Dollar Reprieve

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.

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