USD Rallies as Irish Budget Vote Looms

Summary

The USD recovered lost ground from overnight and rallied to session highs in the late afternoon. A last-minute compromise last night by the White House to extend tax cuts helped to bolster the outlook for the US, while dovish policy statements from the RBA and BOC undermined dollar-bloc currencies. Players awaited an important budget vote in Ireland approving the latest round of austerity measures. 

Headlines

IMF: Managing Director Dominique Strauss-Kahn said the European Union needs to find a "comprehensive" solution to its debt crisis and not rely on a "case-by-case" method. "It's not a good solution to find a solution for every country," Strauss-Kahn said. Strauss-Kahn said the euro needs to be reinforced. "The euro will have to be reinforced because you can't have on currency and not have a dynamic, common policy, more collective solutions are needed."

EU: Irish Finance Minister Brian Lenihan won the support of lawmakers in the first vote of his 6.0B EUR budget to deal with what he called the "worst crisis in our history." Lawmakers voted 82-77 to back increases in levies on petrol and diesel in the first ballot on the measures. Voting on the budget's financial resolutions is due to finish just before midnight in Dublin.

EU: Euro group's Jean-Claude Juncker said any skepticism about the fate of the euro currency is misplaced. "All those voices expressing doubt about the survival of the euro soon will fall silent," Juncker said. "The euro isn't at risk. And in 10 years' time we will be paying with one of the world's strongest currencies." "I don't expect lasting effects for the euro exchange rate," said Juncker, according to the newspaper. "The euro has remained relatively stable, despite a high volatility of exchange rates. Compared with the U.S. dollar or the Chinese currency, the euro is overvalued. It would even help the euro and our exports if it were weaker." "The euro isn't in danger," said Juncker "we had no euro-crisis, we had a debt crisis in some member nations of the euro area."

EU: German Finance Minister Wolfgang Schaeuble said that yield spreads between euro-area government bonds are a necessary part of the euro's setup and reiterated German opposition to the idea of joint euro-region bonds. When the euro was founded, "one wasn't ready to do that and also today many aren't ready for that" idea of Eurobonds, Schaeuble said. Schaeuble added that he is "determined to do everything: to protect the euro. It is "relatively unrealistic" to expect that the euro region will fall apart, he said. "Whoever bets on the collapse of the euro is wasting his money."

US: Moody's Investors Service said an extension of the Bush-era tax cuts agreed upon by President Barack Obama won't lead to a downgrade of the nation's Aaa credit rating. "The extension of the current tax rates is for a temporary period of two years and we think that if that's all there is to it – it does not have ratings implications," Steven Hess, senior credit officer at Moody's in New York, said. "We have a stable outlook. We don't feel it will get changed downward in the next year or two." "We are not sure that there will be other reforms while this temporary extension is in place," Hess said. "If no other measures are taken and if the tax cuts are made permanent, would certainly see rising fiscal pressure. That wouldn't necessarily lead to a rating action, but the pressure on the rating would be more than it would be otherwise."

Canada: The BOC left its benchmark overnight target rate unchanged at 1.0%, in the line with consensus expectations. The accompanying policy statement said that "the recovery in Canada is proceeding at a moderate pace." However, "economic activity in the second half of 2010 appears slightly weaker than the Bank projected in its October Monetary Policy Report." Specifically, "net exports were weaker than projected and continued to exert a significant drag on growth. This underlies a previously-identified risk that a combination of disappointing productivity performance and persistent strength in the Canadian dollar could dampen the expected recovery of net exports." On the inflation side, the statement indicated that "inflation dynamics in Canada have been broadly in line with the Bank's expectations and the underlying pressures affecting prices remain largely unchanged." Consequently, "the Bank has decided to maintain the target for the overnight at 1.0%. This leaves considerable monetary stimulus in place." The statement repeated that "any further reduction in monetary policy stimulus would need to be carefully considered."

