Dollar Pullback Extended Against Euro and Sterling

Pound money on financial figures balance

  • The US dollar is mixed today, but its losses against the euro and sterling are giving it a heavier tone
  • The euro’s recovery has extended even though German factory orders disappointed
  • The G7 summit starts tomorrow, and it is possible that the discord within the group is so palpable that a joint statement may not be forthcoming
  • Central Bank of Turkey is expected to keep rates steady at 16.50%; Mexico May CPI is expected to rise 4.46% y/y

The dollar is mixed against the majors. The Scandies and Swissie are outperforming, while the dollar bloc is underperforming. EM currencies are mostly weaker. KRW and SGD are outperforming, while ZAR and TRY are underperforming. MSCI Asia Pacific was up 0.6%, with the Nikkei rising 0.9%. MSCI EM is up 0.4% so far today, with the Shanghai Composite down 0.2%. Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open. The 10-year US yield is up 2 bp at 2.99%. Commodity prices are mostly higher, with oil up 0.5%, copper up 0.5%, and gold up 0.2%.

The US dollar is mixed today, but its losses against the euro and sterling are giving it a heavier tone. We suspect the move is mostly corrective in nature, but recognize that investors have brought forward the first ECB rate hike next year from September-October to June. A week ago, indicative pricing suggesting a couple basis points were priced in for June 2019, now a 10 bp hike seems discounted.

The euro’s recovery has extended even though a leading economic indicator, German factory orders, disappointed. Specifically, the median forecasts (Bloomberg survey) was for a 2.5% gain after falling every month in Q1. Instead, April factory orders slumped 2.5%, and now the decline is the longest since 2011. Adding insult to injury the March series was revised to reflect a 1.1% loss rather than the 0.9% fall initially reported.   The drop has pushed the y/y rate into negative territory for the first time in two years.

Moreover, the details were poor. Nor can the weakness be attributed to the past strength of the euro. Domestic orders fell more than 4%. Orders from within the euro area plunged almost 10%. Orders from outside the eurozone were the only sector that increased.

Still, the disappointment was not enough to stop the euro’s recovery, and the single currency extended its gains to $1.1840. The $1.1810 area corresponds with a 61.8% retracement of the last leg down in the euro that began on May 14 when it failed to resurface above $1.20.

The next important chart point is seen a little above $1.19. This is a retracement objective of the euro’s drop from the multi-year high seen in February near $1.2550. At $1.19 today, there is an option for 590 mln euros that expires. Ahead of it are about 1.3 bln euros struck between $1.1865 and $1.1885. While the five-day moving average is set to push above the 20-day average tomorrow for the first time since late May, the so-called “deadman’s cross” (where the 50-day average falls below the 200-day average) is taking place today for the first time since last May.

In addition to German factory orders, the other notable economic report came from China. China’s reserves fell for the second consecutive month. The $14.3 bln decline brings the two-month drop to $32.2 bln. Many observers are trying to link the drop in reserves to the performance of the yuan, but that might be the wrong place to look.

The dollar value of China’s reserves was $3.124 trln as of the end of April. In May, the euro fell by 3.2% against the dollar. A conservative estimate puts China’s euro holdings at about 20%. If a fifth of its reserves fell by 3%, it would lower the dollar value of China’s reserves by about $18 bln. Of course, reserves are impacted by other factors, like trade and capital flows, but it may be a stretch to read too much into the decline regarding policy signals or in terms of the elevated trade tensions.

Those tensions come to a head in on June 15. That is when the US is slated to provide the details of which $50 bln of Chinese goods will get another 25% tariff in retaliation for intellectual property rights violations. China has indicated that its offers to target the purchases of more US goods will be withdrawn if the US goes forward with these extra tariffs next week.

While the US dollar is weaker against most of the major currencies today, the Australian and Canadian dollars have slipped lower. The Aussie’s weakness may be a yellow flag. The Australian dollar bottomed nearly a month ago, well before the other major currencies, including the euro and sterling. After rallying on Monday, the Aussie has net-net been flat. It is stalling ahead of important resistance seen near $0.7700. A break of $0.7600 now would suggest a high may be in place, and more broadly, lends credence to our view that the dollar’s setback is corrective in nature.

Meanwhile, equity markets appear to be breaking out, led by the new record highs in the US NASDAQ and fourth advancing session for the S&P 500 that has brought it within striking distance of the 2800 target. The S&P 500 gapped higher on Monday. As long as it remains unfilled, it appears to be a bullish breakaway gap. The MSCI Asia Pacific Index rose for a second consecutive session and its third advancing sessions this week is the most in a week in over a month. Today’s 0.6% advance carries the regional benchmark to its best level since May 14. Most markets in the region were higher, except China’s mainland markets, which edged lower.

Europe’s equities are firmer but not as much. The Dow Jones Stoxx 600 is up about 0.2% near midday on the Continent. It has not closed higher since Monday, and it was coming into today’s session essentially flat on the week after falling for the past two weeks. Of note, financials are leading the way higher today, but with no help from Italian banks, an index for which is paring yesterday’s modest gains. Italian banks are drawing little support from the rally in the sovereign bonds. Italy’s two-year yield is off 10 bp, and the 10-year yield is five basis points lower. Core European bond yields are three-to-four basis points higher.

The G7 summit starts tomorrow, and it is possible that the discord within the group is so palpable that a joint statement may not be forthcoming. Reportedly Germany and France have indicated they will not sign any statement that does not find common ground on tariffs, Iran, and the Paris Climate Accord. If that is the bar and not posturing, a joint statement seems patently unlikely.

The dollar finished the North American session above JPY110 for the first time in a couple of weeks. No follow-through buying materialized, and the dollar is in about a 20-tick range on both sides of JPY110, where a $2 bln option expires today. There is another option struck at JPY109.50 for $882 mln that may help protect the dollar’s downside.

Meanwhile, sterling is continuing to advance. It has quietly strung together a three-day rally, and it has gained on the greenback for six of the past seven sessions. Today could be the first day since April 18 that sterling spends entire session above the 20-day moving average (~$1.34). There is a GBP553 mln option struck at $1.35 that expires today.

The US and Canadian economic calendars are light of market-moving data. The US reports weekly initial jobless claims, Q1 household net worth figures, and April consumer credit. Canada reports its Financial System Review.

Central Bank of Turkey is expected to keep rates steady at 16.50%. However, the market is split. Of the 17 analysts polled by Bloomberg, 9 see no hike, 1 sees a 50 bp hike, 1 sees a 75 bp hike, and 6 see a 100 bp hike. Given renewed pressure on the lira and May CPI inflation just reported at 12.15% y/y, we think anything short of 100 bp would be a disaster.

Mexico May CPI is expected to rise 4.46% y/y vs. 4.55% in April. If so, it would be the lowest since December 2016 but still above the 2-4% target range. Next policy meeting is June 21, and much will depend on how the peso trading as the July election nears.

Peru central bank is expected to keep rates steady at 2.75%. CPI rose 0.9% y/y in May, below the 1-3% target range. As such, we see a small chance of a dovish surprise.