Dollar Begins Week Softer

NEW YORK ( BBH FX Strategy) -- The U.S. dollar is marginally softer as North American players return to their posts.

The better-than-expected official Chinese manufacturing purchasing managers' index (53.1 from 51.0 in February and consensus for 50.5) saw steeper losses in the greenback. The disappointing eurozone manufacturing PMI however (47.7 same as the flash but weak details) helped cap the euro in front of last week's highs, ahead of 1.34, and weighed on European equities.

The UK Chartered Institute of Purchasing and Supply survey of manufacturing surprised on the upside (52.1 vs 50.7 consensus) and sterling extended recent gains, though we suspect it will struggle to extend those gains in North America Monday.

Japan's Tankan Survey disappointed, showing no improvement from the December report (large manufacturers diffusion index -4), with softer capex plans (1.0% vs 1.4% in December) and expectations of a firmer yen (JPY78.14 vs JPY79.02 in the December survey).

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There are several policy implications from the recent data reports. First, the rise in China's official PMI supports the idea of a soft landing in the world's second-largest economy. This would seem to reduce the urgency of easier monetary policy.

Second, it also has knock-on effects for the outlook of Tuesday's Reserve Bank of Australia meeting. Speculation seen last week for a cut has been largely, even if not wholly, reversed. Of the central banks that meet this week (RBA, Bank of England and European Central Bank), Australia still is the most likely to surprise, although we now expect it to wait a bit longer to move.

The Bank of England will leave its rate and asset purchase program unchanged. The ECB is in a more difficult position. March was the eighth consecutive month of a sub-50 PMI reading. Moreover, the forward-looking new orders component gives no hope for optimism of stability. It stands at 45.4 from 45.6 in the flash report and down from 47.3 in February.

The eurozone also reported another increase in the unemployment rate -- 10.8% in February from 10.6% at the end of last year and 10.0% in February 2011. Yet interest rates are not the main obstacle to growth. Instead, austerity and deleveraging are the main culprits. Ironically, in the current environment, weaker growth will force some countries to increase their austerity efforts or overshoot their fiscal targets.

We note another budding problem in the eurozone. We have commented previously on the diverging collateral rules within the eurozone and noted last week that the Bundesbank has decided not to accept debt from countries receiving aid as collateral. It appears poised to extend this further in May. Moody's noted earlier Monday that this has negative credit implications. At the same time, S&P reminded that it has 14 of 17 eurozone members on negative watch and one on selective default.

The Bank of Japan is likely to come under more pressure to ease policy as early as next week's meeting. While stepping up its asset purchase program is one option, we suspect the BOJ could increase its fund provisioning measures to stimulate business sentiment instead. The dollar spiked to JPY83.30 in response to the disappointing Tankan, but has since retreated and is may retest the bottom of its two-week trading range around JPY82.00.

For its part, the euro has tested the $1.34 area several times and remains in a sideways pattern near term. Of note, the three-month implied volatility is near its lowest level since August 2008. Implied volatility has come off as the euro recovered in the first quarter. We suspect the decline in volatility is like a coiled spring, warning of the increasing risk of a large spot move in the offing. Sterling is trying to establish a beachhead above $1.60 and if successful, would signal near-term potential toward $1.62.

There is a U.S. economic report every day this week. The key reports are the auto sales and the employment report. We expect some moderation in both. February auto sales were at a four-year high and, with rising gasoline prices, we suspect the risk is for a pullback from the 15.03 mln unit pace. Nonfarm payrolls are also likely to have moderated.

During the March survey week, there was little improvement in the weekly jobless claims compared with the February survey week. In addition, the warmer winter meant fewer layoffs and the payback should mean less hiring in the spring.
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.