The key issue facing the foreign exchange market is whether the modicum of strength the US dollar demonstrated last week is the beginning of a sustainable move. It is possible that the market is again at a juncture in which the price action will drive the narrative rather than the other way around. A move above JPY108 and a decline in the euro below $1.1350 signal a start to a broader dollar recovery that may have begun last week with impressive gains against the dollar-bloc.
The RBA’s rate cut took many by surprise, and the forward guidance, which included a reduction in the central bank’s inflation forecast, encouraged speculation of another rate cut in the coming months. The Australian dollar has given back half of the gains registered since mid-January. A recognition that the Canadian economy continues to wrestle with its terms of trade shock and a record trade deficit spurred some profit-taking in the Canadian dollar. The US dollar rose through a downtrend line that began in late-January, and short-term Canadian interest rates, which have risen since the end of January, have started softening.
The resilience of the US dollar and the firmness of US yields after the monthly report showed the weakest job growth in seven months may be significant. Just like strong jobs growth in Q4 15-Q1 16 period (averaged monthly jobs growth 243k) did not translate to strong growth, the weaker jobs growth may, in fact, coincide with an acceleration of US GDP.
Of course, the jobs data was not horrific, and employment growth is expected to slow as full employment is approached. Nor were the details particularly troubling. Manufacturing added jobs when economists had been expected it to have shed workers. The workweek increased 0.1%, which given the number of American employees, translates into about 450k full-time equivalents (in terms of hours worked). Not only were there more people working a longer work week, but they were also getting paid slightly better. Average hourly earnings rose 0.3% for a 2.5% year-over-year pace.
Perhaps the most troubling part of the report was not the miss on the headline but the decline in the participation rate. It fell from 63%, a two-year high, to 62.8%. The participation rate had been trending higher, and we caution against reading too much into a single data point.
On balance, one must suspect the Federal Reserve will conclude that the labor market recovery remains intact, and in any event, it will get another reading before next month’s meeting. The issue, which the FOMC’s April statement identified, is consumption. We anticipate better numbers ahead, beginning with this week’s April retail sales report.
April retail sales are expected to have been lifted by stronger auto sales and higher gasoline prices. The 0.7%-1.0% projected increase will be the biggest in a year. If the GDP component (excludes, food, building materials, gasoline, and autos) rises by 0.4%, it would the largest increase since last July.
The wholesale inventory figures will help economists fine tune expectations for revisions of Q1 GDP. Recent trade and shipment data suggests a modest upward revision to the first estimate of Q1 GDP toward 0.8%-1.0% (May 27). However, Q2 growth is projected to move back toward trend, near 2.0%. The Fed funds futures market continues to price in practically no chance of a June rate hike.
The eurozone will take another look at Q1 GDP this coming week. While more details will be provided, there is some risk of a downward revision to 0.5% from 0.6%. It makes March industrial output reports less relevant, though we note that French and Italian production are expected to bounce back after a fall in February. Germany is marching to a different tune. March output likely fell by around 0.2% after a 0.5% decline in February. Both months are payback for the outsized 2.3% jump in January. A rise in factory orders may take the sting out of a small fall in output.
The Eurogroup of finance ministers are to meet Monday to discuss Greece. The problem is that the IMF did not participate in the funding of the third aid package last summer. The IMF’s involvement is essential for the Bundestag’s support. It says it's willing to under certain conditions that the other creditors find unacceptable, including a write-down of the debt owed to the other official creditors (but not the IMF). Greece finds some IMF demands intolerable, like a contingency program of measures that will automatically be triggered if Greece misses its fiscal target.
The euro finished last week a little more than two cents off its multi-month high set on May 3 near $1.1615. Ironically, the eurozone economy is not its most pressing issue. Even with a slight downward revision in Q1 GDP, the eurozone will still have grown faster than the US, Japan, and UK. Its pressing challenges are political in nature, like Brexit, the relationship with Turkey now Davutoglu is gone and Russian sanctions which are set to expire in July.
The biggest build in speculative gross long euro positions in the futures market in three months leaves late-longs in weak hands. A break of the $1.1200 area is needed to signal a move into a lower trading range. Given the size of the ECB latest initiative, and timing of the launch of the new TLTRO and corporate bond purchase program, it will be several months before the ECB can fully evaluate its efforts. This means that it is difficult to envision fresh ECB initiatives before the end of the year at the earliest.
The Bank of England meets. At the same time that price pressures are beginning to increase, the UK economy is slowing. The April PMIs uniformly warn that the slowing has bled into the start of Q2. The last dissent from the BOE was for an immediate hike.
A dovish dissent now would surprise and lead to an immediate fall in sterling. The quarterly inflation report will be presented at the end of the MPC meeting. The Bank of England appears to be anticipating a rate hike in the next two years, or inflation may exceed its 2% target.
Norges Bank, Norway’s central bank meets as well. The risk of a surprise cut are only marginally higher than for a BOE rate cut. Data before the meeting will illustrate why Norges Bank is in no hurry to move again after cutting the deposit rate by 25 bp to 0.50% in March. Consumer prices are steady in the low 3% area and Q1 GDP (both overall and including only the mainland economy) expanded after contracting t the end of last year. The rise in oil prices may make officials more tolerant of the 4.7% appreciation of the krone on a trade-weighted basis and 7.8% against the US dollar this year (second to the yen’s 12.2% appreciation and edging out Canada’s 7.2% gain).
Japan’s current account for March may not help Finance Minister Aso’s press for a weaker yen at the G7 meeting later this month. The March current account surplus is often larger than the February surplus, but the expected increase will lift to it near record highs. It is expected to rise by JPY530 bln to JPY2.965 trillion. The trade surplus does not drive the current account surplus; investment income does. However, the trade surplus is expected to double (month-over-month) to JPY906 bln.
China reported its April reserve and trade figures over the weekend. It will report inflation, lending, industrial output and investment, and retail sales this week. China’s reserve rose for the second consecutive month. Currency fluctuations probably played a small part in the increased valuation, though given current account surplus, many observers will argue reserves growth should have been greater. In any event, by any metric, Chinese officials have managed to stabilize capital outflows.
Measured in dollar or yuan, China’s trade surplus swelled. At $45.56 it was the biggest surplus in three months. The same is true when measured as CNY298 bln. In dollar terms, exports and imports are still declining on a year-over-year basis. In yuan terms, exports rose 4.1%, and imports were off 5.7%.
Lending growth is expected to have moderated while economic activity should firm. Although many investors and policy makers are anxious about it, the data in hand, and projected, suggests the soft landing scenario is holding.
In a strong US dollar environment, the yuan may closely track its trade-weighted basket. This will discourage criticism that the PBOC is seeking to devalue the yuan. In a softer dollar environment, such as over the first few months of the year, the yuan tracks the dollar and under-performs against its basket. Of course, Chinese officials can change tactics at any time.