Strategy Reports

USD:

February was a good month for the U.S. dollar whose index managed to gain 1.2% as risk aversion from Europe, and the prospect of higher interest rates sent the currency higher against majors.

Already stricken by concerns of a debt crisis in Greece, the gains we made primarily against the euro and the pound sterling as international investors flocked to the U.S. currency as a safe haven play. Nevertheless, the yen, Canadian and Australian dollars all made headway against the greenback.

On the economic data front, the markets saw some evidence of the so called “risk trade” creeping back into the picture, with the greenback often rallying on the back of weaker than expected results as investors flocked to the USD to hedge against tensions abroad. The local data were also relatively mixed, with nonfarm payrolls kicking off the month with a surprising 20k decline in jobs despite calls for a 15k increase, and we saw December’s 95k shortfall revised lower to a 150k decline.

Despite this, the unemployment rate decline to 9.7% despite forecasts for no change to December’s 10.0% level.

A second look at Q4 GDP on the other hand, was revised higher to a 5.9% growth rate despite calls for no change to the advanced 5.7% pickup.

On the inflation side, price growth remained softer than expectations with headline annual inflation up 2.6% for January instead of the expected increase to the 2.8% mark from 2.7% previously. Core inflation rose only 1.6% despite forecasts for no change to the previous month’s 1.8% pickup.

On the financial markets side, the S&P 500 managed gains of 2.8% while the Dow Jones Industrial Average added 2.5%.

Central bankers were active in February, with the Federal Reserve surprising the markets by hiking the discount rate by 25 bps to 0.75%, in an effort to push financial institutions to seek cheaper money from the private sector. The subsequent spike in the USD was later quelled by a reaffirmation from Fed Chairman Ben Bernanke telling Congressional leaders at the Humphrey-Hawkins testimony, that rates would remain low “for an extended period”. Central bankers have suggested that the catch-phrase means low rates for at least a six month period, but most traders still don’t expect the Fed to start hiking until the end of 2010 at the earliest.

Implies market forecasts according to overnight index swaps have two 25 bps rate hikes priced in over the next twelve months.
 

EUR:

February was another crippling month for the euro which lost 233 pips against the U.S. dollar to finish the month at 1.3631.

Battered by ongoing concerns surrounding the Greek Budget Crisis, the currency found some solace on the back of word that the European Union was working on a bailout plan for the beleaguered nation.
Nevertheless, amidst ongoing arguments over what form the package should take, coupled with comments from Greek authorities affirming that financial support is not necessary, the euro continued to weaken.
Markets are now poised for detail of the Greek budget plan which should be released over the next several days, as European leaders meet to discuss the country’s finances.

The economic data for the region also pressured the currency lower after Q4 GDP rose only 0.1% quarter-over-quarter, despite hopes for a 0.3% pickup. On an annual basis, GDP was down 2.1% compared to calls for a 1.9% slide, but still better than the prior 4.0% contraction.

In Germany, the Ifo economic optimism index for January unexpectedly fell to 95.2 despite calls for an increase to 96.1 from 95.8.

The inflation picture, meanwhile continues to leave the European Central Bank in a good position to maintain its accommodative monetary policies, with headline CPI up 1.0% year-over-year in January, in line with expectations and just faster than December’s 0.9% gain.

The European Central Bank was relatively quiet in February, with the status quo continuing to hold. The central bank appears well on its way to scaling back some of its quantitative easing, and maintains plenty of room for low interest rates in the coming months.

That being said, markets have priced in 51.6 basis points for of rate hikes over the next twelve months, according to the overnight index swaps.

On the equities side, the results were mixed, with the eurostoxx giving up 1.0% while the Dax managed a modest 0.2% gain.

Going forward, all the pressure is on Greece. If the nation can credibly tackle its budget problems, the euro could get a bit of a relief rally. That being said, if the euro zone indeed bails out the nation, it could hurt the currency’s long term credibility.
 

GBP:
 
 
February was another tough month for sterling which came under pressure from ongoing poor economic fundamentals, and dovish monetary policy. When the dust settled at the end of the month, GBP/USD was lower by 713 pips at 1.5238.

