Daily Commentary

Friday’s numbers from the US and Germany have sent encouraging signals about recovery dynamics on both sides of the Atlantic. Most importantly, Friday’s US employment report was better than expected, while German factory orders numbers also came in ahead of analyst forecasts.

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Yesterday’s two central bank decisions yielded the expected outcomes, as the Bank of England left both the level of interest rates and the size of its asset purchase programme unchanged at 0.50% and £200bn respectively, while the ECB also left official rates in the euro zone on hold at their record low of 1%. The main focus for markets today will be the US employment report, though there is more uncertainty than usual around today’s outcome and the potential market reaction given that adverse weather will have likely impacted these February numbers.

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A much stronger than expected February reading of the services PMI out of the UK yesterday provided only modest support to sterling, indicative of the negative sentiment surrounding the UK currency at present. Services PMI data out of the US also showed stronger than expected gains, with the headline index of the non-manufacturing ISM rising to its highest level since October 2007. This was supportive of risk appetite yesterday, and contributed to the dollar heading towards $1.3750 against the euro at one stage. However, there is a somewhat softer tone to risk this morning, with predictions from a Chinese bank that new lending growth will be slower contributing.

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The Greek story rumbles on. Further indications that the European Union will shortly unveil a debt rescue package has been welcomed by both equity and bond markets. In the sovereign debt markets, the spread (or premium) on 10-year government debt relative to the benchmark 10-year German Government debt narrowed yesterday in most of the euro zone periphery with the exception of Spain. In particular, the Greek spread has narrowed by over 15bps over the last 24 hours. This comes ahead of a new Greek austerity package of spending cuts and tax rises which is due to be announced at 0930 this morning. The Greek public finances also received some support from their best known singer Nana Mouskouri (that’s Nana not Nama!) who yesterday offered her pension to Greece in a bid to tackle its massive debt. It will be interesting to see in the months ahead if Julio Iglesias follows her lead when the Spanish public finances deteriorate further. Talk of the austerity package has boosted the single currency and it is currently trading above $1.36.

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The theme of sterling weakness continued to dominate market news-flow yesterday. Eur/Stg moved as high as 91.50p at one stage, with cable hitting a 10-month low of $1.48. In addition to growing market concerns that the UK election could yield a minority government that struggles to lead the country out of its fiscal problems, weaker than expected earnings results from HSBC did not help sterling yesterday. Market speculation about the Greek situation also continued to grab headlines, with the German Chancellor Angela Merkel avoiding a question as to whether German banks will help the Greeks.

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Despite the fact that Friday’s UK Q4 GDP data was stronger, not weaker, than expected the UK currency was under steady selling pressure for most of Friday. Eur/Stg opens at 90p this morning, from 89p on Friday morning and as low as 87.5p on Wednesday.

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The euro has managed to edge higher against both the dollar and sterling over the past 24 hours, helped by some weaker economic news out of both the US and UK.

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While they would typically take a back seat to such an important event, much weaker than expected US new home sales data somewhat overshadowed Bernanke’s testimony yesterday. However, the greenback failed to make a lasting move above the $1.36 mark against the euro, with the single currency finding itself under some renewed pressure on comments from both Standard & Poor’s and Moody’s that Greece’s credit rating could be downgraded again if there is any slippage on the budget plan. The euro is currently trading at around $1.35 against the dollar and 88p versus sterling.

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In keeping with the tone of the Inflation Report and the minutes of the February meeting, the BoE MPC testimony yesterday morning struck a similarly dovish note. Sterling weakened to around 88.30p against the euro at one stage, but poor sentiment towards the single currency prevented a further slide in EUR/GBP yesterday. The German IFO fell back for the first time in 11 months, which when compounded with other news that Fitch downgraded the rating of Greece’s four largest banks and reports that Greek unions are staging a second strike, resulted in another bout of euro selling yesterday.

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With yesterday a relatively quiet day on data releases, markets should be somewhat more energetic today as we begin a sequence of days that see two of the world’s main policy makers making a series of speeches. Mervyn King, the Bank of England Governor, and his deputy Charlie Bean today testify to the UK parliament on their latest inflation report, while tomorrow will see the beginning of Federal Reserve President Ben Bernanke’s semi-annual testimony to congress. Both of these events should provide market makers with increased colour on the policymakers respective views on the direction of their own particular economies.

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Right at the close of the US session the Fed announced an increase in the discount rate from 0.25% to 0.75%, indicating that the Fed is now clearly on the path of a normalisation of liquidity provisions. The move itself is not surprising as it had been flagged by Bernanke in his testimony last week. However, the timing of the change was a bit sooner than expected. While the Fed reiterated that there are no monetary policy implications associated with the move, the market has interpreted it as signal that tightening is coming down the tracks a bit earlier than previously expected. This has been supportive of the dollar, which is currently trading at around $1.35 against the euro, a nine month high for the greenback.

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The euro has lost some ground on the currency markets, with reports that like Greece Italy too has been fudging its deficit playing a role here. The euro has fallen back by some 0.5% versus sterling since yesterday morning, to around 86.75p currently. Against the dollar, the euro has depreciated by a greater 1.5%, to around $1.36, with USD strength also contributing. Data out of the US yesterday ranging from housing starts to industrial production came in ahead of market expectations, with the slightly more hawkish tone to the FOMC minutes released overnight helping the dollar to hold onto earlier gains.

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The euro continues to look steadier on the currency markets, particularly versus the dollar where it is trading at around $1.3750 this morning. This move comes in spite of a further widening in Greek bond spreads yesterday, with market concerns about the ability of Greece to curtail its deficit problem remaining at the fore. It was more a case of dollar weakness than euro strength that drove the currency moves yesterday, with the USD losing ground against sterling also. As we have pointed out previously traders have taken up sizable short positions in EUR/USD, which meant there was the potential for some move upwards. Looking to the day ahead, the minutes from the February meeting of the Bank of England and January meeting of the Fed’s FOMC will be a main focus of markets.

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Markets are little changed over the past 24 hours or so, a development which has its origins in both the absence of much by way of economic data as well as holidays in the US and much of Asia. We have had plenty of chatter on the Greek situation from Brussels overnight where euro area finance ministers were gathering. One message to have emerged is that the European authorities are clearly putting it up to Greece “to prove that it’s taking very seriously the commitments it has made” as Jean-Claude Juncker (the head of the euro group of finance ministers) put it last night.

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The euro remained under a good deal of pressure on Friday, trading as low as $1.3530 at one point vs. the dollar – levels last seen in May 2009. In addition to ongoing uncertainty surrounding the policy response to the Greek crisis, disappointment at the sluggish performance across the euro area economy at the end of last year was an important theme here. Following weaker German GDP numbers, the estimate for the euro zone as a whole also came in shy of market forecasts, with GDP expanding by just 0.1% q/q vs. 0.3% expected.

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