Jordan Michaelides | Currency Analyst

There’s no doubt that investors are aware of the inverse relationship between Fed QE rhetoric and US Dollar sentiment. In recent weeks we’ve seen the full effect of the ironic banter, from the Hawks, Doves, Owls & Seagulls combined, drastically rallying confidence in the USD and indeed US markets overall.

The sudden outbreak in confidence would suggest then that this week’s Non-Farm Payrolls appears to be the dollar’s moment of truth, and the elephant in the FOMC board room – as to the likelihood of the taper actually occurring. The problem that stands out for Bernanke, and indeed for all Doves, is their lack of foresight and use of economic indicators currently at their disposal – potentially putting markets into a daze with the spell of monetary easing and Central Banker optimism.

The Bank of International Settlement’s Quarterly June Review suggested that risk assets have “extended their rally due to further monetary easing”, not positive economic data, accordingly helping markets tune out the sign of global growth slowdown.

This was reaffirmed by a plethora of US data including recent Chicago ISM Manufacturing Index coming to its lowest point since 2009 (49.0 vs. 50.7 expectation), the largest decline in Mortgage Applications since June 2009, with the S&P500 falling over 4% since May 22nd.

Furthermore, we see the Wall Street Journal identifying that Michigan’s Governor Rick Synder appointing a state represented emergency manager, calling on unions, pensions, creditors and bondholders to a meeting in mid-June to have a “mature and sober discussion”. This all screams out that the if the taper, with a strong emphasis on the if, was to occur by the year end, the US economy would be dealing with a monumental fiscal drag, possibly even deflating.

The Hawkish Dallas Fed Head Richard Fisher was candid in his interview with Money News reporting that the taper must occur sooner rather than later though, as the market can no longer expect “monetary cocaine” and continual can kicking . He reiterated that QE has done little to help the economy, and poses a great risk to doing greater harm – the opposite of Bernanke’s intentions. The response from high profile Doves Bernanke, Yellen, and Dudley was nigh on mute.

What then, could be the potential repercussions for the USD, and more broadly Australian markets on negative NFPs? A less than inspiring print is unlikely to create a bad news is good phenomena, given the fact of “taper” banter proceeding most of last week was the only likely factor spurring USD demand, and has seemingly reverted to “good means good”.

Our fair-value recommendation of a 0.9850 AUDUSD suggests that anything lower than last month’s 165,000 – would spurn a gradual flow back into the Aussie. With the most obvious lesson to be learned that the stock market, and Central Banker rhetoric, is not a barometer of the economy.

However, this short term gain wouldn’t suggest a long term investment; with increasingly worrying data coming out of China and indeed Australia. As particularly highlighted by the Bureau of Research and Energy Economics report on the mining sector, lagging GDP, and a manufacturing and retail industry clearly in recession.

Australia’s GFC invincibility is slowly unwinding as the data flows in, and our mining boom lifeline is used; how the RBA reacts will have nil consequence to our dollar, as our AUD changes moves with the ebbs and flows of Fed/Dollar.

The Pacific Peso goes Loco

Whatever way you view it, the Aussie’s days of heady highs above parity are all but a distant memory. Gone are the calls of $US2 so boldly heralded by a few headline-chasing analyst, and back in are the equally bold calls of a cataclysmic slide. The last month or so has seen the Aussie break out of its near-12 month range either side of the circa 103.5 US cent levels and looking decidedly vulnerable around the 95-handle. While we can of course attribute some of the Aussie’s lost sheen to domestic factors, it’s no coincidence the Aussie’s decline has come at time of heightened conjecture over the Federal Reserve’s quantitative easing plans.

Up until recently, the U.S dollar’s innate aversion to stimulus has of course led to significant spike in demand for the high beta spectrum, for which of course was a win/win for the Australian dollar given its yield advantage and perceived safe-haven attributes. Now the game is changing and the greenback is intermittently reverting to its traditional ‘good news is good’ fundamentals. But the key question remains, have QE-sensitive markets overpriced the potential for the Fed to hit the skids on QE? As far as markets are concerned, this evenings Non-farm Payrolls will hold the answer. Overnight we saw a bought of U.S dollar weakness as markets begin to position for a less-than-inspiring result. While this should act to moderate market moves should the data indeed fail to inspire, it’s clear there remain a fair portion of US Dollar-positivity based rhetoric pouring out of the Fed. It would seem the unprecedented amount Fed comment from every Fed women, man and their respective dogs has led to more confusion then clarity and until Bernanke and Co finally pull the pin and ease off on some 85 billion of monthly asset purchases, the seemingly never-ending ‘price discovery phase’ will continue.

