Dollar and Yen Surge, European Data Disappoint

Dollar Yen

  • The US dollar has extended its gains against most of the major currencies
  • The flash May PMI eurozone report disappointed; UK price pressures eased
  • Italy political drama is has spurred a significant rally in the Swiss franc
  • Investors focus on the minutes is on the significance of adding “symmetrical” (twice) to the FOMC statement
  • The different responses from Argentina and Turkey to a budding currency crisis couldn’t be any starker
  • Malaysia, Singapore, and South Africa all reported lower than expected inflation; Brazil mid-May IPCA inflation is expected at 2.82% y/y

The dollar is mostly firmer against the majors as risk-off sentiment seems to be picking up. The yen and Swissie are outperforming, while the Scandies and sterling are underperforming. EM currencies are broadly weaker. KRW and TWD are outperforming, while TRY and PLN are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei falling 1.2%. MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 1.4%. Euro Stoxx 600 is down 1% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 5 bp at 3.01%. Commodity prices are mostly lower, with Brent oil down nearly 1%, copper down 2.1%, and gold up 0.5%.

 The US dollar has extended its gains against most of the major currencies. Momentum, positioning, and divergence continue to drive it. The euro briefly traded a little below $1.17, an important technical area and has enjoyed a bounce in late morning turnover in Europe. There is a 707 mln euro option struck there that expires today and 1.1 bln euros at $1.1750. The 1 bln euro option at $1.1785 may not be relevant anymore.

The dollar’s pullback began Monday but ran out of steam early yesterday and was snapped up. The positioning in the futures markets, as of a week ago, still points to large speculative (momentum and trend following market segment for the most part) euro exposure. The flash composite PMI for the eurozone confirms that the slowdown seen in Q1 has carried over into Q2.

On the other hand, the yen has surged. It is up 1% against the dollar. There has been much talk today of Japanese accounts buying yen against the Turkish lira. The Turkish lira has been a favorite high yield story for Japanese households. The Turkish lira is off about 3.3% near midday in Europe, while it had been down 5% earlier. It has fallen 8.5% over the past week and is rivaling the Argentine peso for the biggest decline over the past month (TRY-15% vs. ARS -16.5%).

The important point about the yen’s strength is that may not be best to understand it as safe-haven demand, but rather as the unwinding of a short-yen carry trade. The yen’s use as a financing currency is the key and not the attractiveness of Japan’s asset markets.

Stops were trigged as the dollar fell through the JPY110.00 level. It peaked on Monday near JPY111.40. It is slipping through the 20-day moving average for the first time since April 4. The JPY109.70 area that has been tested corresponds to a 61.8% retracement of this month’s gains (from May 4 lows near JPY108.65). Nearby support is seen in a congestion area around JPY109.30. There is a $370 option at JPY109.50 that expires today, and $2 bln struck at JPY110.

The flash May PMI eurozone report disappointed. It impacts expectations for next month’s ECB meeting. Recall that at the end of last year, many seemed to anticipate that the ECB’s word clues would quickly evolve toward a solid commitment to end the asset purchases. However, the facts, in this case, the economic performance, have gotten in the way. Prices and economic activity have gone in the wrong direction. If last time Draghi was “caution tapered by confidence,” the ECB may say that it is its confidence that has been tapered.

The composite reading fell to 54.1 from 55.1 in April. It is the lowest reading since November 2016. The composite PMI averaged 56.4 in 2017 and 57.0 in Q1. Both services and manufacturing fell. German manufacturing weakened (56.8 from 58.1), though France rose to (55.1 from 53.8). German services PMI eased to 52.1 from 53.0. The French service PMI fell to 54.3 from 57.4.

In the UK, price pressures eased. Headline CPI eased to 2.4% y/y from 2.5%, while the CPIH (which includes owner housing costs) slipped to 2.2% y/y from 2.3%. The core rate slowed to 2.1% y/y from 2.3%. The report does nothing to bring forward a BOE rate hike. The implied yield of the December short-sterling futures contract is a couple of basis points lower today. Indeed, the implied yield of 64 bp is the lowest in four months.

Sterling has made a new low for the today, a little below $1.3350. The measuring objective of the large double top we have been monitoring is in the $1.30-1.31 area, and sterling is wasting little time. Nearby support is seen around $1.3300, which is also where the lower Bollinger Band is found.

Italy political drama is has spurred a significant rally in the Swiss franc. Over the past five days, it has been the strongest of the majors, rising 1.1% against the dollar and 1.8% against the euro. Today, it is the only major currency beside the yen that is gaining ground. Italian assets were given a reprieve yesterday, but the selling resumed today. The 10-year yield is up 11 bp, and the spread over Germany has widened by 16 bp. The Italian stock market is off 1.7%, roughly twice as much as the Dow Jones Stoxx 600.

Yesterday, the euro found support near the top of the band of support we identified in the CHF1.1660-1.1680 area. The euro has cut through that area today like a hot knife in butter. It fell to CHF1.1600 before steadying. Old support should now be resistance, with the next technical target near CHF1.1480.

Markit reports the flash US PMIs, but the flash readings have not caught on as they have in Europe. April new home sales are also released. Sales are expected to have slowed after strong gains in February and March (3.6% and 4.0% respectively). The average monthly gain in 2017 was 1.7%.   The highlight of the day may be the FOMC minutes. The market is as confident of a hike next month as it gets.

Investors focus on the minutes is on the significance of adding “symmetrical” (twice) to the FOMC statement in terms of the price stability mandate and the yield curve. Don’t expect much closure. The fact that prices increases and wage growth are not accelerating gives the Fed scope to be gradual in raising rates. It is clear from official comments that the Fed itself is divided on the signals from a negative yield curve.

The different responses from Argentina and Turkey to a budding currency crisis couldn’t be any starker. Argentina hiked rates sharply, announced fiscal tightening, intervened in the FX market, and quickly approached the IMF for a standby program. Turkey has done none of those things, and Erdogan’s strained relationship with the West makes its situation even more unpredictable.

By waiting too long, Turkish policymakers will have to take even more drastic measures. It has not had an IMF program since completing the last one in 2008. Since then, Erdogan’s policies have become more unorthodox and we cannot see him going hat in hand to the IMF now. If Turkey decides to go it alone, then some form of capital controls seem unavoidable. The situation is still developing and a huge Argentina-style rate hike might yet stabilize the lira. However, time is running out for policymakers there.

Malaysia April CPI rose 1.4% y/y vs. 1.6% expected and 1.3% in March. Bank Negara does not have an explicit inflation target, but low price pressures should allow it to remain on hold for much of this year. Next policy meeting is July 11, and no change is expected then.

Singapore April CPI rose 0.1% y/y vs. 0.4% expected and 0.2% in March. While the MAS does not have an explicit inflation target, low price pressures should allow it to remain on hold at its next policy meeting in October.

South Africa April CPI rose 4.5% y/y vs. 4.7% expected and 3.8% in March. Inflation has moved back to the center of the 3-6% target range. SARB meets Thursday and is expected to keep rates steady at 6.5%. The weak rand is likely to keep the central bank on hold for the foreseeable future.

Brazil mid-May IPCA inflation is expected at 2.82% y/y vs. 2.80% in mid-April. While this would remain near the bottom of the 2.5-6.5% target range, the weak BRL is likely to make the next move a hike. CDIs are pricing in a rate hike by year-end, while analysts see one in early 2019. We think the timing will depend in large part on 1) BRL and 2) elections. The two are of course intertwined. No move is seen at the next meeting June 20.