Dollar: Sequester, Weak ECB LTRO Repayments

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Currencies are on the move today with the GBP dropping to its lowest level in 2.5 years, the EUR breaking below 1.30 and the AUD poised for a test of its 4-month low against the U.S. dollar. Weaker manufacturing conditions in China contributed to the sell-off but it was disappointing U.K. manufacturing PMI and the ECB’s report that European banks made only EUR12.5 billion in LTRO payments today compared to EUR67 billion last week that drove the EUR and GBP sharply lower. Lower LTRO repayments are negative for the euro because it reflects concerns about liquidity needs inside banks. In Italy, Bersani confirmed that he is ruling out a grand coalition with the centre right party, adding pressure to the euro. Yet despite the decline in the currency, Italian bond yields are up only 6bp, which is nominal and at 4.78%, 10-year Italian yields are far from dangerous levels.

With the sequester kicking in at the end of the day, U.S. stock futures are pointing to a lower open. President Obama is meeting with Congressional Leaders today but the House out of session so nothing can be done to avoid the spending cuts. Yet investors continue to buy U.S. dollars because they are not overly concerned about the consequences of sequester. We’ve been down this road before with the debt ceiling and survived. The numbers this time around aren’t enormous – only $50B worth of cuts are expected this year and not all of it will kick in at one time. Government agencies are mandated to give their workers at least 30 days notice and this means that if Obama issues his sequestration order tomorrow, Federal agencies will let their workers know Monday March 4th at the earliest and the cuts won’t take place until April 4th. This means that effectively the Obama Administration has another 30 days to come up with a deal to cancel and avoid the cuts. The more important deadline is March 27th, when the government runs out of money and will be forced to shutdown if no additional measures are taken. Of course, Republicans and Democrats want to avoid a government shutdown and House Republicans will be voting on a measure that would finance the government until the end of the year. Investors are clearly holding out hope that a last minute deal before the March 27th deadline will occur.

There are also a number of U.S. economic reports on the calendar this morning. Personal Income and Personal spending numbers have already been released and according to the reports, a decline in incomes have left Americans conservative with their spending. Incomes dropped 3.6% in January, the largest decline in 20 years. Personal spending rose 0.2%, but last month’s report was revised down to 0.1% and the PCE deflator held steady in the month of January. The disappointment in personal spending will add pressure on futures and risk currencies. The University of Michigan, Construction Spending and ISM Manufacturing numbers are expected around 10am ET, but don’t expect any market moving surprises.

Kathy Lien
Managing Director

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