Dollar Rebound Attempt Failed As Risk Aversion Receded Towards The End Of The Week: March 26, 2012

Dollar attempted a rebound last week on selloff in risk markets on global slowdown worry but failed towards the end of the week. Even though S&P 500 suffered the largest weekly decline since last December, it pared much loss on Friday with help from quarter end window dressing buying.

Dollar index has indeed closed the week lower at 79.345. Meanwhile, EUR/USD now looks set to take out 1.33 level this week and could be heading back to 1.35. We'd maintain that equities remain vulnerable to a deeper pull back and that should exert certain pressure on commodity currencies.

European majors could benefit more from risk aversion than dollar this time as European/commodity crosses short positions unwind but that's far from being certain. Yen would possibly rebound further with help from repatriation. Dollar would be mixed. So, we'd favor long in European/commodity crosses and short in commodity/yen crosses in near term.

PMI data from China and Eurozone were a major source of worry in the global economy. The HSBC/Markit manufacturing PMI in China dropped from 49.6 to 48.1 in March, staying in contraction region and was the lowest number since last November. An HSBC economists noted that growth momentum in China could slow further on sluggish export new orders and softening domestic demand.

Eurozone manufacturing PMI unexpectedly dropped from 49.0 to 47.7 in March while services PMI dropped from 48.8 to 48.7. Germany manufacturing PMI dropped from 50.2 to 48.1 while services PMI dropped form 52.8 to 51.8. French manufacturing PMI dropped from 50.0 to 47.6 while services PMI was unchanged at 50. The set of data triggered worry that recession in the Eurozone could be worsening.

PBoC announced, in order to boost credit, a reduction of reserve requirement ratio in 379 more branches in rural areas of the Agricultural Bank of China. The scheme was initially applied to 563 branches in 8 provinces. The reduction of the ratio by 2% is expected to free up RMB 23B. The impact to market was mild though as it's seen as part of the targeted fine-tuning of policy with the use of so called "differentiated reserve ratios".

Fed President Bernanke said that the threats from the debt crisis eased recently as development has lowered the risks. He hailed the exchange of bailout support and deeper budgets by Greece and acknowledged the PSI debt swap deal. Nonetheless, he warned that "a significant expansion of financial backstops" is still needed to safeguard the Eurozone from contagion, and that "full resolution of the crisis will require a further strengthening of the European banking system."

Contagion risks remained a concern for U.S. financial firms and money market funds and their supervisors and regulators. Regarding the U.S., Bernanke said economic recovery still lacks sustainable strength. Bernanke remained cautious on the economic outlook, citing consumer spending, currently taking up 70% of the U.S. GDP, is not robust enough to sustain growth.

He stated that "every country needs to have an appropriate balance of consumption, capital formation, exports and government spending, and that's an important task for us going forward... In terms of debt and consumption and so on, we're still way low relative to the patterns before the crisis".

U.K. Chancellor of the Exchequer Osborne expressed his optimism that the U.K. will avoid recession. In his 2012 budget statement delivered today, Osborne upgraded the U.K.'s 2012 growth projection to 0.8%, up from November's projection of 0.7%. He expects unemployment rate to peak at 8.7% then falls back to 6.3% in 2016. Budget deficit will drop to 7..6% of GDP in the next fiscal year. Nonetheless, Osborne cited Eurozone debt crisis and surging energy prices as the major risks to economic recovery. The budget deficit would be at 7.6% of GDP in the next fiscal year.

The BOE's minutes for the March meeting indicated that policy makers remained split in the asset buying program. Adam Posen and David Miles supported more stimulus (adding an additional 25 GBP) as it was "warranted to reduce the risk that persistently weak growth would damage the future supply capacity of the economy". Yet, the proposal was overruled by the remaining 7 members to maintain the program as it was. More in BOE Members Remained Divided On Asset Program.

Japanese yen should have bottomed in near term after recent selloff got exhausted and with help from fiscal end repatriation. Also, Japan posted the first trade surplus in five months. February trade turned to JPY 32.9B surplus, a significant turn around from January's record deficit of JPY 1.48T. Looking at the details, exports to the U.S. rose 11.9% YOY, the strongest rise since December 2010. Total exports, though, dropped -2.7% YOY but was better than the market expectation of -6.4%, not to mention January's -9.2% YOY fall.

Overall import rose 9.2% YOY comparing with expectation of 8.4%. The outlook is still unclear though, as better demand from U.S. would be offset by weakness to Europe and possibly China too. Overall trend in the Japanese should remain bearish nonetheless as BoJ would continue to expand its quantitative easing program until the inflation target is reached.

The RBA unveiled in the March minutes a more optimistic outlook. The reason for leaving the policy rate unchanged was lessened downside risks in global economic outlook. Moreover, policy makers appeared to have weighed the gains from the mining investment boom again strength in Australian dollar. Overall, the central bank has moved to a neutral monetary bias from an easing one in previous meetings. More in RBA Left Interest rates Unchanged due to Less Downside Risks.