USD squeeze ahead of a next week’s pivotal events.

The USD and JPY were on the defensive today as the world sees the Fed and BoJ in easing mode while other central banks are less dovish. Justified? Next week’s FOMC and BoJ meetings to let us know next week.

The market continues to play the rate differential game, as the pound sterling vaulted higher still on strong UK retail sales today, ignoring the caveat in that data: that March was the balmiest in half a century and that there was a fuel panic related to the potential that drove a considerable number of extra trips with the car to buy petrol and other supplies. With the BoE pulling away from its easing stance and with Europe still in a malaise, we can hardly expect this to be the beginning of a new trend in robust British economic growth. Still, the UK-US rate spread has widened violently in favour of the pound - by the largest margin since October/November of last year – some 16 bps or more. This has supported the most recent move, though as I said yesterday, it’s hard to believe that further dramatic spread widening lies ahead due to the countries’ similar predicaments.

Elsewhere, the JPY remained rather weaker rather than strengthening a bit as I expected it might as bonds sold off today and risk appetite had a go at rallying in the European session. I still think the JPY weakness is overdone – but let’s see if next week’s action agrees with me. And the EURUSD squirted higher again on a resilient IFO survey that that suggests German industry is chugging along just fine, thank you very much, Euro Zone crisis notwithstanding. As well, the harsh rhetoric from the Bundesbank’s Weidmann (see Evans-Pritchard's typically dramatic column on this.) and other comments from ECB members lately suggest that the ECB would prefer to keep a low profile for now despite the elevated peripheral yields and leave things to the politicians. This, combined with rather strong expectations for Fed easing, are preventing the EURUSD from selling off and heavy short positioning is seeing a squeeze ahead of the FOMC meeting next Wednesday.

A busy week ahead
We’ve got a busy week ahead, with the first round of the French presidential election on tap on Sunday, which will very likely see the Socialist Hollande and Sarkozy taking the top two spots for the run-off round on May 6th, which will very likely result in a resounding Hollande victory according to the latest polls. The question going forward are huge for Europe as Hollande will find little in common with Germany’s Merkel, as he is in favour of more integration, the issuance of Euro Bonds, etc.. And it was the “Merkozy” duo that was critical in putting together so many of the extend and pretend policies of the last couple of years. Could Hollande even end up toppling the Merkel government by aggravating pressures in Germany? See also our Chief Economist’s views on this weekend’s election: Paris - the city of dimmed lights?

Chart: EURUSD
EURUSD rallied all the way to the top of the recent range and the 55-day moving average today. There are endless scenarios for the short term – a further squeeze until the FOMC meeting throws cold water on the rally, a dive back into the range immediately, etc.. The key will be in what the FOMC has to say on Wednesday. I suspect the market is a bit too QE happy.

Up Monday night, we have the flash HSBC Manufacturing PMI for China, which will show whether the Chinese manufacturing sector continues to contract and to what degree. That survey has been below 50 since last August. See interesting commentary on Zero Hedge from SocGen’s Albert Edwards on the prospects for a hard landing in China. 

The other two key events next week are the pivotal FOMC meeting on Wednesday and the BoJ meeting on Friday. For the FOMC, is the market leaning too hard on the policy differential theme – expecting further Fed easing when the likes of the BoC and BoE have proven far more hawkish? Or is the view justified. I would suspect that, given the large number of FOMC voters that are uncomfortable with the idea of further easing at this time, it might be at least another meeting and far more evidence of worsening employment and no inflation uptick before we see the Fed dropping further hints. As well, the idea that Bernanke may be very sensitive to the political cycle, as I mentioned yesterday, is an intriguing one.
Stay very careful out there and have a wonderful weekend.

Economic Data Highlights

• Germany Mar. Producer Prices out at +0.6% MoM and +3.3% YoY vs. +0.4%/+3.1% expected, respectively and vs. +3.2% YoY in Feb.
• Germany Apr. IFO Survey out at 109.9 vs. 109.5 expected and 109.8 in Mar.
• UK Mar. Retail Sales ex Auto Fuel out at +1.5% MoM and +2.8% YoY vs. +0.4%/+1.3% expected, respectively and vs. +1.0% YoY in Feb.
• Canada Mar. Leading Indicators out at +0.4% MoM vs. +0.5% expected and +0.7% in Feb.
• Canada Mar. Consumer Price Index out at +0.4% MoM and +1.9% YoY vs. +0.5%/+2.0% expected, respectively and vs. +2.6% YoY in Feb.
• Canada Mar. Core CPI out at +0.3% MoM and +1.9% YoY as expected and vs. +2.3% YoY in Feb.

Upcoming Economic Calendar Highlights (all times GMT)

• Euro Zone ECB’s Asmussen to Speak (1645)
• Australia Q1 Producer Price Index (Mon 0130)
• China Apr. Flash HSBC Manufacturing PMI (Mon 0230)