Euro Slightly Down, Swissie Gets a Boost

• NZD Trade balance better but carry unwind continues
• JPY Manufacturing PMI higher but earnings don’t keep pace
• EUR ESI slightly lower, German unemployment, Retail sales improve
• CHF KoF much better than expected
• USD GDP, Chicago PMI, FOMC all ahead

Yen saw some very mild carry trade liquidation as German Finance Minister Steinbrueck stated that a strong euro remains a risk, triggering off speculation that Euro-zone officials are not going to sit idly by at the upcoming G-7 meeting if the EURJPY rate continues to hover near the 158.00 level. In overnight data from Japan the news once again showed weakness in the labor sector as labor cash earnings declined –0.6% versus 0.6% expected gain. The drop was the biggest decline since August 2005 and continues to suggest that Japanese economic growth remains decidedly skewed towards capital rather than labor. Nevertheless, as we noted yesterday, the yen has become almost inured towards bad news as the pair finds tremendous resistance beyond the 122.00 level especially on fears that G-7 officials will not tolerate a much weaker yen regardless of the country’s underlying fundamentals.
In EZ the news was generally positive with German retail sales and unemployment both beating expectations by a wide margin, but the data was from December – before the increase in the VAT taxes - so players took the news with a grain of salt. Overall, retail sales were still down –0.3% quarter on quarter basis, but this slowdown was anticipated and should have no impact on EZ monetary policy going forward. For the most part most traders continue to expect another rate hike from the ECB in March, and that sentiment largely underpins the support for the euro and helps explain the tug-of-war price action in the pair.
While attention today will clearly turn to the FOMC statement from the Fed, the fact of the matter is that even under the most optimistic scenarios the Fed is likely to only maintain its hawkish bias rather than actually raise rates in the foreseeable future. To do so would risk tipping the badly damaged housing sector from a slowdown into a full blown recession. Despite the recent bounce in New Homes Sales, the underlying trends in housing remain weak with foreclosures continuing to rise and homeowner vacancies rates reaching record highs. We believe that these factors will prevent the Fed from actually hiking rates, unless US economy produces surprisingly strong growth results, materially above 3.00%. Only in this case, will the Fed consider resurrecting its tightening policy which it terminated in August of 2006. Thus, given the expectation that ECB will raise rates further while the Fed will not, the interest rate compression between the euro and the greenback should provide support to euro longs at the 1.2800-1.2900 zone.
Finally, Swiss KoF index of leading economic indicators printed much stringer than expected with the month prior data also revised upward. The downtrodden Swissie which has suffered from carry trade flows much like the yen, should get a boost from tonight’s data. The market continues to believe that the SNB will lag the ECB in rate hikes this year, much like it did in 2006, We, on the other hand think that the SNB will match the ECB rate hike for rate hike this year, neutralizing any further carry trade advantage for the euro. There fore, the EURCHF cross, which just tonight made yet another yearly high may be due for a retrace.