Dollar undermined by lower yield

Risk assets in general appear to have gained traction on the basis that central banks will maintain or expand highly accommodative monetary policies via further asset purchases and balance sheet expansion. The Federal Reserve and European Central Bank will likely provide more fuel to the fire this week, with the former set to maintain its policy settings including USD 85 billion in asset purchases while the latter is set to cut its policy refi rate by 25bps to 0.50%.

Weaker data into Q2 in the US (and the softer than expected reading for Q1 GDP annualised 2.5% QoQ pace revealed last Friday) effectively seals the case for maintaining ultra easy policy at least until later in the year when the Fed is set to taper off asset purchases. As for the ECB are mere rate cut may not be sufficient with attention on any prospects for non conventional easing and rebuilding the monetary transmission mechanism.

Weekend news in the Eurozone was positive, with Italy finally forming a government following two months of deadlock but the week should begin quietly with holiday in Japan and China. In any case market activity is set to be limited ahead of central bank policy decisions and the US April jobs report at the end of the week where a 150k increase in payrolls.

As the US Q1 GDP report revealed the impact of the Sequester via massive spending cuts is increasingly biting into growth and while expectations of ongoing monetary accommodation is helping to buoy markets, growth recovery will need to strengthen to justify the current optimism built into markets. At least there is some realisation, finally in the Eurozone, that recovery may need to be reinforced with less austerity.

FX market activity will remain hesitant ahead the key events this week but overall it appears the USD will lose further wind out of its sails especially as US bond yields continue to drop. The US 10 year Treasury yield dropped to is lowest level this year, a factor that has particularly undermined the USD against the JPY where a failure to test the 100 level has also contributed to a drop in the currency pair. A test of USD/JPY 100 is off the cards unless and until US yields rise again. Lower US yields are helping EUR/USD to stay above the 1.3000 level although this is being mitigated by the fact that German 10 year bund yields are also declining.

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