Dow 11,359.16, -0.03%; NYMEX Crude Oil $88.21, -1.3%

The USD recovered lost ground from overnight and rallied to session highs in the late afternoon. A last-minute compromise last night by the White House to extend tax cuts helped to bolster the outlook for the US, while dovish policy statements from the RBA and BOC undermined dollar-bloc currencies. Players awaited an important budget vote in Ireland approving the latest round of austerity measures. The EUR/USD fell to a session low of 1.3267 by 4:06pm EST, from a session high of 1.3401 at 9am and an overnight low of 1.3279. GBP/USD raliied as high as 1.5823 by 4:44am from an overnight low of 1.5704, before trading back to 1.5760 by the close. USD/JPY rallied to a session high of 83.66 at 3:24pm from an overnight low of 82.34, while USD/CAD rallied to a session high of 1.0120 by 4:05pm from a low of 1.0012 ahead of the NY open. While European bourses closed generally higher on the session, the Dow traded sideways throughout the session closing largely unchanged. USD gains undermine commodity prices with the NYMEX crude oil benchmark off -1.3% from the day to close at $88.21/bbl.

The dovish statement fed into a wave of dollar-bloc currency selling that began about an hour ahead of the BOC decision. USD/CAD rallied as high as 1.0068 from 1.0025 following the decision and a session low of 1.0012 at 7:35am EST. The loonie also fell against the non-USD majors, with EUR/CAD surging to a session high of 1.3450 by 9:55am from 1.3420 following the decision and an overnight low of 1.3383 and GBP/CAD surging to a session high of 1.5904 by 10:05am from 1.5840 following the decision and an overnight low of 1.5790. However, CAD/JPY unexpectedly rallied to a session high of 82.67 by 9:10am from 82.50 following the decision and an overnight low of 81.81, indicating that the reaction to the BOC report was overshadowed by other factors in the foreign exchange market this morning. 

The selloff in the CAD took place at the same time as a selloff in the AUD and NZD as well. The AUD/USD fell as low as 0.9902 from an overnight high of 0.9965, while NZD/USD fell as low as 0.7625 from an overnight high of 0.7667. The loonie's losses today appear to be driven by other factors besides the BOC statement, as losses were simultaneously experienced by AUD, NZD as well as energy and precious metals. While it is tempting to characterized this as a risk-off move ahead of the Irish vote later this morning, neither Dow futures nor several notable high-flying commodities were impacted. The stock market remains the principle barometer of risk appetite in global markets. Given the surprisingly durable post-Thanksgiving rally, we look to the commodities market for the first signs of the expected year-end correction. While volatility has picked up, there is no indication yet that investors have thrown in the towel.
(michael.woolfolk@bnymellon.com)

Flow Analysis:

Our iFlow FX indicators show an overall improvement in risk appetite with the US dollar being net sold for the second successive day. On the flip side, amongst G-10 currencies, we are seeing net inflows into Sterling, Norwegian krone, Swedish krona, Canadian dollar and New Zealand dollar. Interestingly, the Australian dollar continues to be out of favor for now amid the Reserve Bank of Australia's decision earlier today to leave the benchmark rate at 4.75% and indications that policy-makers consider inflation will likely be contained through mid-2011. Amongst emerging market currencies, our iFlow FX indicators show a strong pullback in risk aversion, as a result of which we are seeing renewed buying of recently oversold currencies such as the Hungarian forint, along with the Polish zloty and Czech koruna. The Chilean peso continues to attract more buying interest, consistent with the local currency's rise to an eight-week high vs the greenback amid further sharp gains in the price of copper, Chile's key export commodity. Elsewhere in Latin America, we are seeing ongoing buying interest in the Colombian peso, Mexican peso and Brazilian real remain in place. In Asia, our iFlow FX indicators show continued steady purchases of the Indian rupee as the finance ministry raised its economic growth forecast to as much as 9.1% from an earlier range of 8.25%-8.75% for the present financial year.

Indeed, our iFlow equity indicators also confirm renewed strong net inflows into Indian stocks – in line with latest data released by the Securities & Exchange Board of India showing overseas investors bought INR 769 million worth of local stocks on Monday, which has further raised this year's record equity inflows to INR 1.34 trillion. Elsewhere in Asia as well, our iFlow equity and FX indicators show local stock market inflows are buoying the respective currencies in Indonesia, Malaysia, Thailand, Taiwan and Hong Kong amongst others. Amongst the general improvement in investor sentiment, we would caution that the appetite for peripheral Eurozone debt remains muted, which suggests the European Central Bank will likely have to continue supporting local asset markets for now. We are seeing continued net selling of Spanish, Italian, Portuguese, Irish and Greek debt instruments while the Euro remains on the back foot – any ebb in risk appetite will once again draw investor focus to the lingering sovereign debt problems in the region.
(samarjit.shankar@bnymellon.com)