Behind the Sell-Off Day in FX and Equities

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With U.S. stocks opening lower and European equities under significant pressure, the sell-off in currencies is consistent with a return of risk aversion. The weakness this morning was kicked off by softer Eurozone data, which shouldn’t surprise our readers since we warned in our note last night that the Italian elections in February and Cyprus problems would weigh on sentiment. This morning’s U.S. economic report also failed to ease the pain with pending home sales dropping 0.4% in the month of February after rising a downwardly revised 3.8% the previous month. While January was a very good month for the U.S. housing market, existing, new and pending home sales all gave back some gains in February. Both the U.S. dollar and the Japanese Yen have been big beneficiaries of the shift in risk appetite. Looking ahead if we don’t get any good news from Thursday’s German retail sales and unemployment numbers, the EUR/USD could find itself trading below 1.27.

Meanwhile the market is still talking about Cyprus and whether it will be a template for future bailouts. Based on the big moves in German bonds, it is clear that investors in Europe are turning to the bonds of the strongest Eurozone economy for safety. Ten year German bund yields are trading at its lowest level since August. We don’t expect much recovery in currencies during the North American session. Four Federal Reserve President are scheduled to speak today but only 1 is a FOMC voter. Between Rosengren, Pianalto, Potter and Kocherlakota, Rosengren’s comments are the only ones that carry the most weight and he is usually dovish so don’t be surprised if he echoes recent comments from Dudley who called on the Fed to keep monetary policy “very accommodative.”

Finally, the Canadian dollar reversed its earlier gains after hotter than expected consumer prices. CPI jumped 1.2% in the month of February, which was the strongest increase since 1982. Annualized price growth increased by the same amount while seasonally adjusted prices rose by a more modest 0.4%. For the Bank of Canada, higher inflationary pressures will encourage them maintain their hawkish bias. Between the recent rise in oil prices and stronger data, the CAD has risen to a 1 month high.

Kathy Lien
Managing Director

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