As expected, the latest U.S payroll data provided the direction for currencies on Friday.  According to the Bureau of Labor Statistics, the U.S economy created 236,000 jobs in February, in excess of the 165,000 estimated. The finer points of the data showed gains in professional and business services, construction, and health care. January’s net growth was revised down to 119,000 from the originally reported 157,000. The official unemployment rate fell to a 4-year low of 7.7 percent.

The question on everyone’s lips is of course how does stronger jobs growth change the Fed’s outlook? And does it add weight to the case for the FOMC to scale back asset purchases sooner than anticipated? While it may strengthen the case brought forward by those Fed hawks advocating a gradual unwinding of stimulus, we’re likely to see more guarded optimism from the dovish – and highly influential – end of the board, Bernanke and Yellen.

In a speech last week, Vice Chair Janet Yellen – and likely successor to Chairman Ben Bernanke – defended the Fed’s easing initiatives, noting: “At this stage, I do not see any that would cause me to advocate a curtailment of our purchase program.”

Nonetheless, market reaction in the ensuing period of Friday’s NFP’s (and other outperforming data in recent weeks) suggests investors are quietly recalibrating Fed stimulus expectations. While in recent years an event such as Friday’s jobs data may have induced a risk rally (U.S dollar weakness), we judge U.S dollar strength as indicative of growing expectations the Fed will begin to curtail some $US85 billion in monthly asset purchases sooner than previously thought.

On the assumption the U.S dollar retains its ability to rally in times of market turmoil and strengthen on outperforming (top-tier) data, we see conditions broadly in its favor. There is however a case to suggest markets may have suitably priced-in chances of an early than expected scaling back of asset purchases, which will no doubt be tested in the week ahead with a few key releases on the docket. In turn, it would be wise to expect more moderate appreciation from the greenback should data continue to point to stronger economic conditions, especially in light of the uncertainty surrounding the sequestration.

Whatever the case, the days of a uniform ‘risk-on/risk-off’ response to key data and global themes have made way for a far more complicated set of directives, with Fed easing expectations front and centre.

U.S Data points of interest

Tuesday – U.S Monthly Statement

Wednesday – Advance Retail Sales | Business Inventories

Thursday – Current Account Balance | Producer Price Index | Weekly Jobless Claims

Friday – Consumer Price Index | Industrial/Manufacturing Production | University of Michigan Consumer Confidence

Aussie at the Fed’s mercy; Unemployment data in frame

Friday’s reaction to the U.S non-farm payrolls release serves as an important reminder of just sensitive risk currencies are to U.S stimulus. In years gone by outperforming non-farms may have induced a flight to high-beta assets and currencies like the Australian dollar, however, ‘good news’ is sometimes bad when you take into account the Fed’s quantitative easing efforts. Friday’s flight to the U.S dollar after the solid payroll numbers suggest markets are slowing acknowledging the Fed’s potential for the scaling back asset purchases.

While it may be premature to expect sustained weakness from the Aussie dollar based on this alone, its apparent Fed stimulus has underpinned the Aussie’s ascent, and will eventually be a catalyst to pave the way lower. Instead of benefiting from a risk induced rally, the local unit hit the skids after the U.S jobs reports, settling around half a cent lower by the close.

Still, the local unit fared better than its major counterparts, forging fresh 4 – 1/2 highs against the Yen and 28-year highs against sterling.  For this we can attribute to a two-fold effect of both Yen and Sterling weakness, while the Aussie retains both its yield advantage and safe-haven properties as a currency tied to a fundamentally sound economy.

Expectations the RBA will continue easing through 2013 have also abated. As of Friday just 24-percent of the market expects Governor Stevens and Co will slice another 25bps off the official cash rate in April.

