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Commentary for the week of 09/03/2010

The Australian dollar ended the week up 2.0% versus the US dollar helped in part by strong Australian Q2 GDP data and a broader recovery in risk assets including commodities. While no one looks for the Reserve Bank of Australia to raise rates next week, the strong data from Australia and China (PMI this week) suggest the RBA could hike more later this year and into 2011 which also aided the A$. The markets seemed unconcerned that a week after the election there is no government formed though it would appear that Gillard and Labour will form a coalition government soon. Q2 GDP rose 1.2% quarter-over-quarter and 2.3% year-over-year. Retail sales in July rose 0.7% from June. Building approvals in July were up 2.3% from June. The Q2 current account deficit narrowed from Q1 helped by firm exports. However, the July trade surplus nearly halved on a slump in coal and iron ore exports.
In the coming week Australia releases economic data on housing finance and employment. The RBA meets on Tuesday and is widely expected to leave rates on hold at 4.50%. RBA's Debelle speaks on Thursday. We think with risk assets rallying and confidence in the global recovery elevated the AUD will end next week higher against the USD. Also look for the AUD to get some support in anticipation of strong economic statistics from China in the next two weeks.

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The British pound ended the week down 0.5% against the US dollar on weak economic data from the UK and ongoing worries the Bank of England may need to ease policy more ahead. UK August manufacturing PMI fell to 54.3 from 56.9 in July and was the lowest reading since November 2009. Services PMI fell to 51.3 in August from 53.1 in July, the lowest reading in 18 months. Home prices fell in August from July (down 0.9%), the largest decline since February. Construction PMI was the lowest in August since February. Mortgage approvals rose in July from June but the gain was modest and overall net lending including private consumer credit was the weakest since March. The one bit of good news was the rise in August consumer confidence (GfK).
In the coming week the UK releases data on industrial production, international trade and PPI. Also the Bank of England's Monetary Policy Committee meets on Wednesday and Thursday where it is widely expected to leave rates on hold at 0.50% and quantitative easing unchanged. We expect the GBP to end next week higher against the USD aided by a broad sell-off in the greenback on falling risk aversion as global economic data promote confidence in the UK recovery for the time being.

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With the Bank of Canada poised to hike rates next week, or at least that was the market perception, the Canadian dollar ended the week up 1.2% against the US dollar this week. The market even brushed off weak Canadian GDP figures from Q2 taking the CAD higher. Still the weak GDP report raised doubts about the scope to raise rates beyond next Wednesday. GDP grew at 2.0% SAAR in Q2 down from 5.8% in Q1 reflecting weak final sales (consumption and net exports). The current account deficit in Q2 widened to C$11.0bln from C$8.5bln in Q1. PPI rose 0.1% in July from June and was up 1.0% from a year ago.
In the coming week Canada releases economic data on building permits and starts, PMI, international trade and employment. Monday is a holiday. The Bank of Canada meets on rates on Wednesday and is expected to hike to 1.00% from 0.75% though the scope for future rate hikes has been dimmed somewhat by weak domestic and US economic news. Look for the CAD to end next week higher versus the USD in light of the BOC rate increase and ongoing reduction in risk aversion as confidence in the global recovery improves for the time being we believe.

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Falling risk aversion and confidence the global economy will avert a double dip recession helped the EUR end the week up 1.0% versus the USD this week. The ECB left rates on hold Thursday and moved to keep special liquidity measures in place through year-end including announcing the retention of unlimited reserve allotment operations to the banks via 3-month long-term refinance operations through year end and main refinancing operations (shorter-term repos). Trichet also announced upward revisions to inflation and growth forecasts for 2010 and 2011 though modest ones and said the balance of risks now were slightly in favor of inflation. Concerns over Irelands banks and government budget deficit as the size of the bailout grows persisted but spreads between Irish bonds (and other periphery Euro Zone states' bonds) and German Bunds narrowed. A number of Euro Zone states successfully auctioned more government debt at lower rates as well. Euro Zone Q2 GDP was revised to +0.8% quarter-over-quarter from +0.6%. Economic sentiment in August rose to 101.8 from 101.1 in July. Inflation fell to 1.6% year-over-year in August from 1.7% in July. The unemployment rate in July was unchanged from June at 10%. Retail sales rose 0.1% month-over-month in July. German adjusted unemployment in August fell 17,000 from July while the unemployment rate held at 7.6%. France's Q2 unemployment rate fell to 9.7% in Q2 from 9.9% in Q1. Italian unemployment fell to 8.4% in July from 8.5% in June.
In the coming week, data from the Euro Zone include figures on sentiment. Germany releases data on industrial orders and output, international trade and CPI. France releases data on industrial production as does Italy. We think the EUR will end next week higher against the USD in light of falling risk aversion and optimism the European and global recovery is proceeding on track and skirting a double dip recession.

