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Risk assets rebounded as markets ignored Egypt and fears over the European periphery fade, while the dollar held surprisingly well. Although the situation in Egypt remains unresolved, and it is not clear whether popular anger will be assuaged by the latest US-backed plan to replace Mubarak with his vice president, investors focused on continued positive macroeconomic news coming out of developed countries. Worldwide sentiment indices generally came out higher than expected, pointing to the idea of sustainable recovery. Stocks, high yield bonds and commodities pushed to new cycle highs, government bond yields rose, and it is remarkable that the trade-weighted dollar only dropped marginally in trade-weighted terms. The possibility that the US dollar may be decoupling from other flight-to-safety assets is one worth keeping in mind.

GBP

The main macroeconomic news in the UK last week was the PMI business sentiment indices. All three (manufacturing, services and construction) came out handily above expectations, and seem to dispel, at least temporarily, the fears that the previous week’s bad GDP data had engendered about the impact of fiscal tightening. In response, forecasters began bringing forward in time expectations of Bank of England hikes, and are ascribing the bad GDP data to unusually rough winter weather. Sterling responded with a very strong showing, rising over 1.5% against both the euro and the dollar. While last week was not kind to our bearish views on sterling, we still think the markets are discounting too heavily the impact of fiscal tightening on the UK economy and maintain a negative view of GBP.

EUR

Business sentiment indices also shone in the Eurozone last week. There were even some hints of improvement in business confidence in the benighted peripheral countries, particularly Ireland. As a result, peripheral sovereign bonds severely outperformed bunds, and the euro rose earlier in the week. However, a relatively dovish statement and press conference after the ECB rate-setting meeting dampened the bullish sentiment on the common currency, and the euro gave up all the gains ending the week more or less where it had started against the dollar. Last week’s price action reaffirms us on our neutral view of the euro, at least until details on the revision of the bailout mechanism are released during the coming two months.

USD

US leading indices did not lag other developed countries’ last week. Of particular note was the upside surprise in the PMI services index, which came out at 59.4 vs. expectations of 57.2. It bears noting that this has traditionally been the best leading indicator for US GDP growth. The labour report was more mixed; the establishment survey of businesses payrolls was weaker than expected, while the household survey, from which the unemployment rate is derived, was much stronger and produced a surprising dip of 0.4% in the unemployment rate to 9.0%. The weather disruptions experienced in January make these results hard to interpret, and it’s best to be cautious and conclude that the strength seen in other US economic indicators has yet to spill over in a convincing manner to the labour market. Markets overall chose to take a positive view, and after the PMI numbers the dollar recovered most of its losses to end the week down 0.5% in trade-weighted terms.

Other G10

The breakdown in correlation between the Japanese yen and US rates that we pointed to last week received further confirmation this week. In spite of a dramatic sell-off in US bonds that sent the 5-year Treasury rate up 35 bp, the USD / JPY rate barely budged, ending the week nearly unchanged. However, with trader positioning in JPY longs already stretched, we expect that widening rate differential to continue to exert downward pressure on the Japanese currency.

Dollar bloc currencies almost completely reversed their moves from the previous week. The Australian dollar rose nearly 2%, the New Zealand dollar actually traded lower by 0.5% for the week, and the Canadian dollar was somewhere in between, rising a bit over 1%, buoyed by higher commodity prices. The main trading action in this area had been in the crosses, where the AUD / NZD cross rate recovered all its previous losses and then some ending the week up a whopping 2.5% to near 1.32, validating our bullish view from last week. We now turn neutral on all dollar bloc currencies, both vs. the dollar and relative to each other.

No surprises out of Sweden or Norway last week. The PMI indices came out strong, as expected, and both currencies rallied in unison as risky assets worldwide rose. The Swiss Franc, also as expected, did the reverse, and sold off against the euro as the flight-to-safety bid faded.

Markets will be wary over a spread of Middle East unrest throughout the region, but aside from this, macroeconomic data releases will be light.