Dollar Off After CPI, Markets Await Remainder of Data

The U.S. dollar, was largely firmer overnight after a bout of profit taking saw it back off of a two-month trade-weighted high yesterday. The greenback has increasingly taken its cue from U.S. economic reports, with strong data beginning to more meaningfully translate into a slightly less dovish Fed policy outlook. As a result, continued signs of improvement in U.S. data should keep U.S. Treasury yields biased higher and add further fundamental support to the dollar going forward.

The euro was largely steady near this week’s one-month low against the resurgent U.S. dollar. The single currency, despite Greece’s ability to reach a debt swap deal with its bondholders last week, continues to suffer from broader worries about the 17-member bloc’s three-year long crisis. The lack of growth in the euro zone and upcoming elections in Greece and France raise serious questions about nations’ long-term commitment to austerity measures and to a closer fiscal union. At the same time, improving U.S. economic data have contrasted the bleak situation in Europe and have added to the greenback’s relative yield appeal over the euro.

The pound held its ground against the greenback, displaying the same relative resilience that has characterized its trade for much of 2012. Yesterday’s warning about its AAA status by Fitch’s rating agency failed to meaningfully undermine the pound. However, any further signs that the U.K. economy is slowing would leave it vulnerable to talk of additional BOE policy easing in the months ahead.

The yen fell back toward an 11-month trough against the dollar overnight. The risk of additional policy easing by the BOJ, the structural deterioration in Japan’s balance of trade and the rise in U.S. Treasury yields relative to Japanese bonds all suggest more upside for USD/JPY.

EUR: The euro hovered near key psychological support above a one-month trough against the dollar. Despite last week’s agreement between Greece and its bondholders, which helped avoid a messy default, the euro has struggled against most of its major rivals. Investors continue to look at the very bleak economic outlook throughout much of Europe and its potential to keep many of the bloc’s structural debt problems in place for many years to come as a major liability. Additionally, the ECB’s recent LTOR liquidity operations, while helping avert a broader financial crisis in Europe, have also left the single currency vulnerable to selling against higher yielding assets. On this side of the Atlantic meanwhile, economic reports have painted an improving picture of the U.S. economy and have made for a slightly less dovish outlook for Fed monetary policy. Consequently, the euro remains vulnerable to continued losses, especially if U.S. data continues to support the recent rise in U.S. Treasury yields.

JPY: The yen fell back toward an 11-month low against the dollar overnight as yesterday’s profit-taking induced bounce ran out of steam. The yen has fallen by over eight percent against the dollar since the Bank of Japan surprised the markets with another round of policy easing in early February. The outlook for additional policy support for the economy is keeping the yen pressured, as is the view that the nation’s trade surplus, once a pillar of the economy, has been structurally damaged. A continued push higher in Treasury yields in the U.S. could be the single biggest driver of the dollar’s strength against the yen going forward.

AUD: The Aussie and New Zealand dollars held recent gains as firmer global stocks kept investors’ appetite for higher yielding assets elevated. Indeed, the commodity currencies are most likely to perform well in a scenario where investors remain relatively upbeat about the global growth prospects. However, a sustained move higher in U.S. yields would dull some of the relative yield appeal of Aussie and kiwi in particular, and could limit their upside going forward.

GBP: The pound continues to draw support from its relative strength against the euro, which remains pressured against most of its major rivals. The pound however, looks vulnerable to loses against the dollar if the recent move higher in U.S. yields continues or if upcoming U.K. data points to a still elevated risk of additional BOE easing in the months ahead.

USD: U.S. CPI for February rose by 0.4%(m/m), exactly as expected. However, ex-food and energy, consumer prices rose by just 0.1%(m/m), cooler than the forecast for 0.2%(m/m). The dollar sold off on the news in a knee-jerk reaction, as many had priced in a higher reading of consumer inflation.

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