Dollar Firms But FOMC Minutes Pose Dovish Risks

  • We suspect the corrective/consolidative trading conditions are not over just yet
  • FOMC minutes will be released, where we see dovish risks
  • Sterling has rallied on Brexit optimism; we think this optimism is overdone
  • The US has reportedly asked China to keep the value of the yuan stable as part of ongoing trade negotiations
  • Japan reported January trade data; Governor Kuroda said today that the BOJ does not target exchange rates
  • South Africa January CPI rose 4.0% y/y; Finance Minister Mboweni makes his FY2019/20 budget statement later today

The dollar is mostly firmer against the majors ahead of FOMC minutes. Swissie and Loonie are outperforming, while sterling and Kiwi are underperforming. EM currencies are mixed. CNY and THB are outperforming, while ZAR and TRY are underperforming. MSCI Asia Pacific was up 0.8%, with the Nikkei rising 0.6%. MSCI EM is up 1.1% so far today, with the Shanghai Composite rising 0.2%. Euro Stoxx 600 is up 0.2% near midday, while US equity futures are pointing to a lower open. 10-year UST yields are flat at 2.63%. Commodity prices are mixed, with Brent oil down 0.5%, copper up 0.2%, and gold up 0.2%.

The dollar is stabilizing today but we suspect the corrective/consolidative trading conditions are not over just yet. Markets are still hoping to get clarity on the true state of the US economy but that will take some time. There is some growing optimism with regards to Brexit and US-China trade talks (see below). While that optimism seems overdone, it may be enough to keep the dollar under pressure near-term.

FOMC minutes will be released, where we see dovish risks. In hindsight, recent data clearly justify its patient approach. But what made the Fed so worried back in January? Will the minutes help explain the Fed’s extremely dovish 180 turn last month? With all the recent attention on the Fed’s balance sheet runoff, we expect the minutes to focus on the issue of when to stop it. Next FOMC meeting is March 20. No change in policy is expected then, but it seems likely that the Dot Plots will shift down.

There are many Fed speakers this week. Mester spoke yesterday and said she prefers ending the balance sheet runoff this year. She added that she sees no need to taper before ending the runoff, but that the Fed should announce the end well in advance. She is not a voting member of the FOMC this year. Kaplan speaks today, who is also a non-voter in 2019.

Sterling rallied yesterday on Brexit optimism to trade at the highest level since February 4. Break above the $1.3045 area sets up a test of the January 25 high near $1.3215. However, the move is running out of steam today. Optimism was driven by reports of a “significant” meeting regarding the Irish backstop today between May and Juncker. May’s plan is to get concessions and put it to a Parliamentary vote next week.

We still see this as a non-starter and believe the recent Brexit optimism is overdone. Juncker downplayed today’s meeting, saying it was unlikely to produce any “concrete outcome.” For good measure, Juncker added that “I’m losing my time with this Brexit.”

This Brexit optimism also helped drag the euro higher. The single currency posted an upside up day yesterday that suggests further gains. However, like sterling, the euro’s upside momentum has stalled today. Next retracement objectives from the January-February drop come in near $1.1375 and $1.1405. Break of those levels would set up a test of the January 31 high near $1.1515.

The US has reportedly asked China to keep the value of the yuan stable as part of ongoing trade negotiations. This is a loaded request. If China is to introduce greater market forces in its economy, it can’t pledge to keep the yuan stable. Indeed, the correlation between CNY and MSCI EM FX has risen to a cycle high of -.7380 currently, reflecting what we see as greater market determination of the yuan’s exchange rate.

When push comes to shove, we just don’t think it’s something that China can commit to. Policymakers there are already juggling so many balls right now that it would be foolhardy to try and target the exchange rate too. Pegging or quasi-pegging the yuan while the external balances are rapidly shifting would lead to more problems later, in our view.

Rising US-China optimism has helped fuel further AUD gains. Next retracement objectives from the January-February drop come in near 0.7175 and 0.7205. Break of those levels would set up a test of the January 31 high near .7300. The recent bounce is losing some momentum today. Jobs data out tonight are likely to be a big factor in determining Aussie’s near-term direction.

Japan reported January trade data. Exports were expected to contract -5.7% y/y but instead fell -8.4% y/y, while imports fell -0.6% y/y vs. -3.5% expected. As a result, the adjusted deficit came in at -JPY370 bln vs. -JPY150.7 bln expected. The drop in exports is clearly worrisome, though we put more emphasis on global growth as a cause than we do on the exchange rate.

Governor Kuroda said today that the BOJ does not target exchange rates. He was walking back his recent statement that a stronger yen could force the BOJ to enact more stimulus. Explicitly linking the yen with monetary policy is a big no-no and opens up Japan to accusations of currency manipulation. For now, it’s steady as she goes for the BOJ. Next policy meeting is March 15, no change is expected.

USD/JPY continues to edge higher, up four straight days not and seven of the past eight. A test of the December 13 high near 113.70 seems likely, though the pair first has to get through the 200-day moving average near 111.30 currently. Much will depend on external factors, with risks that the pair will drop during times of elevated market stresses.

South Africa January CPI rose 4.0% y/y vs. 4.3% expected and 4.5% in December. Inflation is below the 4.5% target for the first time since May. Still, the vulnerable rand is likely to prevent the SARB from cutting rates anytime soon. Next policy meeting is March 28 and no change is expected then. However, there are risks that the bank will start to tile more dovish then.

Finance Minister Mboweni will make his FY2019/20 budget statement later today. He faces a tough balancing act ahead of May elections. When all is said and done, we expect a prudent budget that seeks to limit the deterioration in the fiscal outlook. Mboweni knows that if he doesn’t deliver, the rating agencies would be inclined to downgrade the nation.