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Self-Inflicted Wounds in Europe and Japan Help the Greenback Shrug Off the Drag of Lower Rates

Self-Inflicted Wounds in Europe and Japan Help the Greenback Shrug Off the Drag of Lower Rates

Overview: The dollar is bid. What makes its performance standout is that it is taking place as US rates have fallen. The US 10-year yield is near 4.20%, the lowest in more than two months. The two-year yield is near 4.67%. It has fallen every session this week for a cumulative decline of more than 20 bp. It is not so much that constructive developments took week, but that Europe and Japan are suffering from self-inflicted injury. Macron's call for snap elections in France undermined sentiment, and the latest developments warn that his party and allies could come in third place in the first round of voting. In the UK, it is possible that the Tories slip into third place too. In Japan, the BOJ made no change in its bond purchases, disappointing many, though Governor Ueda kept the door open to a move next month on rates and bond purchases. The euro has been sold to almost $1.0670 and sterling has been pushed below $1.2700. The dollar briefly was bid above JPY158 for the first time since the late April intervention but has now a little above JPY157. Only the Swiss franc among the G10 currencies is holding its own against the surging greenback. 

The broad bond market rally continues. European 10-year benchmark yields are 3-9 bp lower and intra-European spreads continue to widen. The 10-year German Bund yield is off almost 30 bp this week. The 10-year UK Gilt is right behind, it off 27 bp. While most of the large equity market but Australia advanced in Asia Pacific trading today, Europe's Stoxx 600 is off about 0.3% after being tagged for 1.3% yesterday. It is off 2% this week, which if sustained would be the largest weekly loss in eight months. US index futures are trading with a heavier bias. Gold is consolidating within yesterday's range. Still, barring a sell-off in North America today, it will snap a three-week slide. August WTI has also been confined to yesterday's range. It appears poised, though, to test the week's high near $79. It is having its best week since early April. 

Asia Pacific

Unsurprisingly, the BOJ maintained its current overnight target range of 0.00-0.10%. Somewhat more surprisingly, it left its bond purchases unchanged at JPY6 trillion (~$38 bln) a month. Governor Ueda's indicated a decision will be made next month and that a rate hike is possible. In the run-up to the meeting, there had been speculation that the BOJ could reduce the pace of its bond purchases from JPY6 trillion a month. Ueda had previously said that their policy purposes had been fulfilled. However, the market downgraded the chances of a hike and took Japan's 10-year bond yield about three basis points lower to bring this week's decline to 10 bp. Early Monday, Japan reports April tertiary industry index, and it is expected to bounce back after falling by 2.4% in March. In early Monday, PBOC will set the one-year Medium-Term Lending Facility Rate, which stands at 2.50%. Some think that after consumer prices fell by 0.1% in May and the drop in US yields, Beijing may use this as an opportunity to provide more monetary stimulus. Arguing against cutting rates is that they are not high, the yuan is at 6–7-month lows, and the equity market has been under pressures. The rate will set shortly before the release of several May data points, including new and used home prices, property sales, as well as retail sales, industrial production, and capex. The general impression is the property market contraction remains despite the numerous policy efforts, and the broader economy is chugging along at a below target (5%) pace. The Reserve Bank of Australia meets next Tuesday. There is little chance of a change in policy. 

Despite the pullback in US rates following the unexpectedly large jump in weekly jobless claims and a softer than expected PPI, the dollar held its own against the Japanese yen. The yen's losses were among the least in the G10, but it was unable to benefit as it often does from lower US rate. In response to the BOJ, the market took the dollar to JPY158.25, the highest level since the intervention on April 29 after the greenback poked above JPY160. The dollar pulled back to around JPY157.25 on Ueda's comments and is hovering around JPY157 in late morning turnover in Europe. The Australian dollar recorded an inside day yesterday and was confined to about a quarter of a cent on either side of $0.6650, around the middle of Wednesday's range. It is giving back more of Wednesday's gain today and is approaching $0.6600. Recall that the Aussie settled last week near $0.6580, its only close below $0.6600 since May 8. This is at risk in North America today. The dollar's broad strength, especially the slump in the yen helped keep the yuan under pressure. The PBOC set the dollar's reference rate at CNY7.1151, the highest this since January (CNY7.1133 yesterday). The dollar continues is at the upper end of its recent range against the offshore yuan, near CNH7.2750. The year's high was set in mid-April near CNH7.2830. This is the fourth consecutive week that the dollar has risen against the offshore yuan. 


