The Dollar Sags as Key EU Decisions Loom

Highlights

* The Dollar sags as key EU decisions loom

* The ECB takes its anti-inflation medicine

* Commodities continue to stay aloft amid tensions in MENA

* The BOE gets pipped at the post

* Kiwi under difficulty ahead of RBNZ

*The Dollar sags as key EU decisions loom*

The greenback slumped further as violence in Libya escalated and fears
continue to mount of unrest spreading to other, more economically
significant countries in the region. Despite the largest gain in jobs
since census-induced hiring in mid-2010, and other signs of
improvement in US labor markets e.g. further declines in early claims,
the buck limped out at its lowest level for the year according to the
USD Index. But the USD's performance was mixed against most currencies
other than the EUR, which rallied across the board on ECB rate hike
expectations (see below). All in all, it could have been much of
poorer quality for the USD and this suggests a safe-haven bid may be
returning to the greenback. US stocks declined and Treasury yields
fell on safe-haven buying of US Treasuries in spite of the ostensibly
upbeat Feb. jobs report. Precious metals and commodities also
continued to gain impose a curfew on the Mid-East upheaval. The focus
there is firmly on efforts to oust Libyan leader Gaddafi and we would
suggest it is a inquiry of when, not if, he disappears into ?migr?,
potentially background up a rapid reversal in safe haven assets. In
the meantime, civil conflict in Libya is likely to drag on and the
dollar's descent seems likely to continue, though doubtless less of a
rapid collapse and more of a slow grind.

Over the next several weeks, EU leaders will be meeting to tackle
their debt/financial crisis, culminating in the March 25 summit that
aims to produce the comprehensive crisis resolution mechanism. The end
of next week will see the 'European Competitiveness Pact' unveiled,
which aims to strengthen economic and fiscal coordination among member
states. Indications are that deep divisions remain on many of the key
issues, such as establishing particular debt reduction goals,
increasing the size of the bailout fund, and whether to allow it to
buy peripheral government debt. The risk to recent EUR gains is that
EU leaders fail to produce a credible mechanism and markets conclude
sovereign defaults remain a serious threat, which may see EUR come
under difficulty despite rate hike expectations. Lastly, we would note
the relatively minimal gains in EUR/USD since the relatively
surprising ECB announcement (only about 120 pips), which we interpret
as a sign most of the go was already priced in.

We see pressing upside potential for EUR/USD while the 1.3800/50 area
holds. Early resistance is at 1.4020/50, above which gains to the
1.4180/1.4200 are our expectation. Overall, a Fibonacci wave extension
suggests 1.4420/25 as a potential target for the current advance, once
above 1.4050.

*The ECB takes its anti-inflation medicine*

ECB Governor Trichet surprised the markets last week with an
explicitness he has saved until the last 6 months of his term in
office. He reverted to the verbal code words he used during the Bank's
previous tightening cycle when he said that "strong vigilance" is
warranted with a view to continuing upside risks to price stability.
In the past this signaled that a rate hike was imminent. Now the
market expects Trichet to announce a rate hike at April's meeting. But
it wasn't this stock phrase that surprised market watchers, it was
Trichet's candidness.

Although he said the ECB never pre-commits to a rate choice he added
that he expects rates to rise by 25 basis points and that a rate hike
next month would not signal the start of a tightening cycle. This was
central bank communication at its most clear.

Immediately investors scrambled to re-adjust interest rates armed with
this new information. 3-month euro Eonia swap rates surged 10 basis
points to their highest level in 2 years, while Euribor - the
inter-bank lending rate - also surged on the news. The extra yield
boosted EURUSD, and it is now on the brink of 1.4000.

Up until last week the markets had been expecting the Bank of England
to hike first. After the ECB press conference the yield differential
between German and UK yields widened considerably which boosted EURGBP
to 0.8600.

So why did the ECB bite the bullet? The most likely reason is that
rapidly rising oil prices don't warrant extraordinarily accommodative
interest rates. Indeed, Trichet omitted to mention that the interest
rate was appropriate; instead he said the current stance of monetary
policy was "very accommodative."

But will one hike be enough? We would say doubtless not. Inflation in
the Eurozone is running at a 2.3 per cent annualized rate. Even with a
25 bp increase real interest rates will still be negative, so the ECB
aren't vacant to stamp out inflationary difficulty with a tiny,
one-off rate hike. So if the Bank is serious about inflation a series
of hikes seems more likely. The market has rushed to price in a more
than 50 per cent opportunity that rates will rise to 2 per cent (they
are currently 1 per cent) in 12-months' time.