The Aussie has opened on the back foot this morning in very thin volume following inflation data out of China over the weekend showing stronger than expected consumer prices growth amid weaker industrial output and retail sales. Inflation grew 3.2 percent annually in February according to the government release, a significant increase from 2-percent in January. Economist’s estimates showed expectations of around 3-percent growth on year.

Although recent feedback from hardly suggest the economy is falling off a cliff, it’s clear the government remains in the delicate situation of balancing efforts to promote stronger growth without igniting inflation.

While trade data on Friday show a surprise surplus, the imports component of the index fell well short of expectations, suggesting a material short-fall in domestic driven demand.

The local economic highlight this week will be Thursday’s jobs data which is expected to show the economy added 10,000 jobs in February with the unemployment rate edging up from 5.4 to 5.5 percent.

Australian Data points of interest

Tuesday – NAB Business Conditions/Confidence | Westpac Consumer Confidence

Wednesday – Home Loan Activity

Thursday – Employment Change / Unemployment Rate

Global market moves resembled a moderate risk-on environment overnight, with the Euro recovering after a recent slump, while the U.S dollar slipped against major counterparts with exception of the Yen.

Although we’ve seen moderate weakness from the greenback overnight, we consider broader conditions favorable for further strength. Intermittent bouts of strength have been noted around solid economic feedback, which suggests a tentative return to traditional fundamentals where the dollar can rally on good news. For this we continue to look to the greenbacks relationship to the Fed’s asset purchase program.

As noted in yesterday’s report:

The greenback is in the unique position of attracting demand in two very different types of market environments. On one hand the U.S dollar retains its safe-haven attributes which can intermittently strengthen its appeal in times of adversity, while positive economic signposts have broadly worked in the dollars favour as markets attempt to define how long the fed will maintain extraordinary levels of economic stimulus. Should the data pulse continue to materially outpace expectations, we’re likely to see intermittent bouts of greenback strength as markets continue to ponder when the Fed will begin scaling back on asset purchases.

In economic news overnight, the number of U.S citizens applying for unemployment benefits fell to a six-week low of 340,000 for the week ending March 2. This comes as data on Wednesday showed a pick-up in private sector hiring, with the ADP employment gauge showing 198,000 new jobs added in February, in excess of the 170,000 expected. January’s growth originally reported at 192,000 was also revised to 215,000. The out-performance from the weekly jobless claims and ADP report are a particularly good precursor to Friday’s official employment report.

As widely anticipated, the European Central Bank kept their main refinance rate on hold at 0.75 percent overnight. The Euro bounced following ECB President Mario Draghi’s post decision address, who noted although the topic of interest rate cuts was on the agenda; the prevailing consensus was to remain on the sidelines. The Bank also expects a gradual recovery through the later part of 2013 with a balance of accommodative policy and improving global conditions expected to broadly benefit the Euro-region.

Across the Channel, the Bank of England also kept interest rates on hold at 0.50 percent with no change to the asset purchases program which is currently valued at GBP375 billion.

True to form, the most pronounced moves came from the Yen which fell across the board as investor’s unwound long exposure after the recent corrective phase.  The greenback slumped against the Yen with the USD-JPY pair peaking above the 95 region for the first time since August of 2009. We also saw notable moves from the EUR-JPY cross which acted to provide some residual weakness for the Yen across the board.

The Aussie dollar crawled higher overnight coinciding with stronger equities from both sides of the Atlantic while residual support from the Euro kept the balance of risks to the upside. Yesterday’s larger than expected trade deficit failed to spur any sustained selling on the Aussie with short-term losses quickly unwound in the hours to follow.

In the absence of any top-tier releases locally, markets will be focusing trade data from China on the docket at 1300 AEDT. Traders are bracing for a slump in both import and export activity with a trade deficit of $US6.95 billion expected in February, from a previous surplus of $US29.15 billion.

At the time of writing the Australian dollar is buying 102.7 US cents.

The U.S dollar continued its solid run overnight as investors looked to signs employment is steadily improving, amid further milestone highs from U.S equities.

The ADP employment gauge showed 198,000 new jobs added to the private sector in February, in excess of the 170,000 expected. January’s growth originally reported at 192,000 was also revised to 215,000. The out-performance from the ADP report is a particular good sign ahead of Friday’s official employment report and may also suggest concerns surrounding the impending budget cuts have failed to discourage U.S businesses from hiring.

