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Summary

  • The dollar is in narrow trading ranges, consolidating yesterday's recovery.
  • The yen is the strongest of the majors this week.
  • Very large fall in Fed's custody holdings, no impact on yields.

The US dollar spent the Asian and European morning, largely consolidating yesterday's recovery. Narrow ranges have prevailed, and we suspect the North American operators may try to push the greenback higher, before it too settles down for the weekend. Equity markets and core bond markets, with US 10-year yields holding steady after falling 9-10 bp yesterday appear more reflective of our sense of the market's mood: Nervous

The weekend poses risk in the form of the referendum in Crimea, where the choice is between leaving the Ukraine and joining Russia. The Crimean parliament has already approved independence. Of course, much of Europe, the US and Japan have warned that they do not recognize the referendum.

China may be quiet on the issue, and strategically, why not, but from its own domestic interest, it could not accept the legitimacy of a referendum by one of its minority populations (e.g. Tibet or Taiwan) from seeking independence.

The next level of sanctions against Russia will likely be announced shortly after the referendum. Eastern and central European countries, like Poland and Hungary have expressed concern about the hardship they will be forced to bear. At the same time, reports suggest a build-up of Russian forces on the Ukrainian border. While they are most likely for defensive purposes, many fear that Russia may expand its operations shortly.

Meanwhile, US aid ($1 bln) is tied up in the Senate as it has become entangled in the debate over IMF reform. Ukraine reportedly has sought military assistance from the US, which has not directly refused, but has indicated not now.

China's economic slowdown and the financial squeeze is also a cause of concern. The dollar finished at new highs not only for the week against the yuan but new highs since last summer, although there were higher intra-day moves last week. The economic slowdown, but especially the financial squeeze is having knock-on impact on metal prices, especially copper and to a lesser extent, iron ore.

They were used for financial purposes, such as collateral. In addition, many wealth management products were tied to the mining industry. There are some reports suggesting that Chinese officials may take some formal action against such schemes.

Some observers are linking China to the outsized $104.5 bln decline in the Federal Reserve's Treasury holdings in its custody account for foreign central banks. Custody holdings have trended lower this year, but the large, possibly record decline, is worth more attention than the market is giving it.

First, it plays into market talk that China has stepped up the diversification of its reserves and could help explain the euro's persistent strength. While possible this seems unlikely given China's other pressing financial issues at the moment. Second, some may try to link this to Russia's recent threat. This would reflect almost half of Russia's dollar reserves and would seem significant.

However, Russia's trade and currency policy is tied to the dollar. It does not hold dollars as a favor to the US, but because it sees it in its national interest. If it is Russia, we wonder it would not be a sale of Treasuries as a transfer from the Fed's custodial account to commercial banks.

In any event, regardless of who sold them and for what purposes, the point is that the trend decline in Treasuries being held for foreign accounts at the Federal Reserve has not coincided with high US yields. Even the sharp decline in holdings, in the latest reporting period, did not see Treasury yields rise, which is a testament to the breadth and depth of the market. It also means that a foreign country, such a Russia, ability to impact US policy by threatening to sell its Treasury holdings, rings hollow.

For its part, the euro remains stubbornly resilient. The euro had already lost the upside momentum that had carried it near $1.40, but Draghi's comments, a not very thinly veiled threat, that the euro's strength was adversely impacting inflation and growth and that the ECB would respond. Words do not seem sufficient to break the euro bulls.

The failure of the ECB to act last week saw the euro rise above the upper end of a five-month five-cent trading range (~$1.33-$1.38) and even now, the euro has not been pushed back into it. The euro has built of a bit of a short-term shelf near $1.3840. On the top side, look for the euro to be capped by the $1.3900-20 band.

The Japanese yen is the strongest currency against the dollar this week, gaining about 1.6%. The Nikkei lost 6.2% this week with more a little more than half coming today. Yesterday's dollar's losses were extended marginally in Europe, but a very narrow trading range has been seen as the market seems to be waiting for US leadership. Resistance is seen in below JPY102. Support is offered by the trendline connecting the early-February and early-March lows. It is found near JPY101.40 today.

The North American features the February US PPI and the University of Michigan consumer confidence. Neither report tends to have much impact on the markets, even when there are not other financial issues (China, Dow Industrials down four days in a row and closed below its 50-day moving average and with the major indices posting big outside down days) or heightened geopolitical tensions (Russia/Crimea)

Source: Nervous Calm In FX, While Equities Tumble And What's Up With Fed's Custody Holdings?