The old adage that you can take a horse to water, but can't make it drink sums up the current market situation. Despite a deluge of cash, underlying de-leveraging will continue to provide important dollar protection, especially against the euro. Although the dollar is still a weak currency, the relative US outlook makes it a better bet than the major alternatives.
The ECB again flooded the market with liquidity and the ISDA has decided that the Greek debt restructuring was not a credit event- not yet at least. The banks still have to face the fact that commercial banks will not increase lending no matter how much cash is flung in their direction, illustrated by the fact that deposits at the ECB rose to a record EUR777bn on Friday from the previous record of EUR528bn. From a longer-term perspective, the blatant favouritism applied to central bank holdings of Greek bonds will also sour a generation of potential institutional investors in sovereign debt. This will make life even more difficult for banks saddled with non-performing debt and the euro will suffer.
The Euro-zone countries, for now, remain committed to fiscal austerity which will drag the peripheral economies deeper into recession and force further bank de-leveraging. There is a very high probability that the policies will implode on the back of economic and political protests with France's May presidential election a key trigger point as rising energy costs lead to a further downturn in demand. The existing policy stance will also continue to drain underlying euro strength with the dollar set to benefit. The wider dollar outlook is likely to be determined to a large extent by developments in China and evidence of a hard landing would trigger a big move into the US currency.
Looking at the immediate outlook, a sharp decline in China's non-manufacturing PMI should help the US currency to a firm start in Asia on Monday. The dollar will also gain some support from fears that Greece's Collective Action Clauses will be forced into action and the ISDA would find it very hard to turn a blind eye to such action which would further destabilise Euro-zone credit markets and undermine the euro.
There are five central bank interest rate decisions during the week. Most attention will focus on the ECB's latest meeting on Thursday as the Euro-zone continues to dominate market sentiment. The central bank has already provided huge amounts of liquidity to the banking sector through the second long-term refinancing operation (LTRO). Comments from bank chairman Draghi have suggested strongly that the central bank considers that it has done all that it can to support the euro area in the short term at least.
The evidence also suggests that there has been increasing disagreement within the ECB as the Bundesbank through Weidmann has been increasingly critical of ECB actions. In this environment, the ECB will find it much more difficult to find a consensus and there will inevitably be a more cautious tone as the bank can ill-afford gaping divisions and this makes inaction the most likely outcome at this stage.
There is a strong case for the Bank of England to take no action at the latest meeting on Thursday with the central banks in New Zealand and Canada also likely to hold fire this month on Thursday. Last month, the Reserve Bank of Australia surprised markets by not cutting rates. This time around, the consensus will be for no action to be taken and this is certainly the most likely outcome. The GDP data on Wednesday and outlook for China is likely to have a bigger impact on the Australian dollar.
The economic releases will inevitably be dominated by Friday's US employment report, although it is doubtful whether the data will add much to the sum of knowledge. The most likely outcome is a slightly weaker report after two months of strong payroll gains. The overall impression gained will still be that the US is in a better position to out-perform Europe in the short term. The ADP employment report will be released on Wednesday with the latest jobless claims data on Thursday.
It is certainly possible that the latest US ISM manufacturing release on Monday will have more important implications for the economy, especially after the surprising dip in the manufacturing index released last week. If the national services-sector index holds firm, there is very little chance of the economy sliding towards recessionary conditions. The orders and employment indices will be particularly important for market sentiment.
As far as UK data releases are concerned, the latest PMI services data on Monday will be extremely important for underlying confidence in the economy after a much stronger than expected release last month. If the index holds above the 55 level, then there is very little chance of a near-term slide towards recession which would help underpin Sterling sentiment.