The greenback is in the unique position of attracting demand in two very different types of market environments. On one hand the U.S dollar retains its safe-haven attributes which can intermittently strengthen its appeal in times of adversity, while positive economic signposts have broadly worked in the dollars favor as markets attempt to define how long the fed will maintain extraordinary levels of economic stimulus.

Should the data pulse continue to materially outpace expectations, we’re likely to see intermittent bouts of greenback strength as markets continue to ponder when the Fed will begin scaling back on asset purchases.

Still, there remains a level of confidence the Fed will not suddenly scale back ultra accommodative stimulus measures. Vice chair of the Fed, Janet Yellen defended the Fed’s stimulus initiatives in a speech earlier this week, noting: “I view the balance of risks as still calling for a highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment.” Adding, “at this stage, I do not see any that would cause me to advocate a curtailment of our purchase program.”

In short, there are a series of factors at play, and while we view feedback from the top echelons of the Fed as broadly dovish, markets continue display a willingness to look further into the future.  The future is of course tighter policy from the Fed, implying the scaling back of quantitative easing as the economy regains composure.

This phenomenon (of solid U.S data translating to a stronger greenback) has been broadly negative for currencies generally considered to get a leg-up in ‘risk-on’ environments. In particular, the kiwi and Aussie dollars recorded moderate losses, and the Euro resumed a downward trajectory below the $US130-figure.

Australian dollar

At the time of writing the Australian dollar is buying 102.3 US cents and we judge a broad band of supportive behavior from 102 US cents and above to contain losses in the domestic session. Trade balance is coming up at 11.30 am which is expected to show a deficit widened to A$500 million in January, from a previous 427 million. Local markets will also be watching for feedback from the Bank of Japan as their two day monetary policy meeting finishes today.

The Aussie dollar slumped to near 8-month lows yesterday following wide-spread concerns efforts by China to curb property speculation will come at the expense of growth in the region. Selling accelerated as traders chipped away at key technical support 101.5, in turn encouraging further downside before bottoming out at 101.14 US cents.

Regional investors also got their first chance to react to Chinese data released over the weekend which showed the official Services PMI fell to 54.5 in February, down from 56.2 in January. This followed data last week which showed manufacturing growth eased in February with both the official and HSBC PMI gauges slipping closer to the ‘50’ levels, which divides expansion from contraction.

Yesterday’s building approvals fell 2.4 percent in January, short of expectations of 2.8 percent growth. Still the yearly rate beat estimates with previous upside revisions moderating the negative monthly rate, including a 3.2 percent increase in private sector approvals.

The Aussie began to slowly regain composure after yesterday’s lows, with moderate strength from U.S equities paving the way for a slow grind higher. Stimulus addicted U.S markets are responding favorably to any suggestion from key Fed officials the central bank will not be unwinding accommodative policy any time soon.

Vice chair of the Fed, Janet Yellen defended the Fed’s stimulus initiatives overnight, noting: “I view the balance of risks as still calling for a highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment.” Adding, “at this stage, I do not see any that would cause me to advocate a curtailment of our purchase program.”

In short, we view this as the Fed’s (inadvertent or otherwise) weak dollar policy remains intact.

We also note a small bounce across the risk spectrum after the release of the ISM New York business conditions index, which rose to an 11-month high.

AUD looks to the RBA to define the trend

It’s a big day for local markets with the RBA policy decision headlining at 1430 AEDT. Before than market will watching closely some mid-tier releases with Retail Sales, Current Account and HSBC services PMI on the docket.

Today’s policy decision is widely expected to see Stevens and Co hold benchmark interest rates steady at 3-percent, and true to form the ensuing statement will be the market mover.

While today’s statement may re-iterate the RBA’s scope to make further reductions to the official cash rate, we anticipate an overall tone of neutrality given some headway has been made in rejuvenating non-mining sectors of the economy. However the statement may also highlight challenges to the domestic economy given renewed concerns from the Euro region and the flow on effect of budget cuts in the United States. We also expect the statement will delicately respond to the latest Chinese growth concerns. At the time of writing the Australian dollar is buying 101.85 US cents.

