Dollar Remains Under Pressure Ahead Of FOMC

The US dollar has yet to stabilize against the euro and sterling, although it has steadied against the dollar-bloc currencies and yen. The euro has been bid through the $1.10 level on the back of stronger month supply growth and the first positive growth in private credit in two years. After finishing yesterday's North American session on its highs, fully recovering from the disappointing Q1 GDP, sterling has extended its gains to $1.54. Since the April 13 low near $1.4565, it has appreciated by 5.8% or nearly 8.5 cents.

We suspect the market is getting ahead of itself. A FOMC statement today that keeps the June meeting alive could help the greenback, but that alone may not be convincing. Instead, it may take a robust jobs report at the end of next week to put a more solid floor under the dollar.

The FOMC statement will recognize the weakness of the economy, and indeed there may be some downside risks to the consensus estimate of 1% Q1 GDP that will be reported today ahead of the Fed meeting. Fed officials have already said as much in their speeches. However, they recognize that the main headwinds are likely to prove transitory. There is no reason at this juncture to reconsider this.

The trajectory of monetary policy is not a hostage to Q1 data. We do not expect the Fed to rule out a June hike. It has worked hard to shift the focus from dates to data. Ruling out a June hike is contrary to this thrust.

Ahead of the US Q1 GDP report and the FOMC meeting there have been five developments to note. First