Weekly Treasury Update

US Dollar

 

There has been a cooling of expectations surrounding an imminent Federal Reserve move to taper bond purchases, especially after the weak manufacturing PMI reading. Confidence will erode further if there is a weaker than expected payroll report.

The US economy is still well placed to out-perform Europe which will offer some degree of protection. The Fed may also decide it has to act soon given the risk of even more serious market distortions if aggressive bond purchases continue. There will also be underlying dollar support if there is a further outflow of capital from emerging markets.

After a robust start to the week, there was a sharp dollar decline over the second half of the week with a reversal of May gains and sharp losses against the yen.

The US ISM manufacturing index release which fell to 49.0 for May from 50.6 previously. This was only the third sub-50 reading in four years and the lowest since June 2009. There was also disappointment surrounding the main components as employment was barely above the 50 level while orders contracted.

The latest US ADP employment report was weaker than expected with a 135,000 increase in jobs for May from a revised 113,000 the previous month. With government payrolls consistently falling this year and a potential negative impact from sequester, there were concerns surrounding a weaker than expected payroll report on Friday. There was some relief surrounding the ISM non-manufacturing index with an improvement to 53.7 from 53.1. There was, however, disappointment surrounding the employment component.

The Fed’s Beige Book reported modest to moderate growth in most districts with Dallas reporting a strong expansion. The construction sector remained strong all round and the labour market was also improving despite major regional variations.

The US currency remained vulnerable to position adjustment and a squeeze on long positions. Volatility surged later in the New York session on Thursday with the dollar being subjected to heavy selling pressure, notably against the yen.

 

Euro

 

The Euro was mixed against major currencies overall, but it did advance strongly against the dollar with a three-month high above 1.32. There was some disappointment surrounding the latest Eurozone data as the final services-sector PMI index weakened slightly to 47.2 from the flash reading of 47.5, in contrast to an improvement seen in the manufacturing release. There was also a larger than expected 0.5% declines in retail sales which did little to improve confidence, although the overall reaction was limited.

As expected, the ECB left interest rates on hold at 0.50% at the latest council meeting with the main focus on Draghi’s press conference. The ECB President remained generally downbeat of growth prospects, repeating his concerns that growth risks were to the downside while inflation expectations were well-anchored. He also made reference to a lack of reform measures by national governments and the bank remains extremely anxious to keep pressure on politicians.

Most attention focused on his comments surrounding negative interest rates, Draghi made clear that the ECB was technically ready to implement negative rates if required, but he saw no need for the bank to act at present and the underlying tone was more confident as he praised the OMT programme. The rejection of further measures at this time and no real hint of any further short-term shift in policy triggered fresh a further adjustment of yield expectations which supported the Euro.

Range for previous week: $1.2954 – $1.3304

Range for this week: $1.3060 – $1.3410

 

Sterling

 

Sterling appreciated for the first week in six against the euro. It rallied to the strongest level in more than three months versus the greenback, as the US currency dropped versus all but two of its 16 major counterparts. UK  government bonds fell for a third week after Bank of England policy makers kept stimulus measures unchanged at Governor Mervyn King’s final meeting.

The UK 10-year yield climbed seven basis points, or 0.07 percentage point, in the week to 2.07%. The price of the 1.75% bond due in September 2022 declined to 97.325.

As expected, the Bank of England left interest rates on hold at 0.5% and the amount of quantitative easing was also unchanged at £375bn at the latest meeting. The unchanged policy did support Sterling as it held close to 0.85 against the Euro and continued to gain ground against the fragile US dollar. Sterling spiked higher to a peak above 1.56, matching April highs, as the dollar was subjected to wider selling.

Sterling maintained a robust tone during the week with a firm tone on a trade-weighted basis with significant gains against the US currency. The latest PMI manufacturing data was stronger than expected with an increase to 51.3 for May from a revised 50.2. This was a 14-month high for the index which boosted confidence with the UK data stronger than the US and Eurozone equivalent releases. The construction PMI index to 50.8 from 49.4, the first reading over 50 for six months as residential construction picked up.

The PMI services-sector index was stronger than expected, rising to 54.9 for May from 52.9 previously, the highest reading since April 2012. The data reinforced a slightly more optimistic tone surrounding the UK outlook with all PMI indices stronger than expected. In response, there was reduced speculation that the Bank of England would make any move to expand quantitative easing at the latest MPC meeting due on Thursday, the final  meeting chaired by Governor King.

Range for previous week: $1.5187 – $1.5683

Range for this week: $1.5310 – $1.5750

 

Yen

 

The yen gained strongly during the week as a sharp drop in the Nikkei index triggered an unwinding of short yen positions. Prime Minster Abe pledged that the government would push ahead with reform measures to boost growth.

There was a lack of specific measures and, after moving lower ahead of the speech, there was a sharp reversal later in the Tokyo session with the yen gaining support as the Nikkei index was subjected to renewed selling.

The latest capital account data recorded another weekly net repatriation to Japan with net inflows of ¥1173bn from ¥1117bn the previous week. Previous yen selling had been based on expectations of substantial capital outflows, but the data has again not backed-up these expectations.

The dollar was subjected to further sharp selling pressure on Thursday. There was a slide to the 98.50 area with an election of stops triggering a sharp move. The rate of selling accelerated rapidly later in the US session with a temporary slide to lows below 96 on position liquidation, the sharpest daily decline for over two years.

PUBLIC: Monetary policy will remain highly expansionary in the short-term as the government and Bank of Japan continue to battle against deflation. There will be important unease surrounding instability within the bond market which will demand some degree of caution surrounding monetary policy. The capital-account trends will be watched very closely and the yen will gain some support if there is still no evidence of significant outflows.

The Japanese currency is unlikely to make strong gains given the underlying monetary policies.

Range for previous week: ¥ 95.02 – ¥ 100.72

Range for this week: ¥ 96– ¥ 101.10