The Australian dollar finished the week on the back foot, weighed down by a series of global themes with Euro region concerns front and centre. The Aussie’s correlative behavior with all things China saw the local unit suitably dragged lower after the official Chinese Manufacturing PMI and the HSBC equivalent fell in February, albeit remaining in expansion territory. Moderate strength from U.S equities provided a tug-of-war effect on the Aussie, with the US dollar well bid across the board after solid ISM manufacturing data, but ultimately support for the local unit at 101.8 US cents contained selling pressure for the second time in the week.

Still, around 1-percent was sliced off the AUD-USD rate over the week and with Chinese concerns back in the frame and the Euro region back on the blacklist, the reasons for to be long of Aussie dollar’s appear to be getting fewer by the day. Nonetheless, there remains valid reason to expect resilience. It could be argued markets have overpriced the potential for the RBA to take the cash rate lower and although the current inflation pulse affords the bank the necessary “scope” to do so, some brightness in the non-mining sectors of the economy appear to be shining through with house prices seemingly back on the rise.

This week we’ll get a glimpse of how the RBA sees it with the March policy decision on Tuesday’s docket.  In his recent parliamentary testimony, Governor Glenn Stevens once again displayed a willingness to sit on the sidelines until previous cash rate reductions have fully infiltrated the broader economy, noting, “Overall, there is a good deal of interest-rate stimulus in the pipeline.”

Tuesday’s statement should likewise resemble the same neutrality; with renewed concerns surrounding the fortunes of the Euro region likely to be offset with guarded optimism as previous revisions to the cash rate infiltrate the broader domestic economy.

In early trade (and extremely light liquidity) the Aussie has opened just below the 102 US cents with investors getting their first chance to react to Chinese data released over the weekend which showed the official Services PMI fell to 54.5 in February, down from 56.2 in January.

Australian data points of interest

Monday – TD Securities Inflation Gauge | Building Approvals | ANZ Job ads | AiG Performance of Service Index

Tuesday – Current Account Balance | Retail Sales | RBA Policy Decision | HSBC Services PMI (China)

Wednesday – Gross Domestic Product | AiG Performance of Construction Index

Thursday – Trade Balance | RBA FX Reserves

Friday – Trade Balance (China)

USD looks to U.S jobs for inspiration

A quick glance across recent price action shows the U.S dollar is responding positively to both negative risk trends and outperforming U.S data. At a basic level there are two major reasons for this, firstly, the U.S dollars safe-haven attributes will generally attract bids in times of adversity (such as renewed Euro region fears). Secondly, outperforming U.S data is viewed as helping the case for the Fed to begin gradually unwinding stimulus. Fed Chairman Bernanke appeared of allayed some of those fears last week by reiterating the benefits of unconventional stimulus measures such as quantitative easing, while not fanning the flames for QE-addicted markets. Still, with previous FOMC meeting minutes noting some members believe a gradual exit of such measures is warranted, markets are now looking at top-tier data points in the context of how soon the Fed will begin unwinding.

The week ahead will see one of the most important barometers of economic health with non-farm payrolls on the agenda, and judging by recent data releases, the U.S dollar may react in kind if the release materially exceeds expectations. The U.S labour market is expected to have grown by 155,000 in February from a previous 157,000. The monthly jobs release can however be extremely volatile and prone to previous revisions, which makes trading the release fraught with danger and complicated. The usual build-up should govern dollar demand beforehand with ADP employment change, Challenger job cuts and weekly jobless claims considered pre-cursors to the main event. Among smaller releases, other data points of interest this week include Factory Orders, the Fed’s Beige book and Consumer Credit

Euro vulnerable ahead of ECB

Take some political uncertainly, a few less than inspiring data points and subdued inflation, and suddenly the case for the European Central Bank to cut interest rates this week is all the more compelling. Friday’s round of less than inspiring data show Euro-Zone unemployment rate rose to a euro-era high of 11.9 percent in January, while a February inflation estimate fell to a yearly pace of 1.8 percent. While recent developments in the region may have been more encouraging, the theme of negative contagion has entered the vocabulary of global markets one again, and as usual investors are looking to the ECB for direction. While Mario Draghi’s ECB is unlikely to pull the trigger this week, it’s abundantly clear the bank has more scope (and reason) then in recent history to do so, therefore the topic is likely to be high on the agenda.

