Euro Strength More Than Dollar Weakness

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  • Minutes from the FOMC meeting seem to confuse some 
  • OPEC is poised to extend its six-month production cuts for another nine months 
  • The US reports the advance April merchandise trade balance, wholesale and retail inventories, and weekly jobless claims 
  • Moody’s downgraded Hong Kong’s rating to Aa2 from Aa1 with stable outlook  
  • Bank of Korea kept rates steady at 1.25%, as expected; SARB is expected to keep rates steady at 7.0%  

The dollar is mostly firmer against the majors. The Swiss franc and euro are outperforming, while the dollar bloc and yen are underperforming. EM currencies are mostly firmer. KRW and THB are outperforming, while TRY and SGD are underperforming. MSCI Asia Pacific was up 0.7%, with the Nikkei rising 0.4%. MSCI EM is up 0.9%, with Chinese markets rising 1.8%. Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a higher open. The 10-year US yield is flat at 2.25%. Commodity prices are mostly lower, with WTI oil down 0.7%, copper down 0.1%, and gold down 0.1%.

The Dollar Index is heavy, just above the lows set earlier this week set near 96.80. However, this exaggerates the dollar’s weakness because the weight of the euro and currencies that shadow it, like the Swiss franc and Swedish krona.

As the North American session is about to start, the dollar is higher against the dollar-bloc currencies and the Japanese yen. The Scandies are flat and sterling is turning lower. That leaves the dollar weakness limited to the euro and Swiss franc.

The euro reached a high earlier this week just shy of $1.1270. It has run out of steam today near $1.1250. Between $1.1175 and $1.1200, there are nearly 1.4 bln euros in options expiring. Sterling was sold in response to the downward revision in Q1 GDP to 0.2% from 0.3%. The UK economy had expanded by 0.7% in Q4 16. Services and production were revised lower and net exports took 1.4 percentage points off GDP, a record drag. There are nearly GBP270 mln options struck at $1.2940 that roll-off today. Sterling has not closed below its 20-day moving average (~$1.2940) since April 10. We note that the technical condition for sterling may be deteriorating. The MACDs and RSI show bearish divergence.

Separately, when US President Trump began this extended trip, many thought that Israel would object to the Administration’s handling of intelligence, but it turns out the British seem more concerned. The BBC reports that Prime Minister May will raise the issue at the highest levels following reports that the British police have stopped sharing information with US officials.

Minutes from the FOMC meeting seem to confuse some. To be sure, the market continues to believe that a hike next month is as done of a deal as these things can get. Our calculations suggest fair value for the June Fed funds futures contract, assuming a hike and some softness at the end of the quarter, is about 1.04%, while the contract currently implies 1.015%.

Some are trying to explain the pullback in US bond yields as a response to the FOMC statement that it needs to see more evidence that weakness in Q1 was transitory before removing more accommodation. We read this as a justification for not hiking rates this month, rather than a change in forward guidance. The December Fed funds futures contract implied yield was 1.215% at the end of last week. It closed yesterday at 1.23%.

The Fed’s balance sheet strategy is evolving. The minutes confirmed expectations that the Fed is likely to begin the process by not replacing maturing issues slowly and then increasing the amount. It is a rolling start that was one of the common scenarios discussed by investors. However, the FOMC did not say how much it may begin with, though subjectively we thought $5-$10 bln divided, perhaps not evenly divided between Treasuries and MBS. The other important question is what size balance sheet does the Fed eventually want. Bernanke recently suggested $2.3-$2.8 trillion.

OPEC is poised to extend its six-month production cuts for another nine months. This has been expected and helps account for the recent rally that help lifted Brent by 17.5% since May 5, while light sweet crude has rallied 18.7%. Prices are off 0.5-0.7%, the second day of losses. It could be the first back-to-back decline since May 1 and May 2. The market looks vulnerable to “buy the rumor sell the fact” type of activity.

Following the slippage in US yields yesterday, Asian and European bonds have followed suit today. Australia’s 10-year yield fell nearly give basis points, while European core bond yields are off three-four basis points and the peripheral yields off two-three basis points. Greek bond yields have bucked the trend and are pushing higher amid disappointment with the lack of closure and negotiations to release the next tranche.

Equities are marching higher. US equities have recovered from last week’s slide. This helped support global equities today. The MSCI Asia-Pacific Index rose 0.7% to reach a new two-year high. Korea’s Kospi rallied 1.1% to new record highs. As widely expected, the central bank left rates on hold. Taiwan’s Taiex rose about half as much as Korea, but sufficient to record new two-year highs. The Hang Seng advanced 0.8% to also record a new two-year high. Perhaps most interesting is the 1.4% rally in Shanghai. It is the biggest rally in a month and some suspect that state funds were active.

European shares are mostly higher, but less energetically so. The Dow Jones Stoxx 600 is up around 0.1%. It is held back by the DAX, which is the weakest of the major European bourses. Over the last five sessions, it has been alternating between gains and losses as it consolidates the gains from the first half of the month that brought it to record highs.

The US reports the advance April merchandise trade balance, wholesale and retail inventories, and weekly jobless claims. The trade and inventory data will impact Q2 GDP estimates, though the key point is that nearly everyone is expecting the economy to accelerate after the unusually weak Q1. The national employment report is out next week and the early call is for a respectable 175-180k increase and a 0.3% rise in hourly earnings, which could lift the year-over-year rate to 2.6% from 2.5%.

Moody’s downgraded Hong Kong’s rating to Aa2 from Aa1 with stable outlook. This comes on the heels of its downgrade of China to A1 from Aa3. Moody’s noted that “credit trends in China will continue to have a significant impact on Hong Kong’s credit profile due to close and tightening economic, financial and political linkages with the mainland.” Our own sovereign ratings model has Hong Kong’s implied rating at AA-/Aa3/AA- and so downgrade risks remain to actual ratings of AAA/Aa2/AA+.

Bank of Korea kept rates steady at 1.25%, as expected. Governor Lee welcomed new President Moon’s plans for fiscal stimulus, noting that monetary policy is “sufficiently accommodative.” Lee also said that the BOK would not automatically respond to any Fed decisions. CPI rose 1.9% y/y in April, just below the 2% target. However, Lee’s comments suggest that the BOK will remain on hold for now.

SARB is expected to keep rates steady at 7.0%. April CPI was reported yesterday up 5.3% y/y vs. 5.6% expected and 6.1% in March. This is the lowest rate since December 2015 and back within the 3-6% target range. After its last meeting March 30, the bank signaled that the tightening cycle was over. Indeed, one MPC member voted for a 25 bp cut then. While we think it’s too early to consider a rate cut now, the SARB statement should tilt a little more dovish to set the table for a cut in H2.