Dollar Softens Ahead of ECB Decision

  • The ECB decision is the main focus and it is expected to keep rates steady; Italy remains defiant
  • The ratings agencies are punishing Mexico; Trump opined that “not nearly enough” progress has been seen in Mexico trade talks
  • We got another piece of the jobs puzzle yesterday; Fed’s Kaplan and Williams speak; Fed Beige Book was slightly upbeat
  • Canada reports April trade and May Ivey PMI
  • India cut rates 25 bp, as expected; South Africa Q1 current account data was -2.9% of GDP

The dollar is mostly softer against the majors ahead of the ECB decision. Yen and Nokkie are outperforming, while Swissie and Stockie are underperforming. EM currencies are mostly softer. RUB and HUF are outperforming, while MXN and TRY are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei flat. MSCI EM is down 0.2% so far today, with the Shanghai Composite falling 1.2%. Euro Stoxx 600 is up 0.6% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 3 bp at 2.11%, while the 3-month to 10-year spread inverted 2 bp and stands at -22 bp. Commodity prices are mostly higher, with Brent oil up 0.6%, copper up 0.8%, and gold up 0.5%.

The dollar has gotten some traction after markets got several reminders about problems in the rest of the world. Italy and the EU are likely to butt heads in the coming weeks, while the UK economy continues to suffer from Brexit uncertainty. The eurozone economy is also stalling as the ECB debates adding more stimulus. The daily trendline for DXY dating back to late January held yesterday and we retain our bullish dollar call.

The ECB decision is the main focus today and it is expected to keep rates steady. More details of the planned TLTRO should be forthcoming, with many looking for generous terms in the form of negative interest rates. Updated staff forecasts will be released, and forward guidance may be extended. We think it will have to acknowledge downside risks to the economy with downward revisions to the growth and inflation outlook.

Italy remains defiant. After the EU announced the start of the disciplinary process for its high debt load, Italian leaders show no signs of backing down yet. Prime Minister Conte and his two Deputies Salvini and Di Maio are now calling for changes to the EU rules. Previously, there were signs of tension in the coalition that risked fresh elections. These tensions are likely to persist into the fall when Italy presents its 2020 budget plans for approval.

The euro recorded an outside down day yesterday, pointing to further losses ahead. It is up slightly today but we note that over the past 8 ECB decision days, the euro has finished lower in 6 of them. Indeed, we fully expect Draghi to push back hard against euro strength.

The ratings agencies are punishing Mexico. Fitch cut Mexico one notch to BBB with stable outlook while Moody’s cut the outlook on its A3 rating from stable to negative. Our own sovereign ratings model has Mexico’s implied rating at BBB/Baa2/BBB and so we are not at all surprised by Fitch’s move. What we are surprised at is that Moody’s still has Mexico at A3.

Elsewhere, President Trump opined that “not nearly enough” progress has been seen in trade talks with Mexico. Talks were held yesterday and are set to continue today. Mexican officials have been putting on a positive spin so far, perhaps too positive. For USD/MXN, the key level to watch for is 19.9280 as a break above would set up a test of the December high near 20.6570.

The US reports May Challenger job cuts, weekly jobless claims (215k expected), and April trade (-$50.7 bln) today. Data so far this week have been on the firm side. Yesterday, ISM non-manufacturing PMI came in at 56.9 vs. 55.4 expected and 55.5 in April.

We got another piece of the jobs puzzle yesterday. To summarize what we have so far: 1) weekly jobless claims fell to 211k for the May survey week, 2) ISM manufacturing employment index rose to 53.7, 3) ADP came in at 27k, and 4) ISM non-manufacturing employment index rose to 58.1. ADP reading is the outlier but has very little in terms of a proven track record. Bottom line: we should get a decent NFP Friday. Consensus is 180k currently.

The Fed’s Kaplan and Williams speak today. Yesterday, Kaplan poured cold water on rate cut talk, noting that it’s too early to make that judgment. Brainard sounded more in line with Powell, saying that the Fed is prepared to adjust policy as needed to sustain growth. We think Kaplan’s view is still the prevailing one at the Fed and so markets can forget about a June cut. July 31 and September 18 are “live” but it all depends on the data.

Fed Beige Book was slightly upbeat.   It noted that the economic activity was “modest” and this compares to “slight-to-moderate” in the prior report. The Fed said the outlook for the coming months was “solidly positive” but noted some pockets of weakness. This does not sound like a central bank getting ready to cut rates. WIRP has odds of a Fed rate cut June 19 at 22%, up from 6% at the start of last week. This 22% seems too high.

Canada reports April trade and May Ivey PMI. Tomorrow, it reports May jobs data. The Bank of Canada just kept rates steady and delivered a less dovish than expected message by saying that the slowdown is seen as temporary. Markets think otherwise, with WIRP showing rising odds of a rate cut in the autumn. Next policy meeting is July 10, no change is expected then.

Reserve Bank of India cut rates 25 bp, as expected. Q1 GDP growth came in much weaker than expected at 5.8% y/y, the fourth straight quarter of deceleration and the slowest since Q1 2014. Governor Das said that “Our decision is driven by growth concerns and inflation concerns, in that order.” The decision was unanimous while the bias was moved to accommodative from neutral previously. Next policy meeting is August 7, and another cut then is likely.

South Africa Q1 current account data came in at -2.9% of GDP vs. -3.3% expected and -2.2% in Q4. The contracting economy probably helped limit the deterioration in the external accounts. Next SARB policy meeting is July 18, no change is expected then. However, we think a rate cut is getting more likely later in H2.