The ECB and the Centralized Reserve are now at either end of the
policy spectrum, with the latter seemingly committed to providing the
full $600bn allotment of QE2 to the US economy until June. The
diverging paths of the two largest global central banks should benefit
EURUSD. So far it has disastrous to break above 1.40, but in the
coming weeks, based in its yield advantage, we see EURUSD back at the
1.4250 highs last reached in November 2010.

*Commodities continue to stay aloft amid tensions in MENA*

This week crude oil prices rose to fresh 29-month highs ($104.30/35)
amid the rapid deterioration of stability in Libya and the threat of
it spreading to other MENA (Middle East/North African) nations. The
persistent violence has caused supply disruptions in Libya of
approximately 1 million barrels a day, which is over half of their
daily output. While news that Saudi Arabia guaranteed to use spare oil
capacity if needed - Saudi's spare oil capacity is estimated to be 5
million barrels a day, temporarily calmed the markets, it's not an
exact match since Arabian oil is much heavier than Libya's light sweet
crude and is thus sticky since it needs additional refining. With the
current geopolitical environment riding high emotionally, fundamentals
are likely to remain in the rear-view mirror. Furthermore, even prior
to the political unrest in the Middle East we saw signs of demand
growth picking up in Plates and India, and with today's U.S.
unemployment rate diminishing to 8.9% it signals demand in the west
may start to pick up as well. Lastly, market participants are
beginning to envision a weaker USD moving forward, based on diverging
interest rate expectations between the Fed and the ECB and BoE, which
has caused superior demand for commodities and ultimately adds more
"fuel to the fire".

The "flight-to-safety" trade has not just been all about oil, but was
also present in precious metals as well. As noted in this week's
Commodities Corner, "with tensions in the Middle East unlikely to
subside anytime soon, this flight-to-safety trade could be stronger
and last longer than the market currently anticipates, subsequently
traders are beginning to take action." Over the past week gold broke
to new nominal all-time highs near $1440/oz. and silver just made
fresh 30-year highs of $35.35/40 at the time of this writing. Vacant
forward, price action should remain volatile, but pullbacks could be
shallower than one would anticipate as investors who have missed the
current go higher in commodities may look to jump on board in the not
too distant future. A resolution to the Libyan turmoil, on the other
hand, could see a more serious set-back.

*The BOE gets pipped at the post*

After the events in the Eurozone, it now seems unlikely that the Bank
of England will be the first of the major central banks to hike
interest rates. The Bank meets next week to choose on policy, but it
is expected to remain on hold. In fact, since the last meeting the
market has slightly reduced its bets that rates will rise in the UK
over the next few months as economic data has disappointed
especiallyQ4 2010 GDP and the PMI air force sector survey for last
month. Sonia rates - GBP swap rates - have fallen from their peak and
3-month UK Libor (inter-bank lending rates) remains within its
near-term range.

This has thwarted the rise in sterling and for now the top in GBPUSD
is 1.6300.

EURGBP looks ripe to outperform in the near-term. After 0.8600, the
0.8900 high reached in October comes back on the radar.

*Kiwi under difficulty ahead of RBNZ*

On Thursday March 10, the Reserve Bank of New Zealand meets to choose
on interest rates. The outlook for the island nation has been very
bleak after the tragic 6.3 magnitude earthquake which struck
Christchurch on Feb. 22. This was the following major earthquake in 6
months, the previous quake occurring on Sept. 4. Both quakes are
estimated to have cause as much as NZ$20 billion in hurt and have
delivered a blow to growth prospects with the risk of a degeneration
into depression as indicated by Q3 GDP which contracted by -0.2%.

The 90-day bank bill rate has plummeted from about 3.20% on Feb. 21 to
current levels of around 2.86%. Additionally, Prime Minister John Key
said he would "welcome" an interest rate cut. He went on to say "the
market has priced in a cut from the Reserve Bank. That would doubtless
be my expectation, that the Reserve Bank would cut, but it's for them
to determine that". While some market participants are anticipating a
rate cut, the distribution of expectations is relatively balanced with
about half of analysts forecasting no change in rates. Of those
expecting the bank to slash rates, about half are looking for a 50bps
cut while the other half is anticipating a 25bps fall. With recent
weakness in the NZD, it appears that a cut may be priced in which
indicates that the risk is to the upside.

Technically, NZD/USD is facing a significant pivot around its 200-day
sma which currently comes in at about 0.7380 and the Dec. lows which
are around the 0.7345/50 area. The pair is trading below the daily
ichimoku cloud which suggests a downward bias. A daily close below the
200-day sma and Dec. lows is likely to see further downside. Key
levels to the upside include the daily Tenkan line which is around
0.7480 ahead of the daily cloud base and Kijun line which are around
0.7580/90 - just below the 0.7600 area where the 55 and 100-day sma's
join.

Source: ActionForex.Com