Dollar Gets a Boost From Mr. Draghi

  • The dollar got a boost from Mr. Draghi, who is setting the table for his successor to be able to add more stimulus
  • During the North American session, the US reports May housing starts and building permits
  • The Tory leadership race continues with the second-round vote today
  • RBA released its minutes
  • Turkey reported April IP; India slapped retaliatory tariffs on US goods

The dollar is mostly firmer against the majors with a little help from Mr. Draghi. Kiwi and yen are outperforming, while Stockie and euro are underperforming. EM currencies are mixed. TRY and ZAR are outperforming, while the CEE currencies are underperforming. MSCI Asia Pacific was up 0.3%, with the Nikkei falling 0.7%. MSCI EM is up 0.6% so far today, with the Shanghai Composite rising 0.1%. Euro Stoxx 600 is up 0.7% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 5 bp at 2.05%, while the 3-month to 10-year spread has inverted 5 bp and stands at -13 bp. Commodity prices are mixed, with Brent oil down 0.8%, copper up 0.8%, and gold up 0.5%.

The dollar got a boost from Mr. Draghi. At the ECB’s annual forum in Sintra, he noted that “additional stimulus will be required” if the economic outlook doesn’t improve. Draghi also noted that further rate cuts remain in the ECB’s toolkit, as does QE. He added that renewed asset purchases would likely require raising self-imposed limits on how much the ECB can buy.

It’s clear that Draghi is setting the table for his successor to be able to add more stimulus. Draghi’s term ends October 31, and he recognizes that the more will likely need to be done. The remaining ECB meetings for this year are July 25, September 12, and October 24 giving him three more meetings to help shape the policy debate before he steps down. Today’s comments suggest he may go out with a bang.

Therein lies the other side of the coin for the dollar rally. We have remained constructive on the US economy and questioned the need for rate cuts. Indeed, we suspect markets will be disappointed by the Fed tomorrow in terms of getting a dovish signal. Now, Draghi is reminding markets that much of the world is still likely to ease. BOJ will likely stress the scope for further easing when it meets Thursday.

The euro is trading at its lowest level since June 3 and is on track to test the May 30 low near $1.1115. DXY has seen similar price action and is on track to test the May 30 high near 98.281. Sterling is making new lows for this move near $1.2510, while USD/JPY remains pinned near 108. We remain bullish on the dollar.

During the North American session, the US reports May housing starts and building permits. They are expected to rise 0.4% m/m and 0.2% mm, respectively. The markets shrugged off yesterday’s much weaker than expected Empire Manufacturing survey reading of -8.6. Canada reports April manufacturing sales, which are expected to rise 0.4% m/m vs. 2.1% in March.

The Tory leadership race continues with the second-round vote today. Boris Johnson dominated the first-round vote last week, winning 114 votes from his party vs. 43 for runner-up Jeremy Hunt. Seven candidates go on to the second round, with Gove (37 votes), Raab (27), Javid (23), Hancock (20), and Stewart (19) rounding out the field. Results of the vote are expected out today around 6 PM London time. At least 33 votes are needed to advance to the next round. If everyone gets 33, then the one with the fewest votes is eliminated.

Several more rounds of voting by MPs will be held Wednesday and Thursday until there are only two candidates left. Voting then goes to a full vote of Conservative party members June 22, with the next Prime Minister to be announced July 22. Meanwhile, sterling continues to sink and making new lows for this move. It is on track to test the January low near $1.2440. Likewise, EUR/GBP is making new highs for this move and is on track to test the January high near .91085.

RBA released its minutes. It signaled that further easing was “more likely than not” given spare capacity in the labor market and the economy. The bank also warned of “intensifying downside risk” stemming from the US-China trade war. Next policy meeting is July 2 and no change is expected then though a couple of analysts are calling for a cut then. WIRP suggests 55% odds of a cut then, but we suspect the RBA will wait until the August 6 meeting. AUD is making new lows for this move near .6830 and is on track to test the January low near .6740.

India slapped retaliatory tariffs on US goods. The move was in response to the US revoking India’s preferential trading privileges as a developing nation. Some tariffs are as high as 70% and cover 28 products overall. While the affected amount of imports is small at $241 mln, India is a top ten trading partner for the US and so the negative impact may grow if further actions are taken by both sides. The move serves as a reminder that global trade tensions are still getting worse, not better.

Turkey reported weak April IP. It was expected to contract -2.2% y/y but instead shrank twice as much at -4.0% y/y. The economy remains weak, but inflation is finally easing. The central bank flagged potential easing when it removed the language pledging to “maintain the tight monetary stance” at its meeting last week. Next policy meeting is July 25 and whether it cuts then will depend in large part on how the lira is trading.

Meanwhile, the budget outlook is deteriorating due to a spending spree ahead of this weekend’s election for Istanbul mayor. This is credit-negative. Indeed, late Friday, Moody’s cut Turkey by a notch to B1 with a negative outlook. Our own ratings model has Turkey’s implied rating at B+/B1/B+ after rising a notch last quarter. S&P and Moody’s appear to be on target now, but we see very strong downgrade risks to Fitch’s BB rating.