Dollar to Rally After ECB Rate Decision

Highlights

The US dollar is softer across the board and is indeed at new lows for the week against most of the major currencies ahead of a relatively constructive string of economic data and rate hikes from New Zealand and Brazil, a healthy reception to the first Spanish bond auction since the credit downgrade at the end of May.  The Bank of England left rates steady and the focus is on the ECB meeting and the subsequent press conference.   Barring a surprise from Trichet, look for the US dollar to see its losses pared in the North American session today. 

Global equities are marching higher today.  The MSCI Asia-Pacific Index rose 1%.  A small upward revision to Japan’s Q1 GDP from 4.9% to 5.0%, helped by upward revisions to consumer spending, helped the Nikkei gain 1%.  Despite news of a sharper than expected of China’s trade surplus, news that property prices rose 12.4%, the second highest on record, and talk that tomorrow’s CPI may be above 3% weighed on the Chinese equities, where the Shanghai Composite slipped 0.8%.   European equities have staged an impressive recovery after opening with losses of 1% or more.  Oil and gas is the only sector in the Dow Jones 600 that is lower on the day.  Industrials and basic materials are leading the way.  A local German paper reports that a US subsidiary of a large German bank may be having financing difficulties and although the DAX is up around 0.6% near midday, financials are under-performing. 

The rally in the equity market and successful auction in the periphery of Europe today are taking away the safe haven bid from German bunds and US Treasuries.  While Italy and Ireland sold bills, that were easily absorbed, the focus was on the roughly 4 bln euro bond sale by Spain,  The bid-to-cover was 2.1 vs 1.79 in April, but at a cost of sharply higher yields.  In April the yield was a little more than 2% and today a little more than 3.30%.

Currency Markets

There is no reason to expect that the ECB will change rates today.  Instead the key focus is on possible new measures in terms of the short and long-term repo operations and the ECB’s bond sterilization efforts.   With last year’s 442 bln euro 12-month repo expiring at the end of the month, banks are seen hoarding cash—overnight deposits at the ECB are at or near record levels.  The market will be disappointed if there are no modifications in the ECB liquidity stance.  The euro’s 5-day moving average is near $1.1985 today and it has not closed the NY session above that average this month. A move above $1.2100 could see additional short-covering to lift the single currency toward the $1.2150 area.  Our caution, however, is 1) the euro’s gains may be position squaring ahead of the ECB meeting and 2) short-term technical indicators are not moving above yesterday’s levels despite the euro doing so, and this is seen as a bearish divergence, and 3) many medium term participants had previously signaled a desire to wait for a euro bounce to sell into. 

The Bank of Canada hiked rates earlier this month and this has been followed by the Reserve Bank of New Zealand today.  The RBNZ’s comments did not seem very forceful and the risk is that the market, which is pricing in a 25 bp rate hike at every meeting  through December, with the official cash rate finishing the year at 3.75% from 2.75% with today’s hike.   This seems excessive.  On the other hand, Australia reported another strong employment report.  The country grew almost 27k jobs and 36.4k full-time jobs (and loss of part-time jobs).  The unemployment rate fell to 5.2% from 5.4%.  Although the RBA has sounded rather neutral lately, a resumption of the tightening cycle late this year seems more likely than the market has priced in.  The Australian dollar has also been aided by news that South Korea’s National Pension Fund has indicated that it has begun diversifying into Australian government bonds. 

Sweden looks likely to be the next G10 country to tighten monetary policy.  The recent string of economic data have been generally better than expected including Q1 GDP and the upward revision to Q4 09 figures.  The softness of the April retail sales report could be played down due to the early Easter distortions.  Today Sweden reported firm May CPI readings.  The 0.2% gain lifted the year-over-year rate to 1.2%, which is above the Riksbank’s year-end forecast of 1.1%.  Last week the Riksbank removed the 1-3% bands on its inflation target and went with the mid-point of 2%, which seems to arguably allow for some near-term volatility and it is true that the core rate slipped to 2.1% form 2.2% in April.  However, on balance, the strength of the domestic economy and the Sweden’s resilience to the European debt crisis are likely to see the Riksbank beginning to normalization interest rates next month.  Norway, which has already hiked rates, is on hold.  Today’s report showed May’s CPI fell 0.5%, bringing the year-over-year rate to 2.5% from 3.3% in April.  The government cut this year’s GDP forecast to 1.6% from the 2.0% forecast issued in February. 

Earlier this week, a Chinese official was thought to leak today’s trade figures by suggesting exports were up 50%.  In our experience, China’s officials typically do not leak.  Indeed it was not a leak.  May’s trade figures were released today and exports for 48.3%, which is still the strongest showing in six years, but in part reflects the base effects from last years.  May imports rose 48.5%.   This generated a trade surplus of $19.5 bln, more than twice the market expectation. The fact that house prices rose 12.4%, somewhat stronger than expected, though still slower than the 12.8% pace seen in April, warns that the PBOC may be poised to raise reserve requirements again.  Tomorrow’s data will be critical.  The official who spoke earlier this week seemed to suggest the risk of a higher than expected CPI figure—the consensus is for a 3% increase—and new loans above the consensus estimate of CNY600 bln.  Meanwhile, US Senator Schumer is signaling a vote on measures to “force” China’s hand on the currency within the next couple of weeks.  Note the yesterday China support sanctions against Iran at yesterday’s UN Security Council.  Only Turkey and Brazil voted against the tighter sanctions.

Upcoming Economic Releases
Today’s main features include US trade figures and initial jobless claims at 8:30 EST/12:30 GMT.   A modest widening of the deficit is expected, but the weekly initial jobless claims may take on greater significance than usual given last week’s disappointing jobs report.   The impact on the foreign exchange market may be limited by the focus on the ECB’s press conference that begins around the same time.