Dollar Rally Derailed by Surprise Election Results in Australia and India

  • We believe the dollar rally remains on track
  • Eurozone political noise came from an unexpected source
  • Japan Q1 GDP grew 2.1% SAAR vs. -0.2% expected; AUD bounce from the shock weekend election results has run out of steam
  • India exit polls suggest that Prime Minister Modi has won another term; Chile Q1 GDP is expected to grow 1.8% y/y
  • Bank of Israel is expected to keep rates steady at 0.25%

The dollar is mostly softer against as the new week begins. The Antipodeans are outperforming, while the Scandies and euro are underperforming. EM currencies are mostly firmer. INR and RUB are outperforming, while TWD and CZK are underperforming. MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.2%. MSCI EM is flat so far today, with the Shanghai Composite falling 0.4%. Euro Stoxx 600 is down 0.6% near midday, while US futures are pointing to a lower open. 10-year UST yields are flat at 2.39%, while the 3-month to 10-year spread is steady at 2 bp. Commodity prices are mixed, with Brent oil up 0.2%, copper down 0.3%, and gold down 0.2%.

We believe the dollar rally remains on track. Today’s bounce in the majors is being led by the Aussie, which is reacting to the unexpected Conservative party election victory. Elsewhere, the bounce in EM FX is being led by the Indian rupee, which is reacting to the BJP victory. Neither of these events are game-changers, and we expect the dollar to eventually regain its footing after this corrective move.

There is a full slate of Fed speakers this week. Today, Harker and Powell speak while Clarida and Williams take part in a “Fed Listens” event. Since the May 1 FOMC meeting, virtually every Fed official has been consistent in saying rates are on hold for now. Whilst acknowledging the downside risks from the trade war, these same officials have set a very high bar for a rate cut.

Yet the rates markets believe otherwise. The Fed Funds futures strip is leaning even more dovish than simply one cut this year and one next year. The implied yield on the January 2020 contract is 2.10%, which is starting to price in a second cut this year. Furthermore, the implied yield on the January 2021 contract is 1.81%, which is starting to price in a second cut next year.

The Atlanta Fed’s GDPNow model is now tracking 1.2% SAAR for Q2, up from 1.1% previously. Elsewhere, the New York Fed’s Nowcast model is tracking 1.8% SAAR for Q2 vs. 2.2% the previous week. April data have been on the soft side, but we note that Q1 also started off on a soft note before rebounding to 3.2% SAAR growth in the advance report.

Eurozone political noise came from an unexpected source. With markets focusing on Italy, Austria has stolen the spotlight. Vice Chancellor Strache has resigned after a compromising tape was released. This allowed Chancellor Kurz to call for new elections this fall, in the hopes of jettisoning Strache and his problematic Freedom Party from the government. European Parliamentary elections at the end of this month should give some hints as to whether Kurz’s gamble will pay off.

Despite the BOE taking a hawkish tone at its last meeting, markets have gone the other way. Implied yields on the short sterling strip continue to fall, not rise. Next hike has been pushed out to mid-2021 and the one after that to end-2023. No wonder sterling is so soggy. Cable broke below the February low near $1.2775 last week and is on track to test the January low near $1.2440. In between is a mid-January low near $1.2670.

Japan Q1 GDP grew 2.1% SAAR vs. -0.2% expected. The upside surprise was driven largely by net exports, as imports collapsed faster than exports. Other important areas such as capital spending and private consumption declined. While the mix appears to be problematic, the headline print should silence chatter about a delay to the October consumption tax hike.

While the BOJ stands ready to add stimulus, this GDP print gives it cover to hold off until after the tax hike. Next policy meeting is June 20, no change is expected then. Earlier, USD/JPY traded at the highest level since May 7 but has since fallen back to the 110 area. The pair has retraced about a third of the April-May drop but further upside may be difficult.

The bounce in AUD from the shock weekend election results has run out of steam. And that’s how it should be. The currency’s outlook will be driven more by RBA expectations and China growth, rather than domestic political considerations. In that regard, we remain negative on AUD and still look for a test of the January low near .6740.

India exit polls suggest that Prime Minister Modi has won another term. The BJP-led Democratic Alliance is expected to win between 267-350 seats in the 543-seat Lok Sabha. 272 seats are needed for a majority. The Congress-led opposition United Progressive Alliance is expected to win between 82-132 seats. The official tally will be released May 23.

Chile Q1 GDP is expected to grow 1.8% y/y vs. 3.6% in Q4. CPI rose 2.0% y/y in April, right at the bottom of the 2-4% target range. With headwinds building on the economy, we believe the central bank is on hold for the time being. Next policy meeting is June 7, no change is expected then.

Bank of Israel is expected to keep rates steady at 0.25%. CPI rose 1.3% y/y in April, still near the bottom of the 1-3% target range. Yet the economy remains robust as GDP grew 5.2% annualized in Q1 vs. 3.1% expected.