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Sequester Kicks in, but Panic Doesn’t

By Kathy Lien
01 March 2013 17:01 GMT

The US dollar’s mild reaction to the now-mandated $50 billion in government spending cuts suggests now is not the time for widespread panic, but a much more critical deadline still looms in the US.

After rising to a fresh five- year high intraday, the Dow Jones Industrial Average gave up all of its earlier gains to end Thursday in negative territory. This turn in risk appetite not only affected equities, but also currencies, as the US dollar (USD) ended the day unchanged or higher against every major currency.

A large part of the nervousness in the market was caused by the Senate's decision to reject a pair of proposals that would have helped avert the automatic spending cuts set to kick in today, March 1. In doing so, $85 billion worth of spending cuts will now begin.

While stocks have fallen and the dollar has risen, the mild decline suggests that investors are not terribly worried about the implications of sequester. Afterall, 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 President Barack Obama issues his sequestration order Friday, Federal agencies will let their workers know on Monday, March 4, at the earliest, and the cuts would take place starting April 4.

Effectively, this means the Obama Administration has another 30 days to come up with a deal to cancel and avoid the forced spending cuts. The more important deadline is actually March 27, when the government runs out of money and will be forced to shut down if no additional measures are taken. Needless to say, both 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 deal before the March 27 deadline will occur.

Meanwhile, mixed US economic reports left very little impression on the forex market, and the dollar barely reacted to the data because it won't change the Federal Reserve’s monetary policy. The Fed is primarily focused on job growth, as opposed to jobless figures, so non-farm payrolls are far more important. Personal income, personal spending and the national ISM manufacturing index are scheduled for release on Friday.

Euro Remains Crippled by Italian Election Concerns

The euro trickled lower against the US dollar throughout the North American trading session. Concerns about the lack of a majority government in Italy continues to weigh on the market, as investors wait to see whether Pier Luigi Bersani will be able to form a coalition government or be forced into early elections. It won't be an easy path for Italy, and the outcome will most likely be a weak government that is unable to deliver meaningful reform or austerity.

See also: 3 Lingering Questions Weighing Down Major Currencies

This latest Eurozone economic reports didn't provide much help, either. While German unemployment declined in the month of February, the unemployment rate held steady at 6.8%. Economists were hoping for an improvement. Consumer spending in France plunged, reminding us of the big gap between the performance of Germany and the rest of the Eurozone. Inflationary pressures, on the other hand, remained muted with Eurozone CPI dropping 1% in January. This trend appears to be abating, however, with German CPI rising 0.6% in February.

German retail sales numbers are due for release on Friday, and based on the rise in consumer confidence, spending should have improved, but according to Markit's Retail PMI report, consumer spending contracted for the second time in three months.

Final PMI manufacturing numbers are also due for the Eurozone, though revisions are not expected.

Meanwhile, it is also worth noting that GDP growth in Switzerland beat expectations. Switzerland's economy grew 0.2% in the fourth quarter, but unfortunately, the Swiss franc (CHF) ignored the news, partly because of the drop in consumer prices, which gives the Swiss National Bank (SNB) continued flexibility to keep monetary policy easy.

UK PMI Data to Decide Fate for British Pound

With no major UK economic reports on the calendar, the British pound (GBP) ended Thursday North American trading unchanged against the dollar and slightly higher against the euro. Consumer confidence held steady in February, according to GfK, which called the development encouraging. While the survey of consumer sentiment was taken before Moody's downgrade, it is still surprising that sentiment held steady despite the decline in consumer spending. It appears that there is a major disconnect between how consumers feel and how they spend.

Nationwide house prices and the UK’s PMI manufacturing report is due for release on Friday. The sharp improvement in the CBI index points to stronger manufacturing activity. If the PMI report surprises to the upside, the GBPUSD could rise back above 1.52. So far, the currency pair has absorbed the downgrade well, and economic data will now determine whether the pair will bottom at these levels or continue lower.

Canadian Dollar (CAD) Hits Fresh Seven-Month Lows

After consolidating for the last two trading days, the rally in USDCAD has resumed with the currency pair rising to its highest level since July. Continued disappointments in economic data renewed the selloff in the Canadian dollar.

While the Bank of Canada (BoC) has not abandoned its call to raise interest rates, investors realize that it will be some time before they get serious about unwinding monetary stimulus. Canada's current account deficit narrowed to -$17.3B in the fourth quarter, down from -$18.0B. This improvement was smaller than anticipated, but still encouraging.

Industrial product prices held steady in January, but raw materials prices soared, which comes as a sign that there's some inflation in Canada. Fourth quarter and December GDP numbers are due for release on Friday, and we believe the selloff in the CAD can be attributed to expectations for much slower GDP growth. Although trade improved slightly, retail sales plunged at the end of the year. A larger-than-expected pullback in GDP growth could drive USDCAD to 1.04.

The Australian dollar (AUD) also weakened slightly ahead of Chinese PMI numbers. If manufacturing activity slows in China—Australia's largest trading partner—we could see additional losses in AUDUSD.

Manufacturing activity in Australia, on the other hand, improved significantly, with the PMI index rising from 40.2 to 45.6, its highest level since June 2012. Unfortunately, the overall decline in commodity currencies prevented the New Zealand dollar (NZD) from rallying despite a sharp improvement in business confidence.

Harohiko Kuroda Nominated New Bank of Japan Governor

The day’s biggest story was Japan Prime Minister Shinzo Abe's formal nomination of Harohiko Kuroda as Bank of Japan (BoJ) Governor, and Kikuo Iwata and Hiroshi Nakaso as Deputy Governors. Contrary to our expectations, there was no major reaction in the Japanese yen (JPY) during the Asian trading session, but Japanese equity investors were clearly satisfied, as stocks rose more than 2.7% overnight following the nomination.

See related: Yen: Big News Inspires Only a Small Move

During the North American session, however, the yen started to fall once investors finally realized that we are getting closer to another strong dose of easing from the Bank of Japan. While we haven't heard any official comments from Kuroda yet, BoJ member TakahideKiuchi confirms that the central bank will consider extra easing, if necessary. Since he believes that the downside risks are large for the economic outlook and thinks the 2% price target will not be easily achieved, it is clear that he will throw his support behind more easing.

Japan’s Economic Minister, Akira Amari, also wants the "BoJ to continue bold easing to reach their price target as soon as possible." There will most likely be hearings in both the upper and lower houses for the BoJ nominees next week, and at that point, we could hear some official comments from Kuroda. Afterwards, votes on the BoJ Governor are likely to occur between March 14 and 15 with the new Governor hopefully in place by the time current BoJ Governor Masaaki Shirakawa steps down on March 19.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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01 March 2013 17:01 GMT