FX Daily, March 22: Terrorist Strike in Brussels Causes Market Angst

A series of attacks at Brussels airport and metro casts a pall over the market.  The attacks come as Europe prepares what for many will be a long holiday weekend.  Gold, the dollar and yen seem to have been the beneficiaries.   Bonds are generally firmer and equities lower.   However, in late morning activity in London, the markets began stabilizing.

Sterling remains the weakest of the major currencies.  It is nearly as much as it was yesterday (0.7%) against the dollar.  Osborne has been forced to scrap some welfare cuts, and this opens a new GBP4.4 bln budget gap.

Such climb downs and missing self-imposed caps and targets have become characteristic of the Chancellor in Cameron's government.  However, within the backdrop of the referendum is having a greater toll.  Cameron's hope that a referendum would unite the party seems to be doing the exact opposite.

Moody's assessment of Brexit could have been worse.  It argued that the costs would outweigh the benefits, which is what most economists have concluded.  Moody's also noted that there would be credit implications.  However, it judged that the costs would be manageable, and the existing trade arrangement with the EU would likely be replicated.

Separately, the UK reported softer than expected inflation.  The headline rise of 0.2% was half of what the consensus forecast, and this left the year-over-year rate unchanged at 0.3%.  The BOE's inflation report in February anticipated a 0.5% increase in March.  The core rate was unchanged at 1.2%.  Input prices for producers was a little less than expected while output price was not quite as soft as forecast.

Sterling had poked through $.145 before the weekend and today neared $1.4250.  The $1.4230 area corresponds to a 61.8% retracement of sterling's gains in the wake of last week's FOMC decision.     A break would warn of losses closer to $1.40.

Poor Japanese data will encourage speculation that the Bank of Japan may ease again as early as next month.   The March manufacturing PMI fell to 49.1, the lowest since at least February 2013.  The Bloomberg consensus forecast an increase to 50.5 from 50.1.  The average for Q1 was 50.5 compared with 52.5 in Q4 15 and 51.3 in Q3 15.

Japanese shares snapped a four-session losing streak with the Nikkei's 1.9% rise. Health care and telecom led the advance.  Energy was the only declining sector.    The MSCI Asia-Pacific Index was up 0.7%.  It is up six of the past nine sessions.

The dollar has recorded its third session of higher highs against the yen.  However, it appears to be faltering ahead of JPY112.25, which is the 50% retracement objective of the dollar's drop since the FOMC meeting.

The flash PMI from the euro area was slightly better than expected.  The preliminary March manufacturing reading was 51.4.  This is in line with expectations and a little higher than the 51.2 in February.  It was the first uptick of the year.  The Q1 average was 51.6 compared with 52.8 in Q4 15 and 52.2 in Q3 15.   The preliminary service sector PMI increased to 54.0 from 53.3.  The consensus was for an unchanged reading.   It averaged 53.6 in Q1 averaged 54.2 in Q4 15 and 54.0 in Q3 15.

This translated into a 53.7 composite reading. This is up from 53.0 in February and what the consensus expected.   It is the best reading of quarter.

Separately, the two German surveys, the IFO and ZEW were released.   The IFO was reported a little stronger than expected while the ZEW was a bit softer than expected.  The former is regarded as more comprehensive while the latter seems to track more closely investor sentiment.    These surveys coupled with the flash PMI suggests the tumultuous start of the year for the financial markets have not derailed the largest European economy. 

The euro is slipping lower for the third session.   The euro ran up from about $1.1070 to nearly $1.1245 in the aftermath of the FOMC meeting.  At $1.1200, it retraced half of those gains and at $1.1165 it would retrace 6.18%.   The intraday technical suggest consolidation may be the most likely scenario for the remainder of the session. 

That said, the North American session has a few features.  First, the new Canadian government will present its budget today.  A C$30 bln deficit is expected.  It is a function of about C$18.4 bln deficit being inherited (which includes a C$6 bln cushion) and about C$10.5 bln in campaign promises.  The focus is primarily on infrastructure and green projects but also includes a child benefit (direct transfer to low-income families with children). 

In the US, we highlight two developments.  The first will be the preliminary Markit manufacturing PMI.  The early Fed surveys for March suggest the US manufacturing sector may have bottomed.  The second will be speeches by two Fed Presidents, Chicago Fed’s Evans and Philadelphia Fed’s Harker.  Yesterday’s comments by Williams, Bullard, and Lockhart suggest not only that a June hike is in the cards, but an April move cannot be entirely ruled out either.  We have argued that the Fed would like to explain a move to investors this early in the cycle and that this favors a June hike over April. 

However, suppose the Fed wanted to enhance is credibility, which some have questioned.  First, it would shift its tactics toward Under-promising and over-delivering.    The dot plots could fit into such a scenario.  Second, it could hike in April and surprise market participants.    Yellen’s speech next week in NY will likely be important.