The Euro suitably priced-in a stronger chance of a rate cut on Friday, dipping below the 1.30 region for the first time since December last year – a move which could potentially see a deeper trough to 1.26-handle should political uncertainty escalate and a weaker data pulse ensue. Recent times have seen a considerable squaring of Euro shorts from the ‘break-up’ trade and global traders will no doubt be asking if there is any more ‘good news’ from the Euro region left to price-in.

European data points of interest

Monday – Sentix Investor Confidence | Euro-Zone PPI

Tuesday – Euro-Zone / German Services PMI | Euro-Zone Retail Sales

Wednesday – Euro-Zone GDP | Euro-Zone Household Consumption

Thursday – French Unemployment Change | German Factory Orders | ECB Policy Decision

Friday – German Industrial Production

Italy reignites Euro fears

Italian political dramas remained a key point of contention last week as global investors attempted to find some sort of stability amid political consternation. In a scene worthy of the Benny Hill theme, the balance of power is effectively held by Comedian Beppe Grillo’s Five Star Movement, with Berlusconi’s People of Liberty Party and Bersani’s Democratic Party, now required to form a coalition with Grillo (or each other) in order to form government. To make things even more interesting, Grillo himself cannot have a seat in Government due a manslaughter charge from a car accident in 1981, while Silvio Berlusconi is currently on trial for tax fraud and unlawful sex charges amid a host of other corruption allegations.

Whatever way you look at it, Italian politics is looking more like on the verge of a grand collapse, rather than the ‘grand coalition’ needed to bring their economy back on the straight and narrow. With Mario Monti’s technocrats now in political oblivion, you don’t need to be a virtuoso in Italian politics to work out the road ahead will be an arduous one, having the propensity to throw the whole of the Euro region back in the proverbial bog.  A highly fragmented Italian parliament will now return on March 15, with their first order of business likely to be to elect a head of state, with President Giorgio Napolitano’s term expiring on April 15, in yet another major uncertainty in the world of Italian politics.

U.S markets weighed up a mixed bag of economic reports with encouraging weekly jobless claims offsetting a weaker than expected revision of fourth quarter growth, while concerns surrounding budget cuts encouraged only moderate weakness late in the session.

U.S jobless claims fell to 344,000 for the week ending February 24, down from 366,000 the week before. The second revision on fourth-quarter GDP failed to meet expectations with growth revised up 0.1 percent, well short of the 0.5 percent growth expected.

After peaking at 1.3162 late yesterday, the Euro resumed its downward trajectory with Italian politics remaining an underlying point of contention. A weaker than anticipated core inflation print triggered further losses with price action now tentatively supported above $US130.50.  While headline consumer prices remained steady at 2-percent, underlying inflation fell to 1.3 percent in January from a previous and expected 1.5 percent. Although the data may not be enough to materially change interest rate expectations, it at the very least supports the case for further near-term easing from the European Central Bank. Comments by ECB President Mario Draghi overnight also suggest the bank is by no means looking for the exits as far as stimulus is concerned.

While the Euro remains vulnerable to further downside, European stocks were driven higher overnight as central banks from both sides of the Atlantic easy policy is here to stay for the foreseeable future. In his two-day testimony this week, Fed Chairman Bernanke gave  no indication the Fed will begin to unwind asset purchases, and markets have suitably re-calibrated expectations the Fed’s life-line will be unwound through the latter half of 2013. In short, the status quo of easy money has been maintained. The Euro STOXX index closed 0.83 percent higher on the day.

Japanese Yen eases on risk trends/BOJ nomination

Yen crosses resumed a slow crawl higher in response to slightly more favourable risk trends and the confirmation of the government’s nomination for the Bank of Japan top job. As widely anticipated, Japanese Prime Minister Shinzo Abe formally nominated Asian Development Bank President Haruhiko Kuroda as Bank of Japan governor. Abe also threw into the mix Kikuo Iwata and Hiroshi Nakaso as deputy governors. Markets will now focus on developments in parliament, with Abe’s nominations needed to be approved by both chambers before Kuroda, Iwata and Nakaso can be formally appointment. All are seen in some form as pro-stimulus allies of the government and expected to hit the ground running once taking the reins. At the time of writing the US dollar is buying 92.5 Yen, up from early week lows of 90.89 Yen.

