Dollar Firm as Divergence Theme Builds

  • Many seemed puzzled as to why dollar was so bid yesterday
  • Strong US data and worries about a weak eurozone were in play last week and that too has carried over
  • With no real Brexit news to speak of, sterling continues its downward drift
  • CAD is soft ahead of the BOC decision
  • Australia reported very soft Q1 CPI data
  • EM FX remains under pressure; Mexico mid-April CPI is expected to rise 4.22% y/y

The dollar is mostly firmer against the majors as the rally continues. Sterling and Swissie are outperforming, while the Antipodeans are underperforming. EM currencies are broadly weaker. CNY and MYR are outperforming, while KRW and TRY are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.3%. MSCI EM is down 0.1% so far today, with the Shanghai Composite rising 0.1%. Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 3 bp at 2.53%, while the 3-month to 10-year spread has flattened 3 bp to 12 bp. Commodity prices are mixed, with Brent oil flat, copper up 0.6%, and gold flat.

Many seemed puzzled as to why dollar was so bid yesterday. We think the main reason is strong momentum carrying over from last week. Recall that we basically ended the week Thursday after the strong retail sales report. Then US and Europe went on vacation. Yesterday was the first full day of trading since Thursday and so we think there is some pent-up dollar demand.

Strong US data and worries about a weak eurozone were in play last week and that too has carried over. Yesterday, we got much stronger than expected new home sales. Sales rose 4.5% m/m instead of consensus -2.7%, while February was revised up to 5.9% m/m from 4.9% previously.

Today, IFO reported softer than expected German business confidence for April. Headline fell to 99.2 vs. 99.9 expected. Expectations fell to 95.2 vs. 96.1 expected, while current assessment fell 103.3 vs. 103.5 expected. France also reported soft April manufacturing confidence today, as it fell to 101 vs. 102 expected.

During the North American session, there are no US data reports except for weekly mortgage applications. The media embargo for the May 1 FOMC meeting has gone into effect and so there are no Fed speakers until after that meeting.

With no real Brexit news to speak of, sterling continues its downward drift. Cable has broken decisively below $1.30 to trade at its lowest level since February 19. A test of the February low near $1.2775 is likely and a break below the $1.28 area would set up a test of the January low near $1.2440.

Bank of Canada is expected to keep rates steady at 1.75%. Soft data in recent months has led the BOC to keep rates steady since October and to maintain a more dovish stance. Market does not fully price in the next 25 bp hike until mid-2020, but we suspect the BOC is done hiking. Risk is tilted towards a dovish hold today.

CAD is soft ahead of the BOC decision. USD/CAD is approaching the March high near 1.3470 and a break above would set up a test of the December high near 1.3665. Higher oil prices might slow the move, but this remains a strong USD story.

Australia reported very soft Q1 CPI data. Headline inflation was expected at 1.5% y/y vs. 1.8% in Q4, but instead it rose only 1.3%. Trimmed mean was expected at 1.7% y/y vs. 1.8% in Q4, but instead it rose only 1.6%. The most recent RBA minutes show that it discussed rate cut scenarios but decided that there was “not a strong case” to ease near-term. We think the case is getting stronger for the RBA to shift to an easing bias.

The next RBA meeting May 7 may be too soon. Instead, we look for an easing bias at the June 4 meeting with a rate cut to follow in H2. Calls for a rate cut as soon as May 7 seem overdone but make no mistake, RBA will ease this year. AUD is on track to test the March low near .7000. A break below the .6955 area is needed to set up a test of the January low near .6740.

EM FX remains under pressure. It’s really a strong dollar story here, but we feel that there are some idiosyncratic risks too. BRL outlook is rocky given likely delays to pension reforms, while TRY should continue to suffer from policy missteps by Erdogan. In addition, the broad macro backdrop for EM as an asset class remains challenging. As we wrote earlier this week, higher oil prices should be seen as a net negative for EM, since the largest EM economies are oil importers.

Mexico mid-April CPI is expected to rise 4.22% y/y vs. 3.95% in mid-March. If so, it would be the highest since January and further above the 2-4% target range. Banco de Mexico might be able to cut rates later this year, but for now, it’s steady rates. Next policy meeting is May 16, no change is expected then. March trade will be reported Friday, where a $2.1 bln surplus is expected.