Carry Trade Remains King as EUR/JPY Soars to Another Record High

• Carry Trade Remains King as EUR/JPY Soars to Another Record High
• Dollar - Sharp Rise in Import Prices Suggest Upside Risk to PPI
• Commodity Currencies Rally on Strong Economic Data

US Dollar
The demand for carry trades and yield is showing no signs of abating as traders remained focused on buying the currencies of countries that still plan on raising interest rates. This is why the US dollar has weakened across the board despite a sharp increase in import prices and a strong chain store sales report. This weakness could be partially blamed on the rise in jobless claims, but at the moment, the labor market is not something that traders are all that worried about. Jobs are plentiful so people have the income to pay their mortgages and the chain store sales indicate that they are spending. In other words, disaster is averted for the time being. We are keeping an eye on corporate earnings however as the warning by Wal-Mart and cost cutting by Citigroup suggests that either the first quarter was difficult for companies or they expect harder business conditions in the second quarter. Looking ahead, tomorrow we have the most important US data due this week, which are the Trade Balance, Producer Prices and the University of Michigan consumer confidence report. The current forecasts indicates that analysts are expecting the reports to be dollar negative, but the fact that import prices doubled expectations indicates that we could see faster growth in producer prices during the month of March. The trade deficit is not likely to be much of a market mover even though it is predicted to rise since the market will be focused on looking for inflation to confirm or deny the Federal Reserve’s intent to leave interest rates unchanged.
Just as the market expected, the European Central Bank left interest rates unchanged at 3.75 percent. Notably absent from ECB President Trichet’s commentaries were the words “strong vigilance.” Instead, he said that interest rates remain accommodative and given their optimistic outlook for growth and their belief that inflation will continue to remain high, they will need to act in a firm and timely manner.
The last few times that Trichet used the words “firm and timely manner” without the words “strongly vigilant,” rates were not increased in the following month. So basically, the central bank head is telling us that he will most likely postpone the rate hike to June. When pressed for an answer on whether a June rate hike would be their last, Trichet simply said “we will see when the time comes.” If the Euro continues to rally we still believe that it will be very difficult for the ECB to raise rates again. However, for the time being, by not closing the door on taking rates beyond 4 percent is enough for the market to run out and buy Euros. This demand took EUR/JPY to a fresh record high and the EUR/USD to a new 2 year high. The technical and fundamental break in the currency pair puts the odds in favor of a test of the December 2004 1.3667 high. Remember, yield is king and with one guaranteed rate hike and the possibility of another, the Euro has wind behind its back.
British Pound
The British pound is stronger against the US dollar but interestingly enough, weaker against the Japanese Yen and Euro. Economic data is not likely to blame as the larger trade deficit was met by stronger growth in house prices. What did do the pound in were the comments from the UK Treasury. Yesterday’s sharp rise in the currency was driven by speculation that the UK Treasury was discussing a proposal to allow UK firms to repatriate some of their international profits tax free. We had warned that it was “only being discussed and has not been passed by the Treasury at the moment, so it could be some time before we actually see the flow.” Today, the Treasury responded by saying that any similar changes would not have an impact on revenue and indicated that this was something they have been discussing for some time. Things like this are not decided on a whim and the market will soon forget about it until the change is official.
Japanese Yen
The one driving force behind the yen crosses is carry and yield. AUD/JPY, EUR/JPY, and CAD/JPY are continuing to press higher as the rallies become more and more over extended. ECB President Trichet actually commented on the Yen at his press conference by saying that the currency should reflect fundamentals. This caused a brief correction in the yen crosses before traders quickly swooped in to lay on more carry trades. The higher the Yen goes before the upcoming G7 meeting of finance ministers and central bankers in Washington, the greater the likelihood that the Japanese may not escape being criticized about the currency’s weakness. Most likely, this will occur unofficially in sideline discussions. With the US on this new plan to crack down on China’s unfair trade practices, do not be surprised if we hear some critical comments about the Yuan as well. China has actually made an excuse to not attend the meeting, so they will not be there to defend themselves.
Commodity Dollars (AUD, NZD, CAD)
The Australian, New Zealand and Canadian dollars are stronger against the US dollar today thanks to solid economic data. Australian labor market data was strong. Even though the headline number fell short of expectations with only 10k jobs created last month, compared to a consensus forecast for a 5k rise, full time employment was much stronger than expected, rising by 31.7k. The unemployment rate also dipped to 4.5 percent, the lowest level in 32 years. New Zealand business PMI also jumped from 54.0 to 57.1 while Canadian housing starts surged by 0.5 percent in the month of February. Oil prices broke higher today, which also helped to fuel solid gains in the Canadian dollar. Looking ahead, New Zealand will be releasing retail sales tonight while we expect trade data from Canada tomorrow.