Is it Too Late to Buy Dollars?

• Is it Too Late to Buy Dollars?
• EUR: Short vs. Long Term Outlook
• GBP: Rally Sapped by Weaker Manufacturing PMI
• AUD Buckles on Weaker Chinese and Australian Data
• NZD: Hits Fresh 2.5 Year Highs Before Reversing
• CAD: Bucks the Trend Thanks to Stronger Inflation
• JPY: What to Make of the Sharp Plunge in Tankan

Is it Too Late to Buy Dollars?

Investors have been loading up on long dollar, short yen positions for the past 4 trading days.  In this time alone, USD/JPY appreciated approximately 200 pips, leading many investors to wonder if it is too late to buy dollars.  We believe this would only be true if U.S. rates are not headed higher and though Treasury yields have been slow to move upwards, it is only a matter time before 10 year bond yields reach 3%.  The Federal Reserve is committed to ending Quantitative Easing this year and while rates will still remain below normal levels, the process of ending QE and the buildup of expectations for the first rate hike should drive U.S. rates even higher, providing additional upside momentum for the greenback. We believe the recent move in the greenback marks only the beginning of the next leg higher in the dollar with opportunities to buy the buck against other currencies such as the euro for a longer-term play and the Canadian and Australian dollars for a shorter-term trade. 

The market's one-track focus on higher rates explains why investors completely shrugged off today's softer manufacturing ISM number and continued to drive USD/JPY upwards.  They are clearly positioning for a strong non-farm payrolls report on Friday and reacting to the latest rebound in Treasury yields.   With more than 2 full trading sessions to go before the labor market report, more investors will probably jump on to the long dollar trade.   Aside from the low level of jobless claims, spring is here which means weather related distortions are finally behind us.  Economists are looking for payrolls to rise by 200k and up until this week, investors have been slow to position for a strong report.  Everyone wants to see U.S. data validate tapering and for that to be true, non-farm payrolls just needs to exceed 150k.  If payroll growth hits the consensus forecast of 200k AND the unemployment rate drops to 6.6% like economists anticipate, these complementary reports will be enough to drive USD/JPY towards 105.  The ADP report is scheduled for release on Wednesday and a nice increase in corporate payrolls would reinforce the rally in the dollar.  In a nutshell, it is not too late to buy the greenback if you share our view that U.S. 10 year yields will break 3% in the next 2 to 3 months.  

EUR: Short vs. Long Term Outlook

Thanks to the dip in Germany's jobless rate and their larger than anticipated decline in unemployment rolls, the euro extended its gains against the U.S. dollar.  Unlike USD/JPY however, EUR/USD's gains over each of the past 3 days have been modest.  The problem is not underlying weakness in recent reports but rather an overall skepticism about how much impact these stronger numbers will have on the European Central Bank's economic outlook and monetary policy bias.  The positive surprises in German data are relatively new and have yet to cause investors to forget about last month's disappointments. Inflation remains extremely low making it impossible for the ECB to considering reducing stimulus at this time.  In terms of the economic outlook, we don't think there's been enough improvement for the central bank to alter its outlook.  Mario Draghi will most likely repeat that negative rates is an option but how much he emphasizes this point will determine how the EUR/USD trades.  Lets not forget that 4 out of the last 5 months, euro appreciated against the dollar on the day of the ECB meeting because the central bank was not as pessimistic than investors anticipated.  However even if EUR/USD bounces this week, we are bearish in the long run because the Eurozone will continue to lag behind the U.S. in the pace of recovery and normalization of monetary policy. 

GBP: Rally Sapped by Weaker Manufacturing PMI

The six-day rally in sterling was halted by a weaker than expected manufacturing PMI report.  For the fourth straight month, manufacturing activity grew at a slower pace with the PMI index dropping from 56.2 to an 8 month low of 55.3.  While the absolute level of the index remains above its 3-year average, this along with last week's massive current account deficit suggests that growth has peaked.  For the time being, the pullback in sterling is limited because investors are waiting for the more important PMI services report. If all 3 PMIs (manufacturing, construction and services) decline in the month of March, a peak in the economy could turn into a peak for sterling.  However if service sector activity improves and it still could because consumer confidence increased, sterling will be able to hold onto its gains because investors refuse to lose hope that the Bank of England will be the next central bank to raise interest rates.  Between the PMI manufacturing and services reports, we have Nationwide house prices and the PMI Construction index scheduled for release.  The housing market remains hot particularly in London and for this reason an increase in activity is expected in March.

AUD Buckles on Weaker Chinese and Australian Data

Over the past 2 months, the Australian and New Zealand dollar experienced significant gains and a pullback like the one that we have seen today is not unusual.  However even though NZD rose to a fresh 2.5 year high this morning, both currencies have been consolidating for the past 3 days leading many investors to wonder if AUD and NZD have peaked especially after last night's softer economic reports. Manufacturing activity in Australia contracted for the fifth straight month at a faster pace in March.   While the Chinese government reported a pickup in manufacturing activity, an independent survey by HSBC was revised lower to report a deeper contraction in activity.  It is hard to say which number is more accurate but both reports indicate that manufacturing activity in China is subdued.  If both reports declined we would have probably seen a deeper correction in AUD and NZD.  Given these reports, it is no surprise that the RBA had nothing new to say about the economy or monetary policy.  The RBA did not mention that the exchange rate was uncomfortably high and instead described it as only high by historical standards. AUD rallied in response but gains faded almost immediately.  AUD and NZD could be vulnerable to further profit taking if you share our belief that the U.S. dollar is headed higher.  Meanwhile the Canadian dollar bucked the trend and appreciated against the greenback on the back of stronger expected inflation reports.   

JPY: What to Make of the Sharp Plunge in Tankan

The Japanese Yen traded lower against all of the major currencies.  The long anticipated increase in the sales tax is finally rolled out and so far, investors have taken the change in stride. The Nikkei dropped less than 0.25% overnight while USD/JPY continued to move higher.  This performance is consistent with the initial moves in 1997 and if history can be a guide, then we expect further gains in USD/JPY this month. However Japanese businesses are not as confident as investors according to the Quarterly Tankan survey.  While the headline number for large manufacturing and service based firms improved, companies in both industries expect conditions to deteriorate in the next 3 months as the sales tax increase hits consumer consumption.  The large manufacturing outlook index dropped from 14 to 8, the largest decline in more than 15 years.  In fact, this drop was even steeper than the decline in 1997 when Japan last raised its sales tax.  The deterioration in sentiment means that businesses will be more reluctant to spend and invest capital, which would add to the slowdown in Japan's economy.  Today's report reinforces our belief that the Bank of Japan will provide additional stimulus in the comings months to prevent Abenomics from turning into Abegeddon.