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The US dollar gained more ground overnight

Fri, May 30 2008, 06:28 GMT
by Westpac Institutional Bank Team

Westpac Institutional Bank

News and views

The US dollar gained more ground overnight, garnering support from higher interest rates. A growing sense that the US economy has skirted a recession, and increasing recognition of inflation pressures, saw US ten-year bond yields reach their highest levels this year. More hawkish comments from Fed officials helped the move–Dallas Fed governor Fisher said that he would expect rate hikes sooner rather than later if inflation expectations continue to worsen (Fisher is a noted hawk who voted against the last three Fed rate cuts).

The European currencies fell, but gained some support from higher interest rates as well. The euro took the brunt of Fisher’s comments, falling from 1.5650 to 1.55 before finding support from reserve managers. The pound recovered its early losses despite poor economic data, with the market now pricing in rate hikes in the UK before year-end.

Yield spreads worked against the New Zealand dollar though, as the local market failed to join in the global surge in interest rates. Long positions in interest rate markets were cleaned out after last week’s Budget, and traders remain reluctant to bet on higher interest rates, given expectations of RBNZ easing before year-end. The NZD fell from around 0.7850 at yesterday’s close to an overnight low of 0.7770.

Commodity prices fell across the board, partly a reciprocal of US dollar strength, but also reflecting concerns about excessive speculation. Crude oil finished the day lower, despite an unexpected fall in US inventories, as commodity exchanges raised margin requirements and increased monitoring of traders. Gold fell by more than $20/oz and other metals prices were lower.

US Q1 GDP growth was revised up from 0.6% to 0.9% annualised, as expected. The main upward revisions came from business investment in structures (revised from a fall to a gain), inventories (revised down from a 0.8 ppts contribution to just 0.2 ppts) and net exports (up from 0.2 ppts to 0.8 ppts). So domestic demand (or domestic final sales) remained negative but only just, thanks to the stronger investment story, but the inventory and net exports revisions were offsetting in the GDP bottom line.

US initial jobless claims rose 4k to 372k last week, and in the payrolls survey period a week prior, continuing claims rose to a new four-year high–further evidence of ongoing weakness in the labour market.

This month’s collection of European business and consumer surveys conducted by/ for the European Commission and the private sector was mixed rather than weak. The retail PMI jumped to its highest in just over a year; yet consumer confidence fell to its lowest since late 2005. Industrial confidence was unchanged, the business climate index (a composite of other survey based evidence) reversed part of its April slide and the broader measure of economic sentiment was also unchanged at its recent two and a half year low. All up, the message is one of slowdown ahead, though not dramatic weakness.

Euroland M3 money supply re-accelerated from 10.1% yr to 10.6% yr in April. This will continue to concern the European Central Bank, which issued a statement today as part of its ten-year anniversary celebrations noting that “some signs are emerging that inflation expectations have been trending up recently”. That does not sound like a central bank that will be cutting rates any time soon.

UK housing and retail data were weak in May. House prices keep falling away in the UK (down 4.4% yr) according to the Nationwide and the retail survey from the Confederation of British Industry remained very weak in May, after allowing for early Easter related distortions in March-April. This sort of news would normally have the Bank of England cutting rates aggressively, but with inflation heading towards 4% it will take an even steeper plunge in activity to get rates below their current 5% level.

Outlook

With the MPS approaching, and the market’s interest rate views in disarray after the surprise Budget spend-up, don’t expect to see a lot of new positioning in the NZD this week, leaving the USD to dictate direction. Beyond this, the bias still looks to be downward – the global switch from growth to inflation concerns has bypassed the local market to some degree (perhaps unfairly) and has seen yield spreads narrow again. Also, the NZD still has to run the gauntlet of Q1/Q2 economic data in coming weeks, which are likely to be soft on balance.

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Published on  Fri, May 30 2008, 06:30 GMT