Panic Selling in Dollar?

We know that when Chinese markets are open they can wreck havoc on currencies and equities but when they are closed the same can happen. Markets in China are suspended for trading all week for the Lunar New Year and last night there was no trading in major financial centers including Hong Kong, South Korea and Singapore. Activity in these countries make up a significant portion of Asian trading and exaggerated moves like the ones we've seen today can be attributed in part to the absence of this volume. Equities sold off hard around the world with Europe leading the losses. The German DAX was down 3.3% while the Spanish IBEX fell 4.4%. Major losses were also seen in U.S. stocks with the S&P 500 falling more than 2%. While there was no specific catalyst for today's moves, the bond markets tell an interesting story.

According to the sharp rise in European peripheral yields and steep decline in Treasury rates, investors are extremely worried about the effectiveness of central bank policies. Ten year Treasury yields fell approximately 8bp while Spanish and Italian yields rose more than 10bp. But the big moves were in Portuguese and Greek yields which jumped 25bp and 61bp respectively. Greek stocks also dropped to their lowest level since 1990 on reports that the Greece bailout review stalled. According to Reuters, "Talks between the heads of the EU/IMF mission reviewing Greece's progress and the government over a tough pension reform plan, fiscal targets and the handling of bad loans, took a break on Friday after four days of meetings. They are due to continue "sometime next week" and then conclude two weeks later."

This is the 5th year in a row that Greece is in the headlines and today's focus on the debt-laden nation serves as a harsh reminder of Europe's credit problems. If Greece fails to secure additional funding, investors can expect another round of headaches for the euro. Voter fatigue is becoming a serious problem and there may not be enough political will to provide additional support to Greece. In the near term however, we don't think the ECB will be pleased with the spike in peripheral yields and the more than 5-cent rise in EUR/USD since their easing in December. The euro is only rallying because it is a deeply sold funding currency and we think it won't be long before we hear renewed concerns from the central bank and talk of more easing.

Verbal intervention is also something we expect from the Bank of Japan if the Yen keeps rising. 115 is long viewed as the line in the sand for the BoJ. Not only has this level held for the past year but with the Yen appreciating almost 300 pips since they went to negative rates, the central bank will not be happy with the recent rise in the currency. The greatest risk for USD/JPY is BoJ intervention and we believe that the currency pair has fallen to a zone that at minimum - warrants verbal intervention especially in the context of weak growth and global market volatility.

However whether the dollar continues to fall versus the Yen hinges on Janet Yellen's testimony on the economy this week. If the Fed Chair shares Dudley's cautious outlook, the dollar will resume its slide but if she puts on a brave face and we think she will the dollar could recover sharply. If we take a step back, while the Fed may have reasons to slow tightening this year most economic reports show that the U.S. is outperforming many major economies which at the end of the day should make the dollar more attractive. The problem is that everyone piled into the long dollar trade and last week's wake up call from Dudley scared many investors out of their positions. In order for the dollar to regain strength, we would need an endorsement from Yellen in the form of continued optimism for the U.S. economy.

In contrast to the euro, sterling trading lower versus the U.S. dollar as the decline in U.K. yields exceed the drop in Treasury rates. There continues to be concerns about Brexit with Prime Minister Cameron most recently being accused of "scaremongering" after he warned that thousands of refugees could come to across their borders overnight if Britain were to leave the EU because the 2003 Le Touquet agreement which affects borders would be ripped up but apparently this agreement with France has nothing to do with EU membership. A number of second tier U.K. economic reports are scheduled for release this week including tomorrow's visible trade balance and between last week's negative Inflation Report and Brexit worries, we continue to view GBP as a sell on rallies.

Lower oil prices drove the Canadian dollar lower despite surprisingly strong building permits. With no major Canadian economic reports were scheduled for release this week, the market's appetite for U.S. dollars and oil will determine the currency's flows. The rally in the Australian and New Zealand dollars were a bit counterintuitive given the sharp drop in U.S. equities but with Chinese markets closed we are mostly seeing consolidation in those currencies.