DEZ
Market Awaits ECB's Words & Actions
Dollar powered ahead of Treasury auctions
By: Ashraf Laidi, chief currency analyst, MG Financial Group
February 7, 2006 - The dollar sustains its rally ahead of this
week’s flood of government debt auctions from the U.S.
Treasury, to which non-U.S. investors are gearing up to snap fresh U.S. paper.
The auctions open with today’s $21 billion issue of three-year Treasury notes, followed by Wednesday’s $13 billion issue of 10-year notes and Thursday’s comeback of the much anticipated 30-year Treasury bond after five-and-a-half-years absence, with a $14 billion issue.
Foreign investors’ participation in the auctions will be closely scrutinized to gauge foreign interest in U.S. debt as well as foreign interest in financing the swelling trade gap. Today’s three-year note auction will be the first since November, when foreign investors snapped up 29% of the sale, well below the 35% average of 2005 and the 45% average of 2004.
As the charts shows below, dwindling foreign interest in these middle of the curve auctions clearly show diminishing interest.
But even if foreigners buy less than 30% or 20%, the dollar may not necessarily be pressured as global fixed income manager’s appetite is expected to seek Thursday’s more attractive long-term 30-year bond in light of the changing demographics and pension funds’ dire need to lengthen the duration of the asset side of their ledgers. In essence, we attribute today’s dollar rally to foreign-base managers’ dollar bound flows in pursuit of the week’s key options.
The chart below shows that foreign official custody holdings of U.S. Treasuries at the Federal Reserve are flat, at around $1.1 trillion over the past seven months, while holdings of Agencies remains at a steep pace, nearing the $470 billion mark.
Meanwhile Japan, the largest owner of U.S. treasuries with $683 billion as of November, has not seen an increase above the $698 billion, since that level had been reached in 2004.
Japan’s reluctance to accumulate an increasing amount of treasuries highlights the nation’s cautious approach to increasing its exposure to USD-denominated paper.
Tokyo has refrained from making any references regarding the forex reserve diversification since the topic sustained dollar selling when it was last tackled by PM Koizumi last autumn.
Euro support emerges but upside short-lived
We expect the worst of the euro sell-off to have receded for now as traders position ahead of any unforeseen results from what already seems like a highly valued U.S. Treasury notes.
The poor performance in the last two auctions of the three-year notes is helping to cool USD enthusiasm, but traders await the 10-year note and 30-year bonds as the highlight of the week, which should renew the cap over the euro.
Euro optimism with escalating European Central Bank hike expectations is not yet in sight as the U.S. auctions, Fedspeak and this weekend's G8 meeting shadow the meeting.
We see the euro turn continuing towards the $1.1990s with interim resistance at $1.20 followed by ST TL resistance at $1.2020. Renewed offers face support at the 100-day moving average of $1.1960, followed by $1.1930 and $1.19—the 61.8% retracement of the $1.1639-1.2322 rally.
Yen supported as selling momentum fades
USDJPY shows signs of topping around the 119.00-20 range as the Moving Average Convergence/Divergence (MACD) shows a weakening in the bullish moving-average cross over on the daily chart while the four-hour chart shows a continuation in the bearish divergence, suggesting 118.50 is within reach.
Previous resistance of 118.30 now acts as a support--—38% retracement of the 121.36-113.41. Upside capped at 118.70. Upside starts at 11.890, followed by interim target at 119.30.
In the last one-and-a-half weeks, yen bearishness soared 117% to 41, 745 contracts in the Chicago Mercantile Exchange, attaining the worst level of bearishness in seven weeks due to contrasting market expectations of the policy outlook at the Federal Reserve and the Bank of Japan. While the market prices a 90% chance of a March Fed hike, the Bank of Japan has signaled that it may extend its ultra easy-liquidity monetary policy beyond the end of fiscal year.
Cable stabilizes for now, sentiment remains bleak
The doves at the Bank of England found more armor for their argument when U.K. retail sales edged up 0.2% in January, showing the weakest January since beginning of the survey 11 years ago.
The data follow December’s brisk 2.6% increase, which was the biggest in 19 months. With U.K. inflation finally at the 2.0% target and retail sales completing the equation for the slowdown story and raising the odds of a March rate hike.
Bank of England is seen on hold on Thursday, but we foresee the number of members voting for a rate cut to rise to two from one, as Stephen Nickell is likely to be joined by Richard Lambert.
Cable traders quickly lost confidence in the currency and reversed net bullishness into a bearish 1,910 contracts, after the prior week’s bullish balance, which was the first in four months.
We see continued short-term stability transitioning into the 100 day of $1.7550 resistance, where offers seen reemerging. Key resistance stands at $1.7570. Support starts at $1.7430, followed by more robust foundation at 1.7395.
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