USD/JPY Lifted by Sharp Rise in U.S. Rates

• USD/JPY Lifted by Sharp Rise in U.S. Rates
• Will the EURO Survive a Grexit?
• GBP Shrugs Off Record Low Inflation Ahead of BoE Minutes
• NZD Extends Gains, Dairy Prices Rise Another 10%
• AUD Rallies on Less Dovish RBA Minutes
• USD/CAD Driven Lower by Oil

 
USD/JPY Lifted by Sharp Rise in U.S. Rates
 
Investors are buying dollars and selling the Japanese Yen ahead of tomorrow's FOMC minutes. Based on the simultaneous gains in U.S. rates, USD/JPY and U.S. equities, the market is clearly bracing for an optimistic and hawkish report. Ten year yields rose as much as 10bp intraday and in response, USD/JPY rose above 119.  However the dollar did not experience broad based gains with the greenback trading higher against the Japanese Yen and Swiss Franc and moving lower versus the euro, British pound and commodity currencies. While we could attribute the lack of consistency in the dollar's performance to weaker U.S. data, this would not be an accurate statement because the currency barely reacted to this morning's reports. The Empire State manufacturing index dropped to 7.78 from 8.0 in the month of February while the NAHB Housing Market Index fell to 55 from 58.  Inclement weather affected both reports but when the snowstorms ease and the temperatures rise, manufacturing and housing market activity should also improve. Therefore the inconsistent performance of the greenback should be attributed to the improvement in risk appetite and the hope that Greece will officially request a six month bailout extension this week. A number of U.S. economic reports are scheduled for release tomorrow including housing starts, building permits, producer prices and industrial production. Unfortunately all of these reports will take a backseat to the Fed minutes.  When the central bank last met on January 28th, they released a short and sweet monetary policy statement.  In less than 600 words, the Fed expressed their satisfaction with the improvements in the labor market and the "solid pace" of expansion in the U.S. economy. They believe that "the transitory effects of lower energy prices will dissipate" and expressed some concerns about international developments.  How the dollar trades on the back of the minutes will be determined by how much emphasis is made on the uncertainties abroad.  If the Fed focuses on domestic strength and expresses an unwavering commitment to raise interest rates, the dollar will extend it gains, helping USD/JPY make another run for 120.
           
Will the EURO Survive a Grexit?
 
I was on CNBC Squawk Box this morning talking to Michelle, Andrew and Scott about how much impact a Grexit would have on global financial markets.  The consensus on the desk was that it wouldn't be a big deal because investors have had plenty of time to price it in and to consider the eventual outcome of a stronger Eurozone.  However, I beg to differ. While it is true that the euro could survive without a sick dog like Greece and end up with a healthier balance sheet, there will be major losses and pain before stabilization.  Volatility will rise, inflation will soar and things will get very messy as fear can have a very powerful impact on prices.  If Greece were to leave the Eurozone, the Drachma would return and it would fall quickly and aggressively, inflation would be on the rise, debt would be defaulted and contagion would occur across the region.  While the leverage on Greece is minimal, this has less to do with Athens than the precedent that it would create for Italy, Spain and Portugal.
 
So while today's EUR/USD rally may suggest that investors are coming to terms with a potential Grexit, we believe that it is really a reflection of the market's continued hope that a deal will be done.  Lets not forget that the European Central Bank could still force the Greek government's hand by cutting off their access to the Emergency Liquidity Assistance program (ELA) just like they did to Cyprus in 2013 and Ireland in 2010. It won't take much to satisfy the market and drive European assets higher.  All Greece needs to do is agree to an extension and a framework for negotiation. However time is running out fast and the gap does not appear to be closing.  Talks with Greece collapsed this weekend and while Greek officials continue to say that they are committed to a deal, their combative stance and comments from other Finance Ministers in the region suggests that they are reluctance to ease on their terms.  Nonetheless at the end of the day, we believe Tsipras and Varoufakis realize that it is foolish to expect more loans without an extension and European policymakers realize that the potential carnage that a Grexit have on the markets would be too much risk at this precarious juncture in the region's economy.  In a nutshell, we still believe that some type of agreement will be reached before the end of the month and most likely before the end of the week.  The euro's move back towards 1.14 indicates that the market shares our optimism.  
 
GBP Shrugs Off Record Low Inflation Ahead of BoE Minutes
 
Thanks to last week's hawkish Quarterly Inflation Report, sterling traders shrugged off today's record low inflation print.  In fact he British pound ended the North American trading session unchanged against the U.S. dollar, weaker against the euro and stronger versus the Japanese Yen and Swiss Franc.  Consumer prices fell -0.9% in the month of January, pushing the year over year rate of growth down to 0.3% from 0.5%. This was not only the largest one-month decline in more than 15 years but also the weakest annualized CPI growth ever.  If the Bank of England had not preempted this report with their hawkishness, sterling would have fell sharply in response. However last week, they raised their 2016 and 2017 inflation forecasts reinforcing their view that the decline in inflation is temporary. Tomorrow the minutes from the most recent monetary policy meeting and the January employment report are scheduled for release.  Chances are they will reinforce the Quarterly Report's optimistic tone, keeping a 2015 rate hike on the table.  Therefore we continue to anticipate further strength in the pound with the rally in GBP/USD extending above 1.55.
 
NZD Extends Gains, Dairy Prices Rise Another 10%
 
All three of the commodity currencies traded higher on the back of positive local developments.  NZD/USD appreciated for the fourth consecutive trading day, rising to its strongest level this year.  The strong performance was caused by dairy prices, which rose 10% at today's auction, cementing a bottom in New Zealand's most important commodity.  Although the latest increase was driven by drought conditions, this marked the fifth consecutive auction at which dairy prices moved higher. This is good news for New Zealand because it means that Fonterra's current milk price forecast can be reached, eliminating the need for another payout reduction that would not only hit the pocketbooks of producers but also the economy as a whole.  The Australian dollar on the other hand benefitted from less dovish RBA minutes. After surprising the market with a 25bp rate cut last month, the central bank cooled expectations for another rate cut in March by indicating that their choice was simply between a February or March and February was chosen not because of urgency but because it "offered the opportunity of early additional communication in the forthcoming Statement on Monetary Policy."  While we believe the RBA will ease again this year, rate cut expectations for March dropped to 56% from 70% after the minutes were released.  Finally USD/CAD traded lower on the back of higher oil prices and a smaller decline in existing home sales.