Euro Slips Ahead of the ECB Meeting


  • ECB meets and there may be some minor tweaks to the forecasts and language
  • Trade remains very much in focus
  • Following the US report of its largest monthly trade deficit since the Great Financial Crisis, China reports its February trade figures today
  • Japan revised its Q4 17 GDP estimate sharply higher
  • USD/HKD traded at a new post-peg high just above 7.84; Moody’s downgraded Turkey a notch to Ba2 with stable outlook
  • Mexico February CPI is expected to rise 5.37% y/y; Peru central bank is expected to cut rates 25 bp to 2.75%

The dollar is broadly firmer against the majors ahead of the ECB decision. The yen and sterling are outperforming, while the euro and Nokkie are underperforming. EM currencies are mostly softer. TWD and MYR are outperforming, while ZAR and TRY are underperforming. MSCI Asia Pacific was up 0.7%, with the Nikkei rising 0.5%. MSCI EM is up 0.6% on the day, with the Shanghai Composite rising 0.5%. 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 flat at 2.88%. Commodity prices are mostly lower, with oil down 0.2%, copper down 1.4%, and gold flat.

Expectations that the European Central Bank would change its forward guidance in a substantive way had been one of the factors behind the euro’s appreciation. However, more recently, the anticipation has slackened.

The last meeting took place around the same time that many perceived US Treasury Secretary Mnuchin as having abandoned the strong dollar policy. Today’s meeting takes place amid US trade provocations. Also, recent economic data, including the surveys that Draghi often cites, and today’s unexpectedly large fall in German January factory orders (-3.9% vs. expectations for half the decline and the December series was revised to 3.0% from 3.8%), warns that the regional economy has lost some momentum.

There may be some minor tweaks to the forecasts and language. The removal of the commitment to increase asset purchases if the economy were to suddenly to worsen may be the most that can reasonably be expected, though it does not really change anything. While the forecasts themselves may only change a little, we suspect the confidence in them has softened.

We do not expect Draghi to be pulled into a discussion about Italian politics. He can say that monetary policy is driven by the mandate of price stability and that the election is not impacting it. Given the length of time it has taken other governments to put together a government, including Germany, it is premature to reach any policy conclusions about Italy.

The euro reached nearly $1.2445 yesterday, which is the highest level since it peaked on February 16 near $1.2555. Today it has slipped a little below $1.2380 in the European morning.   Given the run-up since reversing higher on March 1, the pullback is minor. There is a nearly 700 mln euro option struck at $1.2350 that expires today and the $1.2335 area corresponds to a 38.2% retracement of the recent rally.

Trade remains very much in focus. There have been a couple of developments to note. First, exemptions to the US steel and aluminum tariffs have been granted to Canada and Mexico, pending the outcome of NAFTA negotiations. Recall Canada and Mexico were exempt from Bush’s steel tariffs also. Apparently, other countries may be exempt if they can show that their sales do not threaten US security, which includes economic security and jobs.

Second, reports suggest that the US has asked China to come up with a way to reduce its bilateral trade surplus with the US by $1 bln. Last year, the US trade deficit with China was around $375 bln. Apparently, lifting US bans on some technology exports to China is not what the Administration has in mind. Yet a $1 bln reduction is hardly even a rounding error.

Third, following the US report of its largest monthly trade deficit since the Great Financial Crisis, China reports its February trade figures today. Exports (in dollar terms) jumped 44.5% above year ago levels following an 11.2% rise in January. Imports rose 6.3% following a 36.8% increase in January. The trade surplus swelled to $33.7 bln from $20.35 bln.

Shipments to the US rose 46.1% after an 11.1% gain previously. Exports to the EU were up 42.4% following a 10.3% rise in January. Exports to Japan rose 31.2% after a 1.4% increase in January. However, things are not what they seem. The most important distortion can be traced to the Lunar New Year. It is best to take the two months together. Trade has increased. The surplus has increased, but not as much as it appears. Last year, the two-month combined surplus was about $38 bln. This year it is $56 bln.

The second consideration that can be obscured by the focus on goods and services crossing borders instead of ownership is that some foreign companies use China as an export platform. For example, Chinese figures suggest that companies that have a large foreign investor account for 42% of China’s total trade.

Japan revised its Q4 17 GDP estimate sharply higher. Rather than eke out a 0.1% quarterly expansion, with the help of stronger business spending, the economy grew by 0.4%. The tick up in the GDP deflator to 0.1% also helped. The data confirm the eighth consecutive quarterly advance, which is the longest such streak in 30 years. Separately, Japan reported a larger than expected January current account surplus. Japan’s current account surplus is driven by the investment income account for the trade balance, which in January was a deficit (~JPY666 bln on a balance of payment basis).

Also, what caught our attention was the weekly MOF portfolio flow data. Japanese investors sold JPY1.19 trillion of foreign bonds last week. It was the most since last April, and may be related to the coming end of the fiscal year at the end of the month. The MOF also reported that foreign investors snapped up JPY1.26 trillion of Japanese bonds. It is the most since last September.

Australia reported a much larger than expected January trade surplus of $1.055 bln, close to seven times more than expected. There was a recovery in exports (4%) and a paring of imports (-2%). Some economists attribute the poor Q4 export showing to weather. Australia is also reportedly seeking exemptions to US steel and aluminum tariffs.

The market has shown little interest in the data and the dollar is firm against all the major and most of the emerging market currencies. The Turkish lira is among the worst performers following Moody’s rating cut to Ba2, one notch deeper out of investment grade. Asian equities advanced, with the MSCI Asia Pacific Index gaining 0.7%. European stocks are also rising today as the Dow Jones Stoxx 600 is extending its rally for a fourth consecutive session, the long streak since January.

USD/HKD traded at a new post-peg high just above 7.84. HKMA Chief Executive Chan said that there were no plans to issue extra Exchange Fund Bills for now, which signals low rates are likely to continue (for now). Risk/reward argues against going long USD/HKD now, as the pair can only get to 7.85 at most. On the other hand, if the HKMA starts to drain liquidity aggressively, HK rates can shoot up quickly and USD/HKD would drop like a stone back below 7.80.

Moody’s downgraded Turkey a notch to Ba2 with stable outlook. The agency cited deteriorating fundamentals, rising political risks, and weak policymaking efforts as factors behind the move. Indeed, the widening current account deficit, high external debt, and large roll-over financing needs leave it vulnerable external shocks. Our recent piece on Turkey highlighted all of these risks. Indeed, our own sovereign ratings model showed Turkey’s implied rating falling a notch to B/B2/B after remaining steady last quarter after two straight quarters of decline. We think Turkey faces even greater downgrade risks to its BB/Ba2/BB+ ratings.

Mexico February CPI is expected to rise 5.37% y/y vs. 5.55% in January. If so, it would be the lowest since March 2017 but still above the 2-4% target range. Banco de Mexico next meets April 12. It’s too early to make a call, but there is the potential for another rate hike then if the peso remains under pressure.

Peru central bank is expected to cut rates 25 bp to 2.75%. CPI rose 1.2% y/y in February, close to the bottom of the 1-3% target range. The bank has been cutting rates every other month, which points to a 25 bp cut to 2.75% then after it stood pat in February.