19th of March 2012 - Fundamental Forex Market Overview

DAILY MARKET COMMENTARY
19 March 2012 – 8:00 GMT
Monday

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Market Analysis Desk
Foreign Exchange Research: www.fibosignals.com/5585/resources.html
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FUNDAMENTAL ANALYSIS at 0800 GMT

WORLD
Ranges were broadly flat overnight but the dollar has checked some of its advance amid fears that data is still not strong enough in the US for the Fed to continue allowing the market to price out expectations for monetary easing. On Friday the University of Michigan consumer sentiment index slipped to 74.3 in early March from 75.3 in February; industrial production was unchanged m/m in February; and the y/y reading for core consumer prices slowed to 2.2% in February from 2.3% in January. Yet, this should not mask the positive momentum in the US economy, as the University of Michigan report included key improvements in labour market assessments, while manufacturing production was up 0.3% m/m in February.

Moreover, at a 1.9% annual rate in the past three months, core consumer prices are still growing at a faster clip than the 1.7% recorded last October. In fact, thanks in large part to what has transpired in the US, our global asset allocation team has declared a secular turning point for bonds into a long-term bear market. Our baseline scenario now pegs 10-year UST yields at 2.7% at the end of 2012 (vs 2.4% previously) and 3.3% at the end of 2013 (vs 3.0% previously), with the Fed starting to hike rates in 2013 - defying the Fed's late 2014 guidance. This should support currency pairs like USDCHF and USDJPY, which tends to track UST-JGB yield spreads particularly well - underpinning our three-month target of 85. These shifts need to take place in the context of a stronger US recovery and ever-widening policy divergence, though further policy guidance from the Fed is needed and at this point it remains too early to be over-expectant on the FOMC alone. In addition, the dovish tone from several minor central banks of late suggest that the 'risk-on, high-yield on' framework could also be changing as these nations are seeing clear downside risks to their manufacturing sectors. Today's speech by New York Fed President Dudley plus appearances by Fed Chairman Bernanke on Tuesday, Thursday and Friday will be closely watched. As long as Bernanke does not drop any 'QE3' hints as we suspect, the US dollar should be well supported. Overnight EURUSD traded in a range of 1.3156-1.3187, USDJPY 83.36-83.56.

EUR
EU Commission chief Barroso said on Friday that members should continue considering mutualising 'part of their debt load' to signal their 'commitment' to Europe's monetary union. However, we note that Northern European nations remain strongly opposed to such a step.

On Friday the euro got a boost when ECB Governing Council member Nowotny said the ECB is working on the design of its exit strategy so that it is ready for use when the time comes. However, we would not interpret these remarks as being hawkish. Instead, the comments were likely intended to be reassuring in the wake of concern over the possible dangers of ample liquidity provision. Nowotny went on to emphasise that the ECB is currently in wait-and-see mode and he does not see any evidence of inflationary pressures.

Referring to the bond-buying facility, Nowotny revealed there is a general reluctance to use it on the ECB's governing council: "I think we are all very cautious about it. It still exists, but my personal view is that it should be used with great care and with great restriction".

Germany's Finance Minister declined to "speculate" on successors to Eurogroup Chairman Juncker, though he said that person will be a Finance Minister. This doesn't rule out Italian PM Monti, who also holds the Finance portfolio for Italy.

An International Monetary Fund staff report warned Friday that Greece's loan programme faces "exceptionally high" risks and said Athens may need further debt restructuring and additional financing that Europe should cover. Officials are particularly concerned about the ability of Athens to politically deliver on the tough economic-overhaul policies, especially considering that the forthcoming elections in Athens may mean new leaders aren't as committed to reforms.

JPY
The biggest move in IMM positioning remains with the yen. Net shorts in the currency have trebled over the past three weeks, and momentum remains strong as USDJPY eyes 85. With the Eurozone seemingly managing Greece-related risks, the US dollar's ascendency now looks wholly dependent on further yen developments, and the FOMC decision last week may have given US dollar longs an extra boost (data as of March 13, the day of the last meeting).

The minutes from the BoJ's February 14 Policy Board meeting - where further easing took place and an inflation 'goal' of 1% was adopted - showed that "most" Board members acknowledged that the Bank's "basic thinking was unchanged on price stability" and that this was simply an effort to communicate more effectively.

However, "a few" members felt a target of 1-2% might eventually be appropriate. One member even went so far as to suggest that the Bank should aim eventually to adopt a target of 2% - specifically to bring it into line with international practice, "so that the foreign exchange rate would not move to a long-term trend of being one-sided". We see the minutes as endorsing our view that the BoJ is likely to keep its easing bias long after other central banks have begun to tighten. This backs up our call for USDJPY to push higher towards 85 on a three-month horizon.

AUD
RBA Governor Stevens noted overnight that recent domestic economy was "not too bad". Although GDP suggested growth below trend, other data point to trend. Monetary policy can play a role in supporting demand, should inflation allow it. On the AUD, he noted that the strong currency is forcing some sectors to restructure, [but] monetary policy cannot lessen the pressure.

Our analysts note the comments suggest the door is still open to a rate cut from the RBA, given the weaker than expected GDP data, but still probably need to see the unemployment rate rise to get the cut. However, RBA is still not linking the relatively high level of Australian rates as a key driver behind the high AUD.


A. White
Analyst at Fibosignals.com


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