Dollar Broadly Firmer Ahead of BOE Decision

  • The dollar rally is intensifying
  • UK Prime Minister May has arrived in Brussels to meet with EU leaders
  • Bank of England is expected to keep rates steady at 1.50%
  • The European Commission updated its economic forecasts; Germany reported weak December IP
  • Reserve Bank of India delivered a dovish surprise; Philippines remained on hold
  • Czech, Mexico, and Peru central banks are expected to stand pat too

The dollar is broadly firmer against the majors as the post-FOMC rally continues.  The yen and Swissie are outperforming, while the Scandies are underperforming.  EM currencies are broadly weaker.  MYR and INR are outperforming, while TRY and ZAR are underperforming.  MSCI Asia Pacific was down 0.2%, with the Nikkei falling 0.6%.  MSCI EM is down 0.4% so far today, with China markets closed all week for the Lunar New Year holiday.  Euro Stoxx 600 is down 0.5% near midday, while US equity futures are pointing to a lower open.  10-year UST yields are down 3 bp at 2.67%.  Commodity prices are mixed, with Brent oil down 0.3%, copper flat, and gold up 0.1%.

The dollar rally is intensifying.  Since last Thursday, the greenback is up against every major currency.  The best performers are JPY and CHF, while the worst are AUD and NZD.  DXY has risen every day after the FOMC meeting last week.  The greenback has also rallied against most of EM.  Here, the best performers are MYR and PEN, while the worst are ZAR and TRY.

Dollar gains have come despite low US rates.  The 10-year yield languishes below 2.70%, while the 2-year flirts with the 2.50% level.  The implied yield on the January 2020 Fed Funds futures contract remains below 2.40%, which suggests small odds of a rate cut this year.  When US rates adjust higher as we expect, the dollar rally should continue but for now, gains are being driven by negative developments elsewhere.

The US economy still looks like a relative star.  Atlanta Fed’s GDPNow model is now tracking 2.7% SAAR growth for Q4, up from 2.5% previously.  Elsewhere, the New York Fed’s Nowcast model is still tracking 2.6% SAAR growth in Q4 and 2.4% for Q1.

UK Prime Minister May has arrived in Brussels to meet with EU leaders.  After the recent Parliamentary referendums, May is faced with the impossible task of renegotiating the Irish backstop.  The EU has said this is non-negotiable, and yet here she is saying that the UK cannot be trapped in a customs union with the EU for an open-ended time.

Bank of England is expected to keep rates steady at 1.50%.  With Brexit uncertainty likely to continue right up until the Article 50 deadline of March 29 (perhaps longer), the BOE remains in wait and see mode.  We expect Governor Carney to warn of the risks posed by Brexit and to reiterate the bank stands ready to take whatever actions are needed to deal with the fallout.

After this week’s meeting, the next ones scheduled are March 21, May 2, June 20, and August 1.  We suspect that Brexit uncertainty will remain in play at the March meeting, as talks are likely to go right down to the wire.  And our base case remains that the two sides will eventually kick the can into the autumn.  In that case, all the meetings through the summer are likely to be non-events.  Stay tuned.

Sterling is trading at its lowest level since January 22.  We still expect cable to fall to at least $1.2830, which represents half of this year’s rally.  The next major retracement objective after that is $1.2735, a break of which would set up a test of the January low near $1.2440.

The European Commission updated its economic forecasts.  It basically followed the IMF’s lead and marked down its eurozone forecasts, particularly for Germany and Italy.  Germany is now seen growing 1.1% this year vs. 1.8% previously, while Italy is seen growing 0.2% this year vs. 1.2% previously.  Overall, eurozone is now seen growing 1.3% this year vs. 1.9% previously before rebounding to 1.6% next year.

Germany reported weak December IP.  Rather than rising 0.8% m/m that the consensus saw, IP contracted -0.4% m/m instead.  This dragged the y/y rate down to -3.9% vs. -3.4% expected.  This is just the latest in a series of disappointing data out of Germany.

The euro is trading at its lowest level since January 25.  The break of the $1.1375 area yesterday sets up a test of the January 24 low near $1.1290.  After that is the November low near $1.1215.

New Zealand reported weak Q4 labor market data overnight.  The unemployment rate rose to 4.3% vs. 4.1% expected, while employment growth was only 2.3% y/y vs. 2.6% expected.  The participation rate fell to 70.9% vs. 71.1% expected.  Overall, data support the case for steady rates.  RBNZ meets February 13 and is widely expected to keep rates steady at 1.75%.

NZD has followed AUD lower and is on track to test the January 22 low near .6705.  A break below that would set up a test of the January low near .6575.  This is similar to price action in AUD, which is on track to test its January 25 low near .7075.  Break below that would target the January 4 low near .7000.

Reserve Bank of India delivered a dovish surprise.  Rather than standing pat as most expected, it instead cut rates 25 bp.  Ahead of general elections in May, the RBI just delivered a nice present to Prime Minister Modi.  This was the first meeting under new Governor Das and will immediately call his independence into question since he replaced the more hawkish Urjit Patel.  INR rallied today but we think this rate cut is very negative for the rupee.

Philippines central bank kept rates steady at 4.75%, as expected.  Earlier this week, the nation reported January inflation of 4.4% y/y vs. 5.1% in December.  It was the lowest since last March and nearing the 2-4% target range.  The bank shaved its inflation forecast for this year to 3.07%.  It’s too early to contemplate a rate cut, but we think one could materialize later this year.

Czech National Bank is expected to keep rates steady at 1.75%.  CPI rose 2.0% in December, right on target.  The economy slowed sharply going into year -end.  With headwinds growing, we see steady rates for now.

Mexico January CPI is expected to rise 4.47% y/y vs. 4.83% in December.  If so, it would be the lowest since last May but still above the 2-4% target range.  Banco de Mexico meets later today and is expected to keep rates steady at 8.25%.  Going forward, monetary policy will be driven in large part by the peso.

Peru central bank is expected to keep rates steady at 2.75%.  Inflation was 2.1% y/y in January, well within the 1-3% target range.  Market sees the first hike at the March 7 meeting, but the bank may extend its pause if the global outlook worsens.