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Despite an emergency Bank of Japan meeting at the start of the week to ease policy more to check the rising currency, the Japanese yen ended the week up 1.1% versus the US dollar trading near a 15-year high as market participants sold the USD more broadly and sensed reluctance on the part of Japan's Ministry of Finance and BOJ to intervene in the FX market to address the rising yen. The BOJ raised the amount it offers banks in fixed rate 3-month terms to JPY30trln from JPY20trln which most in the market viewed as insignificant and largely symbolic. The move also followed weeks of pressure from the government on the BOJ to ease policy more to stem the rise in the yen. Market interest in Japan's DPJ (ruling party) leadership election September 14 is growing with Ozawa challenging Prime Minister Kan to head the party. Ozawa is seen as someone who would favor using currency intervention sooner than later and is more inclined to use large fiscal stimulus measures to support the economy than Kan. There were plenty of verbal threats of possible FX intervention by Japanese officials this week but no actual intervention occurred. Japan August manufacturing PMI fell to 50.1 from 52.8 in July. Retail sales rose 3.9% in July from a year ago and 0.7% from June. Industrial production for July rose 0.3% month-over-month and well under the 1.6% expected increase. Capital expenditures fell 1.7% in Q2 from a year ago, but much less than expected.
In the week ahead Japan releases data on machinery orders, the current account, wholesale prices and GDP. The BOJ meets on Monday and Tuesday but is not expected to take any additional steps to ease monetary policy after Monday's emergency meeting and policy easing. We expect the yen to end next week higher against the USD as market participants sell test the resolve of Japanese officials to intervene to keep the yen from rising more and in light of falling risk aversion.

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The Mexican peso ended the week up 0.5% supported by a broad movement of global capital into risk assets and risk FX. Also confidence in the US economy averting a double dip recession added to the upside in the peso versus the dollar especially Friday when US jobs data surprised to the upside (private payrolls in August and upward revisions to June and July). Mexican consumer confidence in August rose to 88.7 from 87.4 in July. July remittances from Mexican workers working overseas rose 1.84% from a year ago.
In the coming week Mexico releases data on inflation and fixed investment. Given falling risk aversion and renewed optimism the US economy will avoid a double dip recession, we think the peso will end next week higher against the dollar even as Mexican inflation is seen remaining well behaved.

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The Russian rouble continued to face problems benefiting from the broad rally in risk currencies and commodities ending the week up only 0.2% versus the US dollar. While the Russian drought ended in August, the impact on agricultural production and prices is significant, if temporary, and seen as an added burden for policy makers and the economy. Manufacturing PMI rose to a 28-month high at 52.9 in August from 52.7 in July. However, services PMI hit a 15-month low at 47.0 down from 54.1 in July. A central bank official said this week that the Bank is ready to start buying CAD and is still considering buying AUD to presumably diversify out of USD bias.
In the coming week Russia releases data on CPI, GDP and international trade. We believe the RUB will finish next week higher versus the USD as risk aversion remains depressed and confidence in the global recovery remaining on track see a broader sell-off in the USD.

