Dollar Consolidates Gains, Sterling Continues to Shine

The near-term developments in Greece are constructive – Comments by Yellen and Carney have put the diverging monetary policies back on center stage – Chinese stocks continue to dance to the tune of policy headlines – Brazil reports monthly GDP proxy for May; Poland reports June real retail sales and IP

  •  The near-term developments in Greece are constructive
  • Comments by Yellen and Carney have put the diverging monetary policies back on center stage
  • Chinese stocks continue to dance to the tune of policy headlines
  • Brazil reports monthly GDP proxy for May; Poland reports June real retail sales and IP

Price action: The dollar is little changed on the day in generally quiet markets.  The euro is stable around the $1.09 level and sterling is up slightly to around $1.5630.  The dollar is trading just over ¥124 against the yen.  Trading in the EM space is equally quiet.  ZAR and TRY are outperforming.  Several Asian markets were closed for holiday but the Shanghai Composite was 3.5% higher while the Nikkei was up 0.25%.  European equities are largely flat, while S&P futures are pointing to a lower open.

  • The near-term developments in Greece are constructive.  European officials have agreed on a guarantee for non-EMU countries in the 7 bln euro bridge loan.  Parliaments are approving the beginning of negotiations with Greece over a third aid package.  The German vote is still pending.  Despite some defects from both of the main coalition parties and Schaeuble’s continued (since 2011) support for a Greek exit, it should be approved by parliament.
  • The conditions then are in place for Greece to make next week’s payments to the IMF and the ECB.  With the ELA being doled out again, Greek banks are set to open on Monday.  More ELA is likely to be granted next week as well.  This coupled with a rally in Greek bonds (where the domestic market has largely been shut as well for the past three weeks) will help support the banks.  Capital controls will have to remain.  The history of capital controls warn that when adopted, they tend to last longer than anticipated.
  • It is too early to reach hard long-term conclusions about Greece’s third aid package.  European officials say the IMF’s role is essential, and the IMF says that Greece’s debt is categorically unsustainable, without significant debt relief.  This is going to have to be worked out in the negotiations in the coming weeks.  This fissure between the IMF and European officials has been exposed by the Greek referendum.
  • With the can apparently being kicked just far enough down the road to push the Greek drama off center stage, the diverging monetary policies reemerged this week as a key force.  Yellen and Carney’s comments underscore that less accommodative monetary policies are coming for the US and UK, while much of the rest of the high income countries (and many emerging markets) are still in an easing mode.
  • The dollar gained against all major currencies this week but sterling, which is up about 0.8% on the week.  This was largely driven by Carney’s comment yesterday that a rate hike will come into sharper focus at the end of 2015.  Since the middle of last week, the March and June 2016 short-sterling futures contracts have sold-off sharply, and the implied interest rates have risen 20-23 bp.  The backing up of interest rates has driven the broad trade-weighted sterling index to new highs since 2008.  It has risen by more than 2% during this increase in rate expectations.
  • Chinese stocks continue to dance to the tune of policy headlines.  Today’s news included a comment that the government’s margin finance and liquidity facility, China Securities Finance Corp, has RMB2.5-3 trln to support stocks via liquidity to brokerages and mutual funds. Meanwhile, China Development Bank and the Export-Import Bank of China will get $32 bln and $30 bln, respectively, from the PBOC’s FX reserves in exchange for equity stakes.  The measures show that the government still has plenty of tricks up its sleeves to prop up equity markets.
  • During the North American session, the US reports June CPI.  Headline is expected to rise 0.1% y/y vs. a flat reading in May.  Core is seen rising to 1.8% y/y from 1.7% in May.  Fed Vice Chairman Fischer speaks today.  We would expect him to reinforce Yellen’s message that Fed lift-off this year remains likely.  The US will also report June housing starts and building permits and July University of Michigan consumer confidence.
  • Canada also reports June CPI, expected to rise 1.0% y/y vs. 0.9% in May.  Core is seen steady at 2.2%.  After the BOC cut rates this week and raised the possibility of QE, it’s clear that real sector concerns are driving policy now and that further easing is being contemplated.  A weaker CAD will be part of the process.  The 1.3065 high from March 2009 is the next obvious target.  After that, the next big target looming ahead is the May 2004 high near 1.40.  With many of the commodity-centric EM currencies on track to test 2002-2003 levels, we see no reason why CAD can’t do the same.  It too benefited from the commodity super cycle that has now ended.
  • Brazil reports monthly GDP proxy for May, expected at -4.0% y/y vs. -3.1% in April.  The economy continues to contract, and appears to have fared worse in Q2.  With interest rates still rising, we do not think the worst is behind us yet.  Yet COPOM is widely expected to hike rates by another 50 bp at its next meeting July 29.  Political risk appears to be rising, with local press reporting that former President Lula is under investigation by federal prosecutors for corruption.  This really shouldn’t come as a big surprise and clearly, it’s negative near-term.  Longer-term, it might end up being BRL-supportive if it removes Lula, Rousseff, and the PT from the 2018 presidential election calculus.
  • Poland reports June real retail sales and IP, seen rising 5.4% and 7.0%, respectively.  Real sector remains robust, so we see steady rates for now.  June CPI was reported Wednesday at the expected -0.8% y/y vs. -0.9% in May.  Low base effects should see the y/y rate return to positive territory in H2, and supports the case for no further rate cuts.  On the political front, opposition Law and Justice is widening its lead ahead of general elections this fall, with latest polls showing 36% support vs. 29% for the ruling Civic Platform.