ECONOMETER

My finger has not exactly been on the pulse given that I am currently on leave and trying to avoid spending much time looking at markets but like an addict it is difficult to stay away. So here are some thoughts on the current state of affairs.

The dollar remains in trouble and not much has changed on this front. It’s hard to believe that the Fed FOMC meeting will change much from this perspective.

The bottom line is that the debasement of the dollar continues as the Fed’s printing press remains in full swing, at least until the end June when the printing press will shut down.

Added to the dollar’s troubles is the jolt of reality given to the US administration and Congress that the country’s AAA rating should not be taken for granted. Whilst an actual credit ratings downgrade looks unlikely the US fiscal/debt situation looks precarious at best. The USD may benefit if the ratings action forces officials into action.

It’s pretty difficult to believe that the EUR is now eyeing the 1.50 handle versus the USD but that the reality. A stronger currency bodes badly for the periphery in the eurozone, making economic recovery all the more difficult. The truth is that the strengthening of the EUR is far more negative than the recent rate hike by the ECB. Nonetheless, the currency continues to float on thin air.

However, weak dollar and Fed QE means continued strong capital inflows to Asia, stronger Asian currencies and more diversification by Asian central banks as they soak up USDs via intervention and then diversify into other currencies, benefiting the likes of the EUR and AUD in particular. Unfortunately for the USD there is not much to deter this trend currently.

The US dollar has managed to gain a temporary reprieve as risk aversion increases in the wake of more aftershocks in Japan and an intensification of nuclear fears, with Japan upgrading the level of the nuclear threat. Overall though, pressure on the USD is unlikely to ease quickly given the relatively dovish Fed stance relative to other central banks.

The ECB’s policy rate hike last week highlighted its contrasting stance with the Fed, solidifying support for the EUR. However, its worth noting that markets have already priced in two more 25 basis point rate hikes in the eurozone. This suggests limited upside potential for the EUR unless the ECB becomes even more hawkish, something that seems unlikely. Given the FX market’s attention on yield and interest rate differentials, this week’s inflation releases in the US, Europe and UK as well as various Fed speakers will provide direction.

The USD may have been helped by the 11th hour US budget agreement at the end of last week, which barely avoided a government shut down. Any relief may prove to be temporary however, given that there is still major disagreement between Democrats and Republicans over medium to long term deficit reduction plans. Ultimately in the worst case scenario this may manifest itself in a failure to increase the US debt ceiling if an agreement is not reached by mid May.

Portugal will remain in the spotlight following the country’s request for an European Union bailout. This week officials from the ECB, IMF and EU will be in the country to begin discussions on the terms and size of the aid package, with estimates ranging from EUR 80-90 billion. FX markets have largely taken news of a Portugal bailout in its stride, but EUR/USD will continue to struggle close to the 1.45 level.