter-over-quarter rate steady at 0.2% but the year-over-year rate lowered to 1.3%. Support seems to be picking up for a larger EFSF/ESM firewall, though numbers being floated (EUR700 billion to EUR940 billion according to one European Union official) are still not large, especially in light of recent press reports suggesting Spain may tap funds for bank rescue (though later rejected by Spain). EU officials are expressing concern about delays in overhauling Spain's banking sector.

Economic Outlook

The UK GDP was the biggest quarter-over-quarter decline since Q4 2010. The breakdown highlighted the fact that real household disposable income in 2011 as a whole fell 1.2%. This is the biggest fall in real incomes since 1977, illustrating one of the core factors that have been battering UK consumer confidence and the retail sector.

However, it is not clear that the current UK economic outlook is dire enough to drive policymakers to ease monetary conditions further. EUR-GBP resistance is near the recent high of 0.842, with support near the recent low of 0.828. The U.S. is reporting revised Q4 GDP Thursday and it is worth noting that there is some upside potential due to an upward revision U.S. consumer services, namely health care.

Chinese equity markets were sharply lower with the Shanghai index falling 2.65%. The State Council has reportedly issued a directive Tuesday calling for increased vigilance on inflation. At the same time, local banks and now the Shanghai Securities Journal continue to revise their GDP forecasts lower -- consensus seems to be moving toward the low end of 8% to 9% for Q1.

Lower profits by several Chinese corporates seem to confirm this view. However, iron ore and steel prices have been rising steadily, which, all else equal, would be a positive sign.
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