Although the euro rallied from a five-week low near $1.0720 on Tuesday to slightly above $1.0850 on Wednesday with the help of a softer US CPI, Europe remains rattled by French President Macron's decision to call for a snap legislative election following his alliance's dismal showing in the EU Parliament elections. With the possibility that the left alliance drives Macron's party and allies to third place, the euro has been sold to $1.0680 today, its lowest level since May 2. The news from the left seemed to blunt the news that the conservative Republicans have unanimously expelled its president for announcing an unauthorized pact with Le Pen shows the difficulty that lies ahead for a center-right alliance. The French 10-year premium over Germany widened every day this week, and near 75 bp, is the most in a dozen years. Moreover, shortly after the election, the new government must turn its attention to next year's budget. The central bank shaved next year's GDP forecast to 1.2% this week from 1.5% projected in March. This will make it more difficult to comply with EC budget rules. It reinforces the pro-cyclical nature of European fiscal policy. Weaker growth forces fiscal consolidation, which in turns reduces growth. Rinse and repeat. The reverberations were felt throughout the European periphery. Italy's debt burden makes it particularly vulnerable. Italy's 10-year premium is at four-month highs over Germany. The EC is reportedly close to citing Italy in breach of its spending rules. Apart from the eurozone, Sweden's reported firmer than expected May CPI (0.2% for an underlying rate unchanged at 2.3%). Nevertheless, the swaps market has 30 bp of easing discounted for the August meeting, which is up three basis points on the week, even if down almost two from yesterday. The market is pricing in that the Riksbank will cut rates for a second time before the Fed cuts once. 

The gains the euro recorded after Wednesday's softer US CPI were unwound in full, even though US rates fell after the PPI came in below expectations and weekly jobless claims jumped. The euro has been sold to almost $1.0670 in the European morning. Last Friday, before the US jobs data and EU election outcome, the euro had been flirting with $1.09. Nearby support is seen around $1.0650, and the low for the year, set in mid-April was near $1.0600. It is through the lower Bollinger Band (~$1.0715) and the intraday momentum indicators are over-extended. Sterling also unwound its US-CPI driven gains that had lifted it around a cent to $1.2860. After setting session highs after softer US data slightly shy of $1.2810, sterling extended its pullback to a little through $1.2740 and has fallen to about  $1.2695 today. In the first four sessions this week, sterling has traded below the 20-day moving average on an intraday basis, but consistently closed above it. That may not be the case today. It is found near $1.2745. The five-day moving average is poised to fall below the 20-day moving average for the first time since May 1. To confirm a top is in place, sterling must close below $1.2700 and ideally, $1.2675. 


The jump in the US weekly initial jobless claims and the softer than expected PPI, on the heels of slower CPI sent US yields lower and took some wind from the dollar's sails briefly. The 0.2% decline in headline PPI was the largest since last October. Over half of the decline in PPI reflected the decline in gasoline. The price of other forms of energy (diesel, jet fuel, and commercial electricity) also softened. Excluding food and energy, PPI was flat. The components of PPI that feed into the PCE deflator fell. This includes airfares (-4.3%) and portfolio management services (-1.8%). Outpatient hospital care rose by 0.5% while physician are costs were unchanged. The April PCE deflator was at 2.7%. It may have fallen to 2.5%. The median forecast in the Fed's Summary of Economic Projections has it at 2.6% at the end of the year. The core PCE deflator was at 2.8% in April, which is where the median Fed forecast is for year-end. It will be reported on June 28. Weekly jobless claims rose 13k to 242k, the most since last August, and well above expectations. Developments in three states seemed to be the driver: California, Pennsylvania, and Minnesota. Still, while no doubt it will be noticed by Fed officials, it is broadly consistent with what Fed Chair Powell said yesterday. The labor market remains strong, even if not as strong as previously was the case. The US two-year yield made a marginal new low since early April near 4.66%, less than a basis point lower than Wednesday, but it again settled above 4.70%. The 10-year yield also made a marginal new low. It settled slightly above last week's low near 4.27%. On top today are import/export prices and the preliminary June University of Michigan survey. The market is more sensitive to the inflation expectations component of the latter than the former. With the conclusion of the FOMC meeting, Fed-speak resumes. Cleveland Fed President Mester is first up (CNBC 8:30 ET, Bloomberg TV 13:15 ET). She votes this year and is seen to lean a little toward the hawkish side and her dot was likely for no move or one cut. Chicago's Goolsbee is next (14:00 ET). He does not vote this year and regarded as among the most dovish members now. Governor Cook, perceived to be among the more hawkish governors, speaks at an evening event (19:00 ET), hosted by the American Economic Association. She very well may have been one of four officials that think there ought not to be a rate cut this year. 

The US dollar was in around a 25-pip range around CAD1.3740 yesterday and remains in that range today, though pressing the upper end in European turnover today. It is difficult to get excited while the CAD1.3660-CAD1.3800 range holds. Changes in the exchange rate and the Dollar Index enjoy a higher 60-day correlation than the changes in the exchange rate and the S&P 500 (~0.82 vs. 0.45). One takeaway is that in the current environment the Loonie is more sensitive to the broad US dollar than the risk appetite for per se. Speculation that the Bank of Canada could cut rates two more times before the Fed cut once may also be weighing on sentiment. The Mexican peso was granted a reprieve yesterday. In fact, it has nearly unwound this week's losses. The dollar settled near MXN18.3960 at the end of last week and traded to almost MXN18.42 yesterday. There was also some sign in the options market calmer nerves after MXN19.00 held on Wednesday and the specter of intervention was raised, which itself is a low rung on the intervention escalation ladder. However, the peso is under pressure again today and the greenback is testing the MXN18.62-MXN18.64 area. Yesterday's high was near MXN18.8450. 


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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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