Dollar Remains Under Pressure Ahead of ECB Decision

Euro closeup on ECB Abbreviation

  • The focus is on the ECB
  • What can Draghi say about the euro?
  • The US has several reports today
  • Korea Q4 GDP contracted -0.2% q/q; Bank Negara hiked rates 25 bp to 3.25%, as expected
  • This is really a weak dollar story for EM

The dollar remains broadly weaker against the majors ahead of the ECB decision.  Kiwi and Swissie are outperforming, while the euro and sterling are underperforming.  EM currencies are broadly firmer.  KRW and TWD are outperforming, while RON and ZAR are underperforming.  MSCI Asia Pacific was down 0.4%, with the Nikkei falling 1.1%.  MSCI EM is up 0.1% on the day, with the Shanghai Composite falling 0.3%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year US yield is down 1 bp at 2.64%.  Commodity prices are mostly higher, with WTI oil up 0.7%, copper up 0.2%, and gold up 0.1%.

The focus is on the ECB.  There are no staff forecast updates.  There is unlikely to be a change in forward guidance.  There are four issues that investors are most interested in:  inflation, growth, QE, and the euro.  The first is expected to gradually rise.  The risks to the second are broadly balanced.  QE will continue through September and could be extended, until inflation is on a sustainable and durable path toward the target.  This means that despite hawks’ push, there will be no pre-committing to ending purchases in September.  It will stay data dependent, not date dependent.

What can Draghi say about the euro?  He can warn that the volatility of the euro injects uncertainty into the policy outlook.  Also, that a rise in the euro beyond what is justified by fundamentals can make it more difficult to achieve it target.  A rising euro imparts deflationary pressures, curbs growth, and hurts corporate earnings.

Despite the BOJ’s best efforts to push back against the market’s more hawkish take on policy, USD/JPY is making new lows daily.  We suspect that we may see a similar reaction today.  That is, the market would sell the euro initially on any ECB pushback but then likely sell dollars into any show of strength.  The ECB is unlikely to be able to reverse this dollar bearishness, as the momentum is clearly against the greenback now.

The US has several reports today.  Weekly initial jobless claims fell to a new cyclical low last week and this week’s report could see a small bounce back.  New homes sales likely paid back for the large 17.5% increase in November.  Leading economic indicators are expected to have risen by 0.5% after 0.4% in November, and suggests the momentum from Q4 will carry into Q1 18.  Note that Q4 GDP will be reported tomorrow.  Kansas City Fed manufacturing survey draws little attention.  Canada reports November retail sales (0.8% m/m expected).

The New Zealand dollar is the strongest of the majors with a 0.55% increase.  This is despite the miss on Q4 CPI (0.1% rather than 0.4%, bringing the year-over-year pace to 1.6% from 1.9%). The US dollar’s losses have been extended.  There are a few options that will be cut in NY today.  There are 748 mln euro struck at $1.24 that expire today.  The $1.25 strike, for which there is nearly 945 mln euros on, may be too far today.  There are $2.5 bln of options struck at JPY110.00-JPY110.05 that are due to expire today as well.

Korea Q4 GDP contracted -0.2% q/q vs. expected +0.1% q/q.  In y/y terms, growth slowed to 3.0% vs. 3.4% expected.  Private consumption continued to expand while gross fixed capital formation decreased.  Net exports also dragged the growth.  A strong won might already be weighing on growth as manufacturing contracted by -2.0% q/q, following 2.9% q/q growth in Q3.  BOK hiked in November but has signaled a cautious pace of tightening.  Next policy meeting is February 27 and rates are likely to be kept steady at 1.5%.

The Malaysia central bank hiked rates by 25bp to 3.25%, as expected.  It said the stance of monetary policy remains accommodative but said that decided to normalize the degree of monetary accommodation. It also suggested additional hiking as it said it would continue to assess the balance of risks between domestic growth and inflation. The ringgit continues to rise as USD/MYR dropped to around 3.89, which is the lowest since April 2016.

This is really a weak dollar story for EM.  We suspect that the REER for most EM countries will not strengthen that much given that their trading partners are seeing similar gains against the dollar.  Still, don’t be surprised if official jawboning against FX gains picks up in the coming days.  With the dollar in a broad-based swoon, however, we don’t think the impact will be significant nor lasting.