Dollar rallies on unresolved euro problems; asset markets trade listlessly

Tom Tong23/May/2011Currency Updates

Asset and currency markets experienced a week of indecisive trading last week. The failure of the year-old Greek bailout, the inability of euro officials to agree on the next steps, and the deepening fears of contagion towards Spain and Italy only managed to force the euro to give up its early gains and end the week unchanged.. The resilience of non-European equity markets and commodities on the face of the deepening euro crisis is quite remarkable, and a testament to the asset-lifting power of ultra-easy monetary policies everywhere in the developed world.


Last week brought another upward surprise in the UK inflation rate. YoY headline inflation jumped to 4.5%, against expectations of 4.1%. More significantly, core inflation also rose to 3.7%, contrary to consensus expectations that saw it remaining stable at 3.2%. Given that wages are growing nearly 2 full percentage points below these levels, it is little surprise that consumer demand in the UK remains subdued. However, as gilt yields remain below the level of headline inflation across the curve, these inflation levels are slowly eroding the national debt burden, so they cannot be regarded as wholly negative. Going forward, the main question remains whether subdued demand and economic slack will bring inflation levels down towards the target, as the Bank of England expects. However, with the European outlook deteriorating, we do not expect a change in the BoE dovish tilt, which should be negative for sterling vs. the dollar.


The common currency had a surprising trading week. It was able to shake off all the known (and worsening) troubles that plague it until Friday, where it peaked to nearly 1.4350, up nearly three full figures for the week. However, the unrelenting stream of bad weeks regarding the Greek situation took its toll that day. A year after it was launched, the Greek bailout has proven a failure. The Greek economy is in free fall, its Government is unable to meet revenue targets, and still its bonds trade at much lower levels than before to the bailout, discounting a default as a near certainty. Worst of all, perhaps, is the deepening sense of disarray among the European leadership. ECB officials stubbornly cling to the notion that default can and must be avoided, and Trichet actually stormed out of a high level meeting in protest that a Greek restructuring was being discussed. European political leaders are increasingly unwilling to continue indefinitely bailing out private Greek creditors at par, but are apparently at a loss as to how to deal with the ECB threat to bring down the Greek banking system if the debt is restructured. Meanwhile, peripheral spreads continue to widen. Given this, it is actually surprising that the euro managed to close the week more or less unchanged, in spite of Friday’s dramatic sell off.


It was a quiet week in US markets. Macroeconomic news was mostly second- and third-tier, and the minutes of the last Federal Reserve meeting contained no major surprises. It is, however, noteworthy that the Fed is discussing the exit process from its extraordinarily accommodative policy stance, although the minutes were also at pains to reassure that such discussions did not imply anything about the timing of such exit. With major domestic drivers absent, the dollar mostly followed risk appetites and news from Europe all week, selling off through early Friday, when news of the deepening disarray in Europe buoyed it to end the week slightly higher.


Written by Tom Tong

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