Australian dollar awaits Chinese PMI

A swift drop in the ensuing period of yesterday’s CAPEX data was met with a flurry of buying activity with the investment intentions component of the index showing mining investment will remain a pillar of support for the economy through 2013/14. Still, residual weakness from the Euro and a late pull back from U.S equities have capped gains overnight and the time of writing the Australian dollar is under moderate pressure at 102.15 US cents.

We anticipated the official Chinese manufacturing PMI release at midday will be a key determinate for the Aussie dollar, followed by the HSBC equivalent at 12.45pm. There does appear a reluctance to carry the local unit deeper into the 101 figure, with respective lows of 101.82 and 101.97 seen through the week. We also note solid demand around 101.5 which should contain another corrective move lower should today’s manufacturing gauges come in short of expectations, but remain in expansion territory.

The greenback was weaker across the board overnight, with global investors seemingly less pessimistic over Italy’s political woes. Despite the threat of a lengthy period of political uncertainty in Italy, existing reforms put in place by existing technocrat government led by Mario Monti are expected to remain in place. Amid the political turmoil, Italy was to attract respectable demand for at auction overnight and investors are suitably encouraged by benchmark 10-yr yields managing to remain below the psychologically important 5-percent level. Still, we anticipate the theme of negative contagion will continue to place intermittent pressure on global markets in what could be months of political uncertainty in the region.

Euro recording respectable gains across the board with the most pronounced moves coming from the EURJPY cross, which edged past the 121-figure after falling to 118.77 on Monday.

U.S Markets

Durable goods slid 5.2 percent in January, but investors looked to the underlying figure with durable goods ex-transportation showing respectable growth of 1.9 percent, well ahead of expectations. U.S housing also continues to surprise to the upside with pending home sales jumping 10.4 percent in January.

A series of positive themes kept risk sentiment alive overnight, with a second day of testimony from Fed Chairman Ben Bernanke easing fears the Federal Reserve will begin unwinding asset purchases.

The DOW and S&P finished up 1.31 and 1.38 percent respectively.

Yen falls ahead of BOJ nomination

Meanwhile the Yen eased across the board in response to positive risk trends with the USD-JPY pair breaking the upside of 92-figure once again before running into resistance around the 92.45 level. We’ve noted a pick-up in short-side positioning from more favorable risk trends and ahead of Prime Minister Abe’s Bank of Japan nomination, which is expected to be announced as soon as today. Markets widely expect Abe’s nomination for the top job will be Asian Development Bank President Harukiko Kuroda, while news agencies reported overnight Kikuo Iwata will be put forward for the role of Deputy. Both are considered to be pro-stimulus allies of the government and expected to hit the ground running with unconventional easing initiatives designed to kick-start inflation.

Australian dollar

After looking decidedly vulnerable below the 102-figure, the Australian dollar began to crawl higher overnight, coinciding with stronger U.S equities. The local unit fell as far as 101.82 US cents before regaining ground in the latter part of U.S trade.

Besides feedback from Japan, local markets will look to data on the investment intentions of corporate Australia with fourth-quarter private capital expenditure on the docket. Also due for release are data home sales, private sector credit and average weekly wages. All releases will be watch closely in the context of the RBA’s next move, therefore a key directive for the Aussie dollar. At the time of writing the Australian dollar is buying 102.3 US cents.

After a short period of relative stability in the Euro-region, the theme of negative contagion has roiled European markets once again, with Italian political concerns front and centre. The possibility of an elongated period of uncertainty in the region saw sharp losses across European equities, pulling currencies of risk down for the ride. Naturally, Italy’s borrowing costs have surged in response to the political gridlock with 10 yr yields now eying the 5-percent level once again. The Euro STOXX 50 index closed  3-percent lower on the day.

With Pier Luigi Bersani’s centre left Democratic Party winning the majority in the lower house, and Silvio Berlusconi centre right taking the lead in the senate, both parties will require each others support to form a coalition. Although a ‘grand coalition’ is possible, political pundits warn it may carry a relatively short expiry date if achieved. Whatever way you look at it, Italy is in a state of political disarray and it doesn’t look like this will change anytime soon.

