The US dollar has thus far failed to benefit from the recovery in the private economic sector and is instead trading in tandem with sovereign bond markets. We believe the end of a bear market rally in equities and hence renewed demand for sovereign bonds should help the bullish US dollar scenario. We think that the buck is likely in its final stage of weakness and equity and bond flows have the potential to surprise. We stick to 1.40/1.30 as 1/3m forecasts.

The May unemployment report, due on Friday is likely to show another sharp decline in payrolls and another rise in the unemployment rate. However, our economists expect the rate of decline in payrolls to moderate. Their -450'000 forecast for May includes a 70'000 boost from census workers, temporarily employed in May. I wouldn't be surprised if the numbers are fudged to support a dollar objective by the feds and come out revised at a later date. At 9.2%, the market is looking for a rise from 8.9% which would be 4.8% from the low of 4.4% early April. Looking back 60 years, the rise would also be above the largest cyclical rise in 1970.

As expected, the ECB kept the refinancing rate at 1%. Trichet elaborated on the EUR 60bln covered bond purchase program, starting in July. The degree of details was limited, but he stressed the appropriate exit strategy once the economy starts to turn around. Strategists think that the details from the ECB were helpful, but not yet comprehensive enough to provide a clear idea of how the programme will impact the market in the medium-term.. The ECB reduced its growth outlook for 2009 and 2010. It now expects GDP growth to print a range of -5.1% to -4.1% vs. -3.2% to -2.2% previously. In Q&A, Trichet elaborated on currencies longer than usual, saying that 'it is very important the US is repeating a strong US dollar policy'. Later in the US session, euro group chief Claude Juncker said that 'a further euro increase was not welcome'. We maintain our 1/3-month EURUSD forecast at 1.40 and 1.30 respectively.

The Bank of England has kept both its policy rate and level of asset purchases unchanged, in line with market expectations. However, the Bank said it would keep the level of purchases under review and our economists expect the size to be expanded to £150bln or even more in the coming weeks.

The Bank of Canada left the overnight rate target unchanged at 0.25%, as expected. While noting that financial conditions and consumer and business confidence have improved in recent weeks, they warned that if the rapid rise in the Canadian dollar proves persistent, it could offset these positive factors. The Bank expects the recoveries in global and Canadian economies to be more "muted" than usual. It judges underlying macroeconomic risks to be "roughly" balanced with risks to the inflation outlook still slightly tilted to the downside. The Bank reiterated that conditional on the inflation outlook, the overnight rate target can be expected to remain at its current level until the end of Q2/10.For the second consecutive statement, the Bank makes no mention of credit or quantitative easing. USDCAD has shown a strong (negative) correlation to commodity price developments and equities. However, we still favour a higher USDCAD as the global fundamental backdrop remains problematic and is a good buy at current levels 1.0990.
In a speech entitled "Economic Update", the key comments by RBA Governor Stevens were that "some scope remains to ease monetary policy further, if that were to be helpful to securing a durable upswing," but "it would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates." In particular he said that "the Board has not felt the need to cut our policy rate to the very low levels - effectively zero - seen in some other countries." So, the RBA continues to see scope to cut rates further, such that we continue to expect further modest 'confidence-building' cuts from the RBA over the course of this year as unemployment rises - though we continue to note upside risks to our terminal rate forecast of 2%...highlighted by the reservations cited today by the RBA Governor about the 'counterproductive' impact of lowering rates too far, creating systemic problems down the track. I view AUD/USD as a sell on rallies.
Source: Bloomberg, UBS, Chris Lori CTA