DB Spotlight Shifts from JPY to USD

[RTFX-Trading]

Spotlight Shifts from JPY to USD

The past two trading days have seen a shift in FX markets from a focus on the risk of a further yen rally and pressure on G10 carry trades to concern over a more generalised dollar sell-off. Though a breach of 116 could see the attention turn back to the yen, the mix of data and positioning in the USD seems a more likely driver in the near-term.

The fundamental pressure on the USD in our view has come from weak US activity data coupled with still elevated inflation rates. Our US macro pulse index (MPI) has remained at very low levels, indicating a steady flow of negative US data surprises, despite already being near the extreme observed over the past two years and so far failing to mean revert as we had expected. Weak readings on retail sales, the Empire manufacturing survey and the Philadelphia Fed index have delivered a consistent message that the bounce in US activity data seen early this year has not been sustained later into Q1. Inflation data, whether the prices paid balances on PMI indices or yesterday's PPI data, do not yet show an easing of inflation pressures and therefore keep the probabilities of Fed easing concentrated in the second half of this year (25 bps of easing currently priced by August and another 25 by the end of 2007). This has resulted in rate differentials between the Eurozone and the US changing little since March 5 but the US curve steepening as weak activity data and still elevated inflation readings have painted a more negative backdrop for USD assets. With this backdrop, a higher than expected CPI today may not produce a significant USD rally.

The market may not be positioned for a generalised move lower in the USD. Though short USD and long EUR positions are significant in the IMM data, our DB positioning indices show only modest readings on short USD and long EUR at -4 and +5 respectively on a historical scale of -10 to +10. The pop in the 1M EUR/USD 25d risk reversal to its highest level since November-December period when the USD was last under pressure also indicates more concern with the breach of 1.33 in EUR/USD than seen during the grind higher from the beginning of this month.