Respite From Dollar Short Squeeze

euro

  • The euro ‘s recovery has not been derailed by a shocking miss on the preliminary eurozone April CPI
  • UK service PMI rose, but the gain was less than expected
  • Volatile trading was seen after the release of the FOMC statement, which by most accounts was unsurprising
  • The release of US Q1 GDP steals much of the thunder from March US data that will be released today
  • Turkey April CPI rose  10.85% y/y vs. 10.45% expected
  • Czech National Bank is expected to keep rates steady at 0.75%; Chile central bank is expected to keep rates steady at 2.5%

The dollar is broadly weaker against the majors in the aftermath of the FOMC meeting. The Scandies are outperforming, while sterling and Swissie are underperforming. EM currencies are mostly firmer. RUB and ZAR are outperforming, while KRW and TRY are underperforming. MSCI Asia Pacific ex-Japan was down 0.5%, with Japan on holiday for the rest of this week. MSCI EM is down 0.6% so far today, with the Shanghai Composite rising 0.6%. Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 2 bp at 2.95%. Commodity prices are mostly higher, with oil up 0.3%, copper up 1.5%, and gold up 0.6%.

The euro bounced after being drilled to support levels in the $1.1930 area post-FOMC yesterday. The recovery has not been derailed by a shocking miss on the preliminary eurozone April CPI. Headline CPI inflation slipped to 1.2% y/y from 1.3%, but the more meaningful miss was the slump in the core rate to 0.7% from 1.0%. Recall that the core rate bottomed at 0.6% three years ago.

Sterling is also enjoying relief from its recent slide. It is trying to snap a six-day slide. In each of the past two weeks, sterling has managed to close higher in one session. Today may be the session for this week. To do so, sterling has to shrug off the service PMI. Although it rose, the gain was less than expected. The April service PMI rose to 52.8 from 51.7. The market expected 53.5. Given the disappointment (decline) in manufacturing, the better construction PMI, and today’s service reading, the composite was sure to disappoint. It improved to 53.2 from 52.4, missing the recovery to 53.7 as expected.

The Australian dollar is higher for a second session. It has been helped today by stronger than expected data in the form of a larger than expected March trade surplus (A$1.57 bln vs. expectations for A$865 mln). Also, building permits up more than twice as expected (2.6% vs. 1.0%). Today is the first session since April 19 that the Australian dollar has risen above the previous day’s high. Initial resistance is seen near $0.7550 and then $0.7580.

The yen is firmer but largely sidelined. After trying to push through JPY110 unsuccessfully for a third session, the market has pushed the dollar toward JPY109.50.

Global equities are trading heavily after US losses following the FOMC meeting. The MSCI Asia Pacific Index was off (~-0.1%) for a third consecutive session. China, Australia, and Thailand managed to buck the trend and post modest gains. Japan is closed for the rest of the week. Foreign investors, which had turned buyers of South Korean equities this week after heavy sales in late April turned back to the sell side today and offset the purchases conducted in the first half of the week.

European equities are also lower, with the Dow Jones Stoxx 600 nursing about a 0.3% loss, led by telecom, real estate, and financials. Energy, utilities, and healthcare are posting small gains. The benchmark has alternated between gains and losses this week and today’s loss trims the week’s net gain by nearly half.

US 10-year Treasury yields have pulled back from the 3.0% threshold. At 2.95% now, the yield is off a basis point on the day. European benchmarks are off two basis points. There is little stress in Italian debt despite the failure of the Five Star Movement to reach an agreement to form a government. The center-right may be given an opportunity, and if that fails new elections may be difficult to avoid. Italian shares are slightly underperforming.

Volatile trading was seen after the release of the FOMC statement, which by most accounts was unsurprising. Some observers seemed to place emphasis on the use of the word symmetric when referring to inflation, which they understood to mean that was signaling that it would tolerate inflation overshoot as it tolerated inflation undershooting. The dollar initially sold off to approach session lows, while the S&P 500 recorded session highs.

However, the markets quickly reversed. The modest dollar pullback was snapped up the and greenback’s recent gains were extended against the major currencies except for the Australian dollar. The S&P 500 gave up nearly one percent from the high made shortly after the FOMC announcement. The real material impact on expectations was negligible.

The January 2019 Fed funds futures contract is arguably among the cleanest metrics of expectations for the year-end Fed funds effective rate. It edged a half a basis point lower to 2.26%. At the start of April, it stood at 2.125%. If there were to be three hikes more hikes by the end of this year, the effective Fed funds rate would be 75 bp more than the current 1.70% or 2.45%. If the Fed would to hike rates only twice more than effective Fed funds rate would be around 2.20%.

The release of US Q1 GDP steals much of the thunder from March US data that will be released today. The FOMC statement suggests officials will look past whatever weakness is seen, and therefore the data, including the April non-manufacturing ISM. The market is more interested in the April employment report tomorrow. We suspect today’s price action is about an overdue (see Bollinger Bands for example) and not about the economic data. The miss on the eurozone core CPI is most important development with policy implications but one that will take time to digest.

Turkey April CPI rose 10.85% y/y vs. 10.45% expected and 10.23% in March. Inflation is the highest since December and moves further above the 3-7% target range. The central bank recently surprised with a larger than expected 75 bp hike in the Late Liquidity rate. With the lira remaining under pressure and making a new all-time low today, more tightening will likely be needed at the next policy meeting June 7.

Czech National Bank is expected to keep rates steady at 0.75%. CPI rose 1.7% y/y in March, and is in the bottom half of the 1-3% target range. The central bank has been hiking rates every other meeting since it started the cycle in August. While that points to another hike at this meeting, there is a possibility that lower than expected inflation delays that move until the June 27 meeting.

Chile central bank is expected to keep rates steady at 2.5%. Earlier that day, Chile reports March retail sales. CPI rose 1.8% y/y in March, below the 2-4% target range. While the central bank has signaled an end to the tightening cycle, low inflation will allow it to resume cutting if the economy were to slow sharply.