Dollar Bounces Back

Some profit-taking in the middle of last week pushed the dollar lower and gave rise in some quarters that the run was over. However, the greenback has come back the bid. It is gaining against all the major currencies today and most of the emerging market currencies.

Much of the coverage attributes the gains to comments by the Philadelphia Fed President Harker. He joined the chorus of officials who have refused to rule out a March hike. Yet the market is not biting. The Fed funds have been averaging 66 bp. The March contract implies 69.5 bp, and the April contract implies 71.5 bp. Our work suggests this is consistent with about a one-in-four chance of a hike. Bloomberg puts the odds at 36% compared with 34% a week ago. The implied yield of the March and April contracts have risen by half of a basis point over the past week.

Leaving aside the New Zealand dollar, which is being dragged lower apparently by the continued weakness in milk prices (off five consecutive sessions through yesterday) ahead of today's auction, the euro is the weakest of the majors. We suspect the euro is an important driver of the broad dollar gains. The latest polls have support for Le Pen ticking up, while the Left continues to hampered by sectarianism, and the two main candidates Fillon and Macron appear to have lost some momentum.

The 10-year French premium over Germany has widened to 80 bp, the most since August 2012. It has risen nearly 14 bp since the middle of last week. The two-year spread is also widening. It is at 44 bp today, the widest since May 2012. It is up about 16 bp over the last four sessions. The five-year credit-default swap was at 68 bp yesterday, up from 38 bp at the end of last year and 42 bp at the of January. The sell-off in French debt instruments has reportedly come on high volume.

The demand for German paper, not only emanating from flows out of France but the periphery more general, has seen the German two-year note fell to a new record low (~-88 bp). This in turn has widened the spread between the US and Germany. The US two-year premium took out the end of last year's high (~205 bp) today to make a new post-2000 high. The US 10-year premium is near 330 bp today, which is the widest so far this year, but still a little below peak from the end of last year near 339 bp, which is the widest since at least 1990.

The euro has been sold back toward last week['s low near $1.0520. The sell-off has come in two legs. The first in Asia took the euro through $1.0580. Then Europe took it down another half cent. The sell-off came despite a robust flash PMI. The eurozone composite jumped to 56.0 from 54.4. The median guesstimate in the Bloomberg survey was for a little slippage to 54.3. The details were also favorable. The manufacturing PMI rose to 55.5 from 55.2. The median looked for a softer number. Economists expected an unchanged the service PMI. Instead, it jumped to 55.6 from 53.7. New orders reached a six-year high and prices charged rose to the highest level since July 2011.

Of note, the French composite rose above the German composite (56.2 vs. 56.1). Some observers try to draw a political implication from the recovery in the French economy. This may be mistaken. The two high income countries where the populist-nationalist agenda had electoral success, the UK and US, enjoyed among the strongest recoveries from the Great Financial Crisis, including levels of unemployment that were broadly regarded near full employment.

In addition to the eurozone PMI, the flash manufacturing PMI for Japan was reported. It rose to 53.5 from 52.7. Markit reports its preliminary manufacturing, service, and composite PMI for the US today. Modest upticks are expected. The backdrop is that the US, Europe, and Japan are off to a firm start to the year. Equity markets seem to appreciate this. The MSCI Asia Pacific eked out a small gain, its fourth in the past five sessions. Of note, Korea's Kospi rose 0.95 to its best level since mid-2015. In Europe, the Dow Jones Stoxx 600 is up nearly 0.3%. It is the third consecutive gain and the tenth advance in 11 sessions. Financials are the weakest sector in Europe, off about 0.7%, dragged in part by the disappointing earnings at HSBC. On the other hand, BHP Billiton and Anglo-American beat expectations. Iron ore future extended this year's rally, adding 3.2% to bring the year-to-date advance to 34%. Copper, zinc and lead prices also rallied.

Support for the euro is near $1.0520, which corresponds to the low from last week and the 61.8% retracement objective of last month's euro rally. Below there is potential toward $1.0450. The intraday technicals are stretched. A little short squeeze toward $1.0560 may give North American dealers a better selling opportunity. The dollar faces immediate resistance near JPY113.80, but a move above JPY114.10 is needed to suggest another run at JPY115.00. Sterling is flirting with the $1.2400 level. It has probed this shelf several times this month and has been unable to close below it.

The Australian dollar found initial support near $0.7650, a five-day low, but the $0.7670 area may cap corrective upticks. After the attempt on CAD1.30 failed in the middle of last week, the US dollar has recovered to CAD1.3160 in the European morning but has run out of steam. Recall that in the futures market, speculators are net long the dollar-bloc currencies and but net short the euro, sterling, yen and Swiss franc.