In Europe Recession Extends

In Europe recession extends
The rate of employment descends
Their policy makers
Those movers and shakers
Cannot stop the current strong trends

It is all dollars, all the time if you are seeking an asset to buy.  The dollar is at its strongest level overall since July, 2010 having made new 4+ year highs against the yen overnight and 6 week highs vs. the euro.  The proximate cause of the euro’s weakness was consistently weaker than expected Eurozone GDP data, with Germany printing at 0.1%, France at -0.2%, Italy at -0.5%, all three lower than expected, and the EZ as a whole at -0.2%.  This makes 6 consecutive quarters of negative growth in the Eurozone, an ignominious new record.  While the market seems convinced that Draghi will act to cut rates again if things get worse, for the time being, the contrast between the US story, where data has seemed to have bottomed, and the European story, where things continue to sink, is quite sharp and the dollar remains the key beneficiary.

In the UK, the employment data was mixed, with a slightly lower claimant count and downtick in the Unemployment rate to 7.8% offset by weaker than expected earnings.  But more importantly, the BOE’s Inflation Report was released, with the Old Lady raising its GDP forecast for Q2 to 0.5%, and lowering its longer term inflation forecast, although with several caveats.  The pound’s response has been to trade somewhat lower, although on the day it has done very little.

Meanwhile, the yen has traded above 102.50 for the first time since October, 2008, and shows no signs of stopping.  Yesterday I expected a bit of consolidation given the strength of the move since breaking through 100, but the market has other ideas.  Overall, nothing has changed in my view that USDJPY will be at 110 come December.  If anything, I am probably being too conservative.  Japanese Consumer Confidence was a bit weaker than expected at 44.5, but the stories that are really getting coverage are those that discuss foreign investment by Japanese companies.  Last night, the focus was on the big Japanese banks, which are suffering because they can’t play the yield curve with the BOJ buying 70% of all JGB’s, and so are forced to find foreign acquisitions of assets to grow.  This is just another facet of the weak yen trade, and one that is likely to increase as time passes.

US data today brings PPI (exp -0.6%, 0.1% core); Empire Manufacturing (4.00); Capacity Utilization (78.3%) and IP (-0.2%).  Given the recent patterns of data, I expect that these numbers are likely to err on the high side, rather than be weak.  The other big story this morning has been the increase in tax revenues in the US.  Tax receipts through April have been almost $100 billion higher than expected, although that was likely the result of capital gains brought forward to 2012 given the impending change in tax rates.  However, for now, the Administration is pushing the numbers hard to show that their plans are working, and the data does look better.  Will it continue?  I guess it depends on how the US economy continues to perform.  Why does it matter?  This is one of the things that will underpin the dollar going forward, proof that the US economy is rebounding, so pay attention to this.

Looking at the commodity currencies, both have also continued to weaken in the face of the USD’s remarkable recent strength.  Aussie has tested key support at 0.9850, which thus far has held, but a break there will encourage a major technical response opening up an opportunity for a move to as low as 0.9350 before its all over.  Receivables hedgers beware!  CAD, on the other hand, has been weakening, but not quite so much as other currencies given its strong ties to the US.  An eventual move to 1.05 seems realistic, but I see limited opportunity for much beyond that.

With all the focus on the majors, the emerging market currencies are not getting much attention.  Frankly, I think that is an appropriate market response.  These will continue to follow the dollar’s overall lead unless something remarkable happens in a given emerging market.  So look for further USD strength here.

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