Dollar Lifted By ECB QE And UK Deflation

The US dollar is broadly higher as yesterday's gains are extended. The driving force is not so much a shift in perceptions of the US economy, though the San Francisco Fed that claimed seasonal adjustment quirks are behind the repeated weakness in Q1 GDP helped market sentiment yesterday in North America.

Rather, the euro has been weighed down by comments from the ECB's board member Benoit Coeure indicating that the bond-buying program will be stepped up this month and next to allow for a slower purchases during the thin summer months. This in turn helped spur a European bond market rally. The German 10-Year benchmark yield is off 9 bp to 54 bp, a one-week low. Spain, Italy, and Portuguese yields are off 13-14 bp.

Not only are European bonds rallying, but so are stocks. Major markets are up 1.3%-2.0%. The Dow Jones STOXX 600 up 1.5%, led by consumer discretionary and staples, and telecoms.

The euro had approached $1.15 before the weekend. Today it is flirting with the 100-day moving average, near $1.1175. It held above the 20-day moving average that is found near $1.1155. It has not closed below the 20-day moving average since April 23. Resistance is now seen in the $1.1280-$1.1300 area.

The German ZEW was disappointing, but the euro did not make new lows in response. A softer report was expected, but the decline was more than anticipated by the consensus. The assessment of current conditions fell to 65.7 from 70.2, and the expectations component fell to 41.9 from 53.3. Despite the pullback, both readings remain new cyclical peaks.

Sterling is lower for a third day. It peaked on May 14 after poking through the $1.58 level briefly. Today it is testing the $1.5540 retracement area of the leg up that began on May 5 below $1.50. The next retracement objective is near $1.5450.

Sterling was already coming under pressure, but the negative CPI print accelerated the push lower. April consumer prices rose 0.2% on the month, which was half as much as the consensus expected. This was sufficient to push the year-over-year rate into negative territory (-0.1%) for the first time since at least 1960. The core rate also was lower than expected at 0.8%. The consensus was for an unchanged reading of 1.0%. The implied yield of the short-sterling futures strip fell in response. Next year's implied yields are off 4-5 bp, and 2017 yields are off 6 bp. UK gilts yields are off 6 bp, among the least in core Europe. The FTSE is also lagging though it is up 0.4% near midday in London.

The New Zealand dollar is bucking the trend today by posting gains against the US dollar. A slight increase in inflation expectations undermined confidence that the central bank would cut interest rates as early as next month. Such expectations had been fanned by official comments, concerns about the strength of the kiwi, and the willingness to use macro-prudential measures to address the housing market (which frees up the interest rate tool to support the economy). The 12-month inflation expectation rose to 1.32% from 1.11%. The 2-year expectation rose to 1.85% from 1.80%.

On the other hand, the minutes from the recent Reserve Bank of Australia meeting were a bit more dovish, and this has weighed on the Aussie. The RBA minutes indicated that although officials failed to provide much in the way of forward guidance, its policy options, i.e., the rate cut door, remains open. The Australian dollar is lower for the fourth session after peaking on May 14 near $0.8160. It has been down to $0.7960 today. The 20-day moving average is found near $0.7930. It has not closed below this average since April 14. Trend line support is also seen near there.

The yen is sidelined. The dollar has been confined in a range thus far today that is just about a quarter of a yen wide. The rise in US yields (yesterday) and gains in the Nikkei today (~0.6%) lent the greenback support. Hedge funds and Japanese importers were reportedly dollar buyers. A trendline drawn off the year’s high (March 10 ~JPY122.05) comes in near JPY120.30 today.

The North American session features April housing starts and permits. This sector had been undermined by the weather, especially in February. A small recovery was seen in March, and a stronger recovery is expected in April. Permits, a leading indicator, have held on better. The Q1 monthly average was 1068. The Q4 '14 monthly average was 1070. The consensus expects April permits to have risen to 1064. That said, the economic bounce back in Q2 has thus far not been very impressive, and not on par with last year’s recovery after the Q1 contraction.