Dollar Firm in the Wake of ECB Decision and FOMC Minutes

  • Despite some early post-ECB losses yesterday, the euro battled back to end up basically flat
  • We believe shifting market expectations, especially with regards to the Fed, will be the next driver in the dollar rally
  • There are many Fed speakers today; US reports March PPI
  • The UK and the EU have agreed to extend the Brexit deadline until October 31
  • Voting began in India today and will run until May 19; Peru central bank is expected to keep rates steady at 2.75%
  • South Africa February manufacturing production is expected to rise 0.5% y/y

The dollar is mostly firmer against the majors in the wake of the ECB decision and FOMC minutes. Swissie and Stockie are outperforming, while the dollar bloc is underperforming. EM currencies are mostly weaker. INR and PHP are outperforming, while ZAR and TRY are underperforming. MSCI Asia Pacific was down 0.4%, with the Nikkei rising 0.1%. MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 1.6%. Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 1 bp at 2.48%, while the 3-month to 10-year spread steepened 2 bp to stand at 7 bp. Commodity prices are mostly lower, with Brent oil down 0.7%, copper down 0.5%, and gold down 0.3%.

Despite some early post-ECB losses yesterday, the euro battled back to end up basically flat. This broke a string of four straight ECB meetings day that the euro weakened.   Mr. Draghi did his best, as his dovish stance initially pushed the euro down to $1.1230 before it recovered. Less dovish than anticipated FOMC minutes did not have much lasting impact on the markets.

What exactly did the ECB signal? We thought Draghi was rather downbeat and that he is setting the table for possible action at the June meeting. New staff projections will be released then, are likely to reflect Draghi’s assessment that the slowdown has extended into this year. This would provide a good excuse to add further stimulus. And yet markets are coming around to the fact that the ECB is now pushing on a string, with limited recourse for more stimulus.

On the other hand, FOMC minutes were not as dovish as some hoped. Rather, the Fed presented a balance view that supports keeping rates steady until the economic outlook becomes clearer. The next FOMC meeting is May 1. While no action is expected then, it could be a meeting where officials hone their message. This is what happened at the January 30 meeting.

We believe shifting market expectations, especially with regards to the Fed, will be the next driver in the dollar rally. We remain upbeat on the US economic outlook this year and believe expectations of easing are overdone. When (if?) markets come around to this view, the greenback should benefit. Until then, we fear that currencies are stuck in recent ranges.

There are many Fed speakers today. Clarida, Williams, Bullard, Kashkari, and Bowman speak. All are voters this year except Kashkari. Fed officials have been pushing back forcefully against ideas of a rate cut this year, but the market has not yet come around. The Fed Funds futures strip still shows that the market is still pricing in solid odds of a rate cut in 2019 followed by another one in 2020.

The US reports March PPI. Headline PPI is seen steady at 1.9% y/y, while core PPI is seen falling a tick to 2.4% y/y. Yesterday’s CPI data was mixed, with headline coming in higher than expected and core coming in lower than expected. Limited price pressures mean that the Fed can keep rates on hold for the time being. Weekly jobless claims will also be reported.

The UK and the EU have agreed to extend the Brexit deadline until October 31. This was a compromise by both sides. The UK had asked for June 30, while the EU favored a longer one of up to a year. They basically split the difference. There would be a mid-term review in June, and the UK can leave earlier than October if Parliament can pass a deal.

The takeaway is that neither side wants a no-deal Brexit. It also appears likely that the end-game is some sort of soft Brexit. Over six months remain for a deal to be struck but never underestimate the capacity of politicians to go to the brink once again. May must now sell this latest compromise to an increasingly skeptical Parliament.

Despite what could be good news, sterling has not reacted much. Cable remains near the middle of the $1.30-1.32 range that has held since late March. Likewise, EUR/GBP remains smack in the middle of the .85-.87 range that has held since mid-February.

Perhaps sterling’s underperformance can be chalked up to rising UK political uncertainty. It’s clear that May is on the way out and that it’s a matter of when, not if. But the uncertainty runs much deeper. Can the Tories pull together with the DUP and remain in control? That is the base case but what if fresh elections are called? This is tail risk but opposition Labour is waiting in the wings. We do not think it’s coincidence that Labour did not throw May any sort of lifeline when she reached across the aisle last week.

Sweden March CPI remained steady at 1.9% y/y vs. 1.8% expected. On the other hand, CPIF eased a tick to 1.8% y/y. The Riksbank has started a modest tightening cycle, and this CPI data support the slow pace of rate hikes. Riksbank meets April 25 and is not expected to change policy.

Voting began in India today and will run until May 19, with results likely to be announced May 23. The vote is spread out over seven stages due to the difficult logistics involving 1 mln polling stations servicing an estimated 900 mln eligible voters. Polls suggest the ruling BJP-led coalition will win. With Modi seen as likely to win a second term, investors are likely to remain positive on Indian assets.

South Africa February manufacturing production is expected to rise 0.5% y/y vs. 0.3% in January. The economy remains sluggish, but the central bank cannot cut rates anytime soon as inflation picks up and the rand remains vulnerable. Next SARB meeting is May 23 and no change is expected then.

Peru central bank is expected to keep rates steady at 2.75%. CPI rose 2.3% y/y in March, above the 2% target but well within the 1-3% target range. Given global uncertainties, we think the central bank will remain on hold until at least H2.