Dollar Firms With Focus Back on Fed Liftoff

BBH Market Strategists discuss key market events: The Bank of Canada cut rates while the BOE is seen as next central bank to hike rates. Greek parliament approved the “prior action” reforms and Mexico’s first oil field auction a disappointment.

  • The US dollar remains bid after Yellen’s comments and the Beige Book signal that the Federal Reserve is still on track to raise rates this year
  • The Bank of Canada cut rates yesterday and signalled that if needed, it can cut rates again or use other tools, such as asset purchases
  • The BOE is widely seen as the next central bank to hike rates, after the Federal Reserve
  • The Greek parliament approved the “prior action” reforms by an overwhelming majority
  • The ECB meets today; Draghi will likely face many questions about Greece
  • Mexico’s first historic oil field auction turned out to be a disappointment

Price action:  The dollar is mostly firmer against the majors.  The Norwegian krone is outperforming, while the Kiwi is underperforming in the second session of heavy losses and now trading just over $0.65.  The Australian dollar is moving the other way, rising back to $0.74, making up for some of yesterday’s losses.  The euro is testing the $1.09 level, but has yet to make a decisive break below.  Against the pound, the euro fell below the £0.70 level for the first time since 2007.  The dollar is little changed against the yen at around ¥124.0.  KRW continues to underperform on the EM side, with most currencies softer on the day.  TWD and IDR are outperforming and flat on the day.  The Shanghai Composite was up 0.5% and the Nikkei was up 0.7%.  Euro Stoxx 600 is up 1.3% and US futures are pointing to a higher open.  Greek 10-year yields are down 48 bp according to Bloomberg pricing, while the rest of the periphery is little changed.  Crude prices are rebounding by 1% after yesterday’s heavy losses.

  • The US dollar remains bid.  Yellen’s comments and the Beige Book signal that the Federal Reserve is still on track to raise rates this year.  In contrast, as Draghi will make clear today, the ECB is committed to completing its unorthodox easing.
  • Yesterday the Bank of Japan trimmed its inflation forecasts.  It no longer expects its target to be hit until after 2018.   Many continue to expect the BOJ to provide more stimulus.  News that China’s GDP expanded by 7% last quarter was met with derision.  The PBOC is also expected to provide more stimulus.
  • The Bank of Canada cut rates yesterday and signalled that if needed it can cut rates again or use other tools, such as asset purchases.  The Canadian dollar has fallen to new multi-year lows.  A soft inflation report (Q2 0.3% year-over-year) and the nearly 11% drop in milk prices has sent the New Zealand dollar to new multi-year lows.  While a 25 bp rate cut for the July 23 RBNZ meeting is completely priced in, there has been some new speculation of a 50 bp move.  This is a bit much but illustrates the psychology at work.
  • The BOE is widely seen as the next central bank to hike rates, after the Federal Reserve.  Although sterling’s upside momentum against the dollar has eased after an almost 3.5-cent rally five days through yesterday, it is at its best level against the euro since 2007.  The SONIA curve implies a shift in BOE hike expectations to March 2016 from mid-2016 in the past couple of weeks.  Wage pressures are the main reason why expectations that 1-2 MPC members will dissent as early as next month in favor of a rate hike.
  • The risk is that the market is getting ahead of itself here, as it has done before.  Carney wants British households to begin acting as if a rate hike is coming, as he did last year, but, like the Federal Reserve is constrained by the data.  News that British Gas will cut prices as of next month (others expected to follow) and the new drop in oil prices, coupled with sterling’s strength on a trade-weighted measure, illustrate some of the broad economic forces that may mitigate the wage pressure.
  • With the Greek parliament approving the “prior action” reforms by an overwhelming majority (229-64), attention turns to the ECB meeting.  Draghi is likely to note that the region’s economy has moved along the way the staff forecasted last month.  The expansion continues, and the lending conditions, both supply and demand, are gradually improving.  The media questions are likely to focus on Greece.  There may be some questions too about the accelerated bond purchases that do not appear to have materialized.
  • The decision about Greece’s ELA is key.  It is not clear when it will be announced.  Greece has passed the reforms needed to start negotiations for a third aid package.  The ECB could wait for the national parliaments to approve the new negotiations.  News that the euro area has agreed in principle to a 7 bln euro bridge loan is another sign that conditions are moving away from the edge of the abyss.
  • In addition to a political hurdle, there are two more technical issues the ECB must consider.  First, are Greek banks still solvent, given the deposit withdrawals and deteriorating loan books?  The second issue involves the collateral that Greek banks use for the ELA borrowings.  Do they have sufficient collateral?  Has some of the existing collateral been impaired?
  • Greek banks cannot re-open without new liquidity provisions.  Even with the capital controls, there are still many practical difficulties, like ATMs running out of money or 20 euro notes (meaning more people end up withdrawing 50 euros rather than 60 maximum).  Capital controls will likely have to remain in place for some time.
  • The Shanghai Composite rose 0.5%, recovering from an intra-day loss of over 3%.  The smaller-cap Shenzhen Composite rose 1.3%.  About a quarter of the market remains suspended.  Margin use fell today, after rising for the past three sessions.   Separately, we note that the PBOC drained liquidity from the banking system via money market operations for the first time since April.  The PBOC conducted CNY40 bln of reverse-repos in the face of CNY85 bln maturing.  This represents a net withdrawal of CNY45 bln.  In the initial response to the stock market slide, the PBOC injected funds and cut rates.
  • Mexico’s first historic oil field auction turned out to be a disappointment.  Only 2 of the 14 shallow-water fields received qualifying bids.  The government had targeted $17 bln for this first round, but only got $2.6 bln.  The president of Mexico’s oil regulator agency, Zepeda, tried to put a positive spin on the results by calling them a “solid start.”  It doesn’t look that way.  Some believe that the main reason was that the government’s minimum investment requirements were too high given the pressure on oil prices.  There are four more auctions, so the government still has plenty of opportunities to adjust.  The Mexican bolsa shrugged off the news closing flat on the day, but the peso has underperformed.  We expect USD/MXN to continue making new all-time highs in the coming weeks.