The month kicked off with the Bank of England leaving rates and quantitative easing unchanged, as expected, but uncharacteristically issuing a statement explaining that CPI would surpass the 2.0% inflation target before coming down in the coming months.

The comments were later reaffirmed when the Office for National Statistics reported that January CPI rose to an annual. 3.5% from 2.9% the month prior, prompting Bank of England Governor Mervyn King to write a letter to Chancellor of the Exchequer Alistair Darling, explaining that inflation was going to come down. To calm the markets’ concerns, Darling responded to King’s letter by agreeing with his assessment of the situation.

Nevertheless, the monetary outlook of the UK remains uncertain with some policy maker saying that the central bank may yet continue adding money to the financial system, another negative for the pound. Indeed, markets have priced in only 39.5 bps worth of rate hikes over the next twelve months, according to overnight index swaps.

In other news weighing on sterling, the UK claimant count rate unexpectedly rose by 23.5k in January, despite forecasts for a 10.0k decline and prior 9.6k shortfall. Then claimant count rate, nevertheless remained at 5.0% as expected.

On the other hand, Q4 GDP was revised higher with the economy growing 0.3% despite the advanced 0.1% growth rate reported by the ONS.

On the stock market front, the outlook was upbeat, with the FTSE 100 adding 3.2% on the month.

Going forward the upcoming election in the UK will be of particular interest, especially if a minority government is formed. It is feared that such a development will lead to a lag in the reduction of the country’s budget deficit and consequently threaten the UK’s AAA credit rating.
 
 
 
 
JPY:

With global risk aversion rising on the back of the Greek budget crisis, the Japanese currency benefitted as a safe-haven play, however tough talk from the government over inflation may also have given the currency a boost.

Indeed, February was a month of rhetoric from the Federal Government, which promised to aggressively fight deflation in 2010, alongside the Bank of Japan. Although there is no expectation of a rate hike any time soon in the region, the comments nevertheless are a positive for the yen.

In the mean time, a lot of the debate between government and central bank officials lies over how to spur inflation. The government wants the Bank of Japan to increase quantitative easing (a negative for the yen), while the central bank argues that the government must take control of its finances to help secure a sounder financial system (yen positive).

On the data side of things, Q4 yielded a 1.1% quarterly growth rate in Japan, better than expectations for a 0.9% pickup and the prior quarter’s flat reading. Annualized GDP rose 4.6%, ousting forecasts for a 3.5% increase and prior flat reading.

International trade also strengthened significantly, with the January adjusted merchandise trade surplus rising to ¥728.4 billion, from ¥655.9 billion the month prior, courtesy of a 40.9% annual jump in exports compared to the prior month’s 12.0% increase.

On the inflation front, national CPI managed to rise to -1.3% in January, more than calls for an increase to -1.4% from -1.7% the month prior.

With the BOJ indicating that they want to achieve CPI growth of 1.0%, it leaves the prospect of higher interest rates well off the table for now, giving traders plenty of reason to expect no shift in rates over the next twelve months, according to overnight index swaps.

Finally, on the equity side, the Nikkei 225 declined 0.8% on the month.
 
 
 

CAD:

The Canadian dollar piggybacked higher against major currencies in February, as markets priced in more interest rate hikes form the central bank, on the back of some hawkish developments at the Federal Reserve further south. By the end of the month’s USD/CAD finished 190 pips lower at 1.0517.

Supported against the European currency because of the financial crisis, many traders bought Canadian dollars expecting the currency to make some headway against the USD, given the Bank of Canada’s disposition to hike rates this summer.

Indeed, the central bank had maintained that rates are expected to remain accommodative until June 2010, and that deadline is starting to loom, particularly after the Fed hiked the discount rate south of the border.
Otherwise, the monetary policy front has been rather bare, with no meetings taking place in February.
 
Markets have priced in 98.6 bps worth of rate hikes for the Bank of Canada over the next twelve months.
 
In economic news, the data were relatively strong, with the economy creating 43.0k jobs in January, exceeding the expectation for a 15.0k gain, although the prior 2.6k decline was revised to a 28.3k shortfall.Nevertheless the unemployment rate fell to 8.3% from 8.4% although expectations had been for an 8.5% level.