The Euro remains a barometer of Italy’s uncertain political future, falling to lows of $US1.3017 overnight before regaining ground over the course of U.S trade. A similar theme of risk currency weakness was noted across the board with the high-beta Kiwi leading the charge lower.

There have been moderate improvements across currencies in the latter half of U.S trade with the USD-JPY rate climbing from near session lows of Y91.1. The aftermath of Italy’s political stalemate yesterday saw a considerably strong Yen across the board, but we’ve seen this theme moderate somewhat with the potential for further losses should news surrounding the Japanese Government’s BOJ nomination prove favorable.

U.S markets find solace in Bernanke

Amid the political fracas in the Euro region, Fed Chairman Ben Bernanke was able to provide some solace for markets and broader risk trends overnight. In a testimony to congress, Bernanke gave no indication the Fed will begin to unwind asset purchases, and markets have suitably re-calibrated expectations the Fed’s life-line will be unwound through the latter half of 2013. “Economic activity in the United States has continued to expand at a moderate if somewhat uneven pace,” Bernanke noted. Bernanke also flagged potential headwinds from automatic budget cuts (sequester) due to kick in on March 1^st.  Still the forthcoming sequester (which will take a $US85 billion chunk out of the economy) appears to be doing little to deter investors.

Markets also eyed stronger than expected reports on housing. The S&P/Case Shiller house price index jumped 7.3 percent in the December quarter, and the official new home sales data showed a solid 15.6 percent jump in January. Also in the frame was a stronger than expected consumer confidence print in February.

A$ falls to a 4-month low

The natural correlative value between the Aussie and broader risk trends remained in play overnight with the local unit forging new 4-month lows of 102 US cents. It’s also apparent the case for the RBA to take the cash rate lower has now became a little more compelling courtesy of renewed instability in the Euro-region. Still, with U.S markets breaking Europe’s negative lead, there’s was a reluctance to take the Aussie below key support of 102 US cents. At the time of writing the Australian dollar has regained some composure around the 102.45 US cent region but remains at the mercy of feedback from the Euro region and broader risk trends.

Given the Yen’s sustained path lower, buying activity prompted a short-squeeze with stops triggered along the way which only increased buying momentum.  The EURJPY pair led the charge lower falling around 600 pips to a 1-month low of 118.77.  Similar moves were noted across the board with the USDJPY breaking the downside of 91-figure for the first time in nearly a month.

Whether we see a v-shaped recovery from Yen crosses remains to be seen, but one would expect a material bout of Yen strength may be more of a value proposition for Yen bears should we see some favourable news out of Italy.

Likewise, major currency moves reflected a night of broad risk aversion overnight; with safety flows directed towards the U.S dollar and the aforementioned Yen.

The Euro’s currently acting as a more rational barometer for Italian political uncertainty falling to fresh 1 ½ month lows against the greenback. Equities from both sides of the Atlantic also suffered solid losses with the Italian elections front and centre. Markets are clearly concerned the anti-austerity movement in Italy will derail efforts by Mario Monti’s technocrat government to put Italy back on the straight and narrow.

The safe-haven play dictated much of the broader currency activity overnight, with the CAD leading the commodity bloc lower with the Aussie dollar close behind. We’ve seen the selling escalate after Yen crosses slid deeper into negative territory but it would appear supportive behavior around the 102.65 level should contain short-term losses. Nonetheless, it’s apparent high-beta currencies like the Aussie remain vulnerable to further downside with markets concerned over how political fragmentation in Italy (Europe’s third largest economy) will disturb the relative stability across the entire Euro region.

Beside feedback from Italy, we shall be watching for news out of Japan with Prime Minister Abe expected to announce his nomination for the Bank of Japan top job this week.

Among a host of top-tier data points in the U.S this week, the most important short-term directive may perhaps be Fed Chairman Ben Bernanke’s testimony to the Senate Banking Committee This evening. Markets were thrown into a tizzy last week after the FOMC minutes for February revealed some members advocate the need to begin scaling back asset purchases.

At the time of writing the Australian dollar is buying 102.75 US cents.

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