Dollar Bid, But Relationships Break Down

The US dollar is firmer against most of the major and emerging market currencies. The euro is trading at three day lows, partly in response to comments by the ECB's Nowotny dampening the sense that a negative deposit rate is a done deal. The Australian dollar is at two week lows following S&P's warning of the fiscal risks to the country's AAA rating. The RBA minutes offered a downbeat growth message and helped push the Aussie to $0.9260, where it found bids.

Sterling and the yen are resisting the dollar's upticks today. The greenback ran into resistance near JPY101.60, the upper end of its three day range. That there was not a stronger recovery from yesterday's test on the 200-day for the first time in six months may warn the short squeeze may not be over. Softer share prices in Europe and indications of a lower equity opening in the US, coupled with firmer US Treasuries, may also be helping keep the yen bears at bay.

Sterling is a horse of a different color. The UK reported the first uptick in CPI since last June and the highest core reading since last September. April consumer prices rose 0.4% for a 1.8% year-over-year increase. It stood at 1.6% in March. The increase was a little above expectations. The core rate rose to 2.0% from 1.6%. The consensus had expected an increase to 1.8%.

Short sterling futures contracts fell a couple of ticks on the news, and gilts are trading a bit softer. Sterling itself rallied a little more than half a cent in response. We would not want to exaggerate the tick up in UK inflation.

First, the rise in the CPI is almost wholly accountable to the increase in transportation costs (0.4%). Nearly all other components fell. The exceptions were clothing an footwear (0.08%) and furniture and household goods (0.02%). Second, producer prices remain subdued. Input prices fell 1.1% in April. The consensus was for a 0.2% decline. Output prices were flat. Economists had expected a 0.2% increase. Third, the ONS measures of house prices was considerably slower than expected at 8% on a year-over-year basis in March. This is down from the upwardly revised 9.2% in February. The market had expected a 9.6% increase.

One of the starkest developments over the past week has been a dramatic reversal in the European peripheral bonds. The move is being extended today, though Spain and Greece's 10-year yield is below last week's high water mark. This is not true for Italy, Portugal and Ireland. Consider that Italy's 10-year bond yield is up about 35 bp from May 15. Portugal's yield is up 47 bp. Ireland's yield is up 16 bp, perhaps tempered in part that it drew in less hot money and was upgraded by two notches by Moody's before the weekend (matching the other major rating agencies).

We had previously noted a shift in sentiment, with some large institutional investors indicating they were beginning to take some profits while officials at the EU and IMF raised questions over the sustainability of the bond market rallies. The critical push, however, seemed to come from speculation that the ECB would likely focus on rates rather than an asset purchase scheme. Some funds had bought peripheral bonds on ideas that QE would be unveiled that would be broadly supportive.

While the profit-taking in the peripheral bond markets may have lent support to the core bond markets and emerging markets, this is not a firm relationship. Core European bonds are lower today, and emerging markets are not doing particularly well. The MSCI Emerging Equity Index is off a quarter of a percent today. Most of the liquid freely traded emerging market currencies are lower today. When everything is said and done, the euro is really broadly flat. Over the last five sessions, the euro has finished the North American session between $1.3694 and $1.3715 (according to Bloomberg).

There are no important US or Canadian economic data today. The FOMC minutes from the April 29-30 meeting will be released tomorrow. Canada reports retail sales (Thursday) and CPI (Friday). Of note, the Philadelphia Fed President and FOMC voting member Plosser speaks on the economy at 12:30 ET today. He is seen as a hawk. The NY Fed's Dudley also speaks today (1:00 ET) on the economy and monetary policy. Dudley is much more aligned (and is part of) the Fed's leadership.

Elsewhere, note that the US Senate may vote to end the debate on Fischer's nomination to the Fed. The nomination of Fischer and Brainard have languished for several months now. This is purely a function of partisan political wrangling. Note that after Stein leaves the Fed next week, no two governors will be able to meeting without constituting a quorum, which requires public notification.