On the CPI front, inflation came in a touch higher than expected with headline CPI rising 1.9% year-over-year in January, expected calls for a 1.8% pickup and the prior month’s 1.3% increase. Core CPI advanced 2.0%, also faster than expectations for a 1.9% advance and prior 1.5% increase.

In financial markets, the TSX delivered a solid 4.3% gain on the month.

Going forward the upcoming BOC rate decision should provide further reassurance that a June or July rate hike is indeed coming, a development which will strengthen the loonie.
 
 
 

AUD:

The Australian dollar managed another month of gains against the USD despite an expected hold in interest rates at the beginning of the month, with AUD/USD adding 157 pips to 0.8954.

At the start of February, the Reserve Bank of Australia, fearful of the fallout from the Greek deficit crisis, opted to leave rates unchanged at 3.75%, shocking the financial markets which expected a 25 bps rate hike to 4.00%.

The central bank’s accompanying statements nevertheless remained on the hawkish side, with rate expected to continue “normalizing” over the coming months. This resulted in 107 basis points worth of rate hikes being priced into the markets over the next twelve month, according to overnight index swaps.

On the economic data front, the January employment situation came in very strong, with the economy creating 52.7k hobs over the course of the month, exceeding expectations for a 15.0k gain and the prior month’s solid 37.5k jobs created. The unemployment rate moved lower to 5.3% despite expectations for an increase to 5.6% from 5.5% in December.

Retail sales, on the other hand, performed poorly for December, falling 0.7% month-over-month despite calls for a 0.2% pickup and prior 1.5% gain.
 
In the equity markets, the S&P/ASX managed a 1.5% gain on the back of strong crude oil prices for the month.

Looking ahead, the next RBA rate decision should provide future clues about the timing of monetary policy tightening and expected gains in the Australian dollar as a consequence.
 
 
 
 

NZD:

Contrary to its Australian brethren, the Kiwi dollar failed to gain on the USD, giving up 35 pips to 0.6982 instead.

The moves come ahead of the first rate decision since January, and in the absence of any real economic developments in the region.

Monetary policy has remain rather quiet, with the last indication from the central bank that rates may indeed start rising eventually, back in January.

In the mean time, the overnight index swap market has priced in 147 bps worth of rate hikes for New Zealand.

In economic data, the results of the Nation’s Q4 unemployment report were disappointing, with the unemployment rate rising to 7.3% despite calls for a more modest gain to 6.8% from 6.5% the quarter prior.
 
Retail sales came in flat in December despite expectations for a 0.6% month-over-month increase and prior 0.8% pickup. Core sales fell 1.8% in spite of expectations for a 0.3% gain to add to the prior 0.8% pickup.
 
The next RBNZ rate decision is the next event to watch particularly for signs of monetary policy toughening down the road.
 
 

CHF:

In the absence of an interest rate decision in February, the Swiss franc continued to be rather quiet, with markets seeking to drive up the currency and test the central bank’s resolve over its foreign exchange controls on the Franc.

In February, EUR/CHF fell 74 pips to 1.4630, despite some interventions by the SNB earlier in the month.
Any signs that the SNB is indeed starting to tolerate a strong Franc opens the door for markets to buy the currency, however with the euro plunging on the back of the development’s in Greece, many are unwilling to test this resolve.

On the data front, the Swiss unemployment rate fell to 4.1% in January despite expectations for an increase to 4.3% from 4.2%, more importantly, however, CPI rose 1.0% year-over-year, exceeding calls for a 0.8% increase and prior 0.3% gain.

The SNB has said in the past that the Franc is being artificially weakened due to deflation concerns, so the higher CPI numbers suggest the central bank may be more willing to relax its grip.

Implies market forecasts suggest the overnight index swap market has priced in only 18 bps worth of interest rate hikes in Switzerland over the next twelve months.
 
 
Commodities:

Despite gains in the USD, commodities nevertheless managed additional gains in February with crude oil rising a solid 9.5% to $80.51.

Meanwhile Gold broke a two-month losing streak, rising 3.3% to $1117.60.

The gains are uncharacteristic of a stronger USD, and amidst concerns in the European financial system, however, poor weather in the United States has been responsible for higher energy prices in the region.

In gold, the massive budget deficit in the United States continues to shake confidence in the longer term prospects for the U.S. dollar.