Confident Fed Key to Newfound Respect for the Dollar

united states

  • There remains a stark contrast between the major central banks
  • There were several new data points in Europe; UK reported stronger than expected April construction PMI
  • The US ADP private sector job estimate may draw some attention
  • We anticipate that the FOMC statement will look through the softness seen in some recent data
  • There’s really no specific news behind this week’s EM washout
  • Indonesia April CPI rose 3.4% y/y; Poland April CPI rose 1.6% y/y

 

The dollar is mostly weaker against the majors as many markets reopen after May Day. Sterling and the dollar bloc are outperforming, while Stockie and yen are underperforming. EM currencies are mostly weaker. CZK and PLN are outperforming, while RUB and KRW are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.2%. MSCI EM is down 0.5% so far today, with the Shanghai Composite flat after returning from holiday. Euro Stoxx 600 is up 0.6% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is up 2 bp at 2.99%. Commodity prices are mostly higher, with WTI oil up 0.5%, copper up 1.4%, and gold up 0.5%.

There is a has been a brief respite in the powerful short squeeze that has fueled the dollar’s dramatic recovery. The greenback, nearly friendless a month ago, now has many suitors. It is higher on the year against all the major currencies but the yen (~2.6%), the Norwegian krone (~1.6%) and sterling (~0.9%). It is virtually flat against the euro.

There remains a stark contrast between the major central banks. The Federal Reserve is likely to confirm its intention to continue to gradually guide US rates higher later today, while the ECB sounds more cautious than confident. The BOJ continues to press hard and refuses to even discuss an exit. Then there is the Bank of England, where Carney (in all fairness, due to soft data) once again yanked the football away as it was about to be kicked. A rate hike next week now would be more disruptive than standing pat.

With the euro straddling the $1.20 level, we note several technical levels converge in the $1.1920-1.1935 range. There are many with long euro exposures that are trapped from higher levels by the speed of the move. The euro’s recovery to $1.2030 brought in fresh selling. The dollar is knocking on JPY110.00. Above there we see initial potential into the JPY110.50-110.65 area. Sterling is through the neckline of a possible double top (~$1.37), which should offer resistance now. It projects toward $1.30-1.31, near the 50% retracement of the rally from the flash crash low (on Bloomberg) in October 2016. More immediately, support is seen near $1.3550, a retracement objective of the leg up since last November.

The Australian dollar has recovered from the brief push through $0.7480-0.7500 area which had held last December. That put the Aussie at its lowest level since last June. It is possible that area corresponds to a neckline of a double top pattern (from September 2017 and January 2018 ~$0.8100). If valid, the would suggest a measuring objective near $0.6850, near where it bottomed in 2016. While the other currencies are trending lower, the Canadian dollar has moved broadly sideways in recent days. With a couple of exceptions, the CAD1.2820-1.2900 area has contained the US dollar for the past seven-eight sessions.

Asia’s economic reports included Japanese auto sales, which rose (0.5%) for the first time since last September. China’s Caixin manufacturing PMI ticked up to 51.1 from 51.0. The market had expected a slightly softer report. New Zealand reported a drop in the unemployment rate (4.4% vs. 4.5%), to a new nine-year low. The participation rate eased (70.8% vs. 70.9% and was initially 71%), and private sector wages slowed in Q1.

China’s markets re-opened after a two-day holiday. The Shanghai and Shenzhen composites slipped fractionally, but the CSI 300 managed to eke out a small gain. An index of H-shares fell over 1%. The yuan declined by 0.5% and saw its lowest level in more than three months. The PBOC set the reference rate 0.44% lower, which is a little more than the market expected. Some observers seem to be seeing an implicit threat ahead of the talks with a team of senior US Administration officials, led by Treasury Secretary Mnuchin and including noted trade hawks Lighthizer and Navarro.

It is possible, but that is not the most likely interpretation. As of the end of last week, the yuan was at a two-year high against its basket. It would help if the PBOC made the basket more transparent, though the Monetary Authority of Singapore has a similar practice. The yuan’s decline this week is less than the other reserve currencies in the SDR. That said, the same fundamental and technical considerations behind the dollar’s recovery broadly are also at work against the yuan. These include increase interest rate differentials and market positioning, and the prospects for further dollar appreciation may spur Chinese companies and investors to adjust hedges.

There were several new data points in Europe. The eurozone reported a 0.4% q/q increase in Q1 GDP, in line with expectations, down from 0.6% in Q4 2018 and the slowest pace since Q3 2016. We suspect that part of the moderation was spurred by transitory factors, like the weather. At the same time, though, we suspect that the cyclical growth momentum peaked last year. This assessment implies better data in Q2.

Lending support to this hypothesis, the April manufacturing PMI for the eurozone was revised to 56.2 from the 56.0 flash reading. It stood at 56.6 in March. France’s reading was revised higher (53.8 vs. 53.4 flash and 53.7 in March), while Germany was unchanged at 58.1 (vs. 58.2 in March). Spain surprised on the upside (54.4 vs. 54.1 expected) but still softer from the 54.8 report in March. Italy was the main disappointment. Its manufacturing PMI fell to 53.5 from 55.1 (54.5 expected). It is the lowest since January 2017.

The UK reported stronger than expected April construction PMI. It rose to 52.5 from 47.0 in March. The median forecast in the Bloomberg survey was for a 50.5 reading. Of the three main Markit surveys (manufacturing, services, and construction), today’s covers the smallest part of the UK economy and does little to offset the impact of a recent string of disappointing data. The UK holds local elections tomorrow, and Brexit continues to cast a pall over many issues. The hard exit camp is pushing back against some recent successes of the pro-Europe camp that is pushing to stay in the customs union.

The US ADP private sector job estimate may draw some attention, but it provided poor guidance in March by not giving a warning of the dramatic slowing in non-farm payrolls. Moreover, a disappointing report will also be shrugged off like yesterday’s softer ISM manufacturing reading, which at 57.3 is the lowest since last July.   Given the inflation print seen at the start of the week (core PCE deflator 1.9% vs. Fed target of 2%) and the possibility that unemployment and underemployment ticked lower in April, investors have begun discounting a chance for three more rate hikes this year.

We anticipate that the FOMC statement will look through the softness seen in some recent economic readings. These include the April Philly and Empire State Fed surveys the disappointing manufacturing PMI. The Fed’s assessment of price pressures will likely be tweaked higher. We have characterized our expectation as a hawkish hold, whereby the Fed does not change policy today but leaves no doubt in the market’s mind about the next moves in rates.

There’s really no specific news behind this week’s EM washout. Higher US rates are one major factor, perhaps ongoing trade tensions are another. Yet this week’s price action is simply a continuation of the trend that’s been seen all quarter. For Q2 so far, every EM currency is down except for PHP, with the worst performers being the high beta group RUB, ZAR, BRL, MXN, and TRY. Many currencies have seen their Q1 gains wiped out in Q2, and then some. This trend should continue, as we don’t really get the sense anyone wants to step in front of this freight train now.

Indonesia April CPI rose 3.4% y/y vs. 3.5% expected and 3.4% in March. Inflation remains in the bottom half of the 3-5% target range and should allow Bank Indonesia to remain on hold for the time being. However, the weak rupiah is a growing concern. Next policy meeting is May 17, and a hawkish surprise is possible.

Poland April CPI rose 1.6% y/y vs. 1.5% expected and 1.3% in March. Inflation has moved back into the 1.5-3.5% target range for the first time since January. However, limited price pressures should allow the central bank to keep rates steady this year. Next policy meeting is May 16, and no change is expected.