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The Swedish krona ended the week up 1.4% against the US dollar aided by a widely expected quarter point rate hike to 0.75% by the Riksbank and a broad recovery in risk assets and FX at the expense of the USD. The Riksbank left its future rate path unchanged but did note uncertainty for growth in key export markets (US and Euro Zone). One Bank board member voted against the rate hike and two others wanted fewer rate hikes than planned. Manufacturing PMI in August fell to 60.6 from 64.2 in July. The current account surplus narrowed in Q2 from Q1 to SEK51.3bln.
In the week ahead Sweden releases economic data on CPI. Given the Riksbank is committed still to tightening policy gradually through 2011 and our belief that risk aversion will stay depressed in the near-term on firmer economic data from around the globe, we think the SEK will finish next week higher versus the USD.

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The Swiss franc ended the week up 1.4% against the US dollar reflecting a recovery in risk assets and FX and broad USD selling and a strong Swiss GDP report. Last weekend the SNB said it was watching the CHF closely but there were no signs of intervention from the Bank this week and if anything it is the lack of intervention from the ECB since the spring that has catapulted the CHF higher. Q2 GDP rose 0.9% quarter-over-quarter and 3.4% year-over-year. Retail sales rose 4.8% in July compared with a year ago. There was brief and modest CHF selling on weaker-than-expected Swiss inflation data showing the annual rate at 0.3% versus 0.4% in July and the month-over-month change flat. Manufacturing PMI fell to 61.4 in August from 66.9 in July.
In the coming week Switzerland releases data on unemployment. We look for the CHF to finish next week higher versus the USD helped by a broad rally in risk assets, an absence of intervention by the SNB (versus the EUR) and a firmer outlook for Swiss growth ahead.

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The US dollar index ended the week down 1.0% as stronger than expected US employment data for August, firm manufacturing ISM reports from the US and China, strong Australia GDP and a jump in US pending home sales saw risk currencies and assets run higher as confidence in the global economic recovery rebounded. The yen ended higher against the dollar as well this week despite an emergency meeting of the Bank of Japan to ease policy in part to check the rise in the JPY. Minutes from the August FOMC meeting reaffirmed the Fed stands ready to do more on quantitative easing to aid growth should the economy slow more ahead, though there appeared to be little in hand to warrant any action. Retiring Fed Vice Chairman Kohn said he did not think the Fed had a hair trigger approach to more quantitative easing. President Obama said on Friday he would announce new proposals next week for reducing joblessness which many speculated may include a payroll tax holiday, infrastructure spending and more tax credits for businesses that hire. US non-farm payrolls fell 54,000 in August but the more closely watched private payrolls advanced 67,000 above an expected 41,000 gain. The unemployment rate rose to 9.6% in August from 9.5% in July. Manufacturing ISM in the US in August rose to 56.3 from 55.5 in July. Non-manufacturing ISM fell to 51.5 in August from 54.3 in July. Pending home sales in July rose 5.2% month-over-month to 79.4, though still a low level for the index. Factory orders in July rose 0.1% from June after two straight months of decline reflecting a surge in transportation orders (factory orders fell 1.5% excluding transportation orders). Jobless claims for the latest week fell 6,000 partially reversing the more recent trend up in weekly claims. Q2 productivity was revised sharply lower (-1.8% SAAR) reflecting the large downward revision in GDP reported last week. Consumer confidence rose to 53.5 in August from 51.0 in July according to the Conference Board. Chicago PMI rose 56.7 In August from 62.3 in July. The Case-Shiller home price index for the major 20 metropolitan areas rose 0.3% in June from May. Consumer spending rose 0.4% in July from June, the larges gain in four months, while income rose 0.2%. Construction spending fell 1.0% in July from June to the lowest annual rate in a decade. US August auto sales were down 21% year-over-year and were the weakest for any August since 1983.
In the week ahead the US releases data on consumer credit, jobless claims, international trade and wholesale inventories. Monday is a US holiday and markets are closed. The Fed publishes its Beige Book for the upcoming September FOMC meeting. We expect the US dollar index to finish next week lower as the recovery in risk assets and FX continues to benefit from firmer data from Europe and Asia, as the US economic calendar is particularly light in holiday-shortened trading.

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