Dollar Rally Accelerates as Riksbank Adds to Divergence Theme

  • The dollar rally is picking up speed and strength as the divergence theme remains in force
  • DXY is trading at the highest level since May 2017
  • Riksbank delivered a dovish hold, as expected; yesterday’s dovish hold by the BOC is worth discussing
  • During the North American session, there are several date releases
  • Bank of Japan kept policy unchanged, as expected
  • EM remains under pressure
  • Korea saw a big miss for Q1 GDP; Bank Indonesia kept rates steady at 6.0%, as expected
  • Central bank of Turkey is expected to keep rates steady; we see slight chance of hawkish surprise

The dollar is broadly firmer against the majors as the divergence theme strengthens. Yen and Kiwi are outperforming, while the Scandies are underperforming. EM currencies are broadly weaker. PHP and TWD are outperforming, while KRW and RUB are underperforming. MSCI Asia Pacific was down 0.5%, with the Nikkei rising 0.5%. MSCI EM is down 1% so far today, with the Shanghai Composite falling 2.4%. Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a lower open. 10-year UST yields are up 1 bp at 2.53%, while the 3-month to 10-year spread has steepened 1 bp to 11 bp. Commodity prices are mixed, with Brent oil up 1.3%, copper down 0.8%, and gold up 0.1%.

The dollar rally is picking up speed and strength as the divergence theme remains in force. Yesterday, we got lower than expected Australia Q1 CPI and a dovish hold from the Bank of Canada. Today, it was the Riksbank’s turn to deliver a dovish hold and it did not disappoint (see below). The krona took it on the chin and is trading at its weakest level against the dollar since August 2002. EUR/SEK is trading at its highest level since August 2018 and is on track to test that month’s high near 10.7290.

DXY is trading at the highest level since May 2017. That month’s high near 99.888 is the next target, followed by the April 2017 high near 101.340. The euro traded at its lowest level since June 2017 and looks likely to break below that month’s low near $1.1120. After that, the next target is the May 2017 low near $1.0840.

Riksbank delivered a dovish hold, as expected. The bank kept rates steady at -0.25% but pushed the next hike out to end-2019 or early 2020 instead of sometime in H2 previously. The Riksbank added that “rate rises thereafter are expected to occur at a somewhat slower pace.” At its February meeting, the Riksbank saw 50 bp of tightening in 2020 and another 50 bp in 2021; it has now cut those in half. Lastly, the bank extended its bond purchase plans from July 2019 until December 2020.

Yesterday’s dovish hold by the Bank of Canada is worth discussing. By dropping the reference to future rate hikes, we think the BOC has signaled that the tightening cycle has likely ended. That phrase had been in every statement since the end of 2017. now joined the RBA and RBNZ in tilting more dovish.

During the North American session, there are several date releases. US reports March durable goods orders (0.7% m/m expected), weekly jobless claims (200k expected), and Kansas City Fed manufacturing index (8 expected). The media embargo for the May 1 FOMC meeting has gone into effect and so there are no Fed speakers until after that meeting.

Bank of Japan kept policy unchanged, as expected. It hardened its forward guidance, saying current stimulus would be kept in place at least through spring 2020. Previously, BOJ had pledged easy policy for “an extended period.” However, the implied forward guidance goes even further. The BOJ released its first forecasts for FY2021, with inflation seen remaining below target then at 1.6%. This would imply easy policy through March 2022 (rather than spring 2020) and yet market reaction was muted. Diminishing returns to extreme dovishness, perhaps?

Yesterday, USD/JPY traded at its highest level since December 20 near 112.40. However, there was no follow-through from the BOJ decision and the pair has since fallen back below the 112 level. We still believe the pair is on track to test the December 13 high near 113.70, but it won’t be a straight line there.

EM remains under pressure. Any notions that EM FX would somehow escape the dollar’s wrath have been dashed by recent price action. While there have been some periods of divergence between the dollar’s performance against the majors and EM, they rarely last very long. Rather, the dollar typically experiences broad-based rallies or sell-offs where the correlations between the majors and EM become quite high. We think that is what will be seen for much of this year.

Korea saw a big miss for Q1 GDP. Growth was expected at 2.5% y/y but instead came in at 1.8%, the lowest since Q3 2009 and down sharply from 3.1% in Q4. GDP contracted -0.3% q/q instead of expanding 0.3% q/q that consensus saw. Q2 is starting off weak, with exports for the first 20 days of April contracting -8.7% y/y. The BOK just left rates steady but shaved its growth forecast for this year a tick to 2.5% and cut its inflation forecast to 1.1% from 1.4%. Those forecasts now seem too optimistic. We believe rates will be kept on hold for the rest of this year, with risks of a cut now materializing. Next policy meeting is May 31, no change is expected then.

Bank Indonesia kept rates steady at 6.0%, as expected. Governor Warjiyo said that “To boost the growth of domestic demand, Bank Indonesia will expand its policies to be more accommodative.” We think this is setting the table for rate cuts to start any time after mid-year. CPI rose 2.5% y/y in March, the lowest since November 2009 and just at the bottom of the 2.5-4.5% target range. Next policy meetings are May 16, June 20, and July 18.

Central Bank of the Republic of Turkey is expected to keep rates steady. However, there is a chance of a hawkish surprise if the bank resorts to more stealth tightening. CPI rose 19.7% y/y in March, above the increasingly irrelevant 3-7% target range. With the lira down another 5% this month so far and oil prices rising, inflation is likely to accelerate further. Eventually, more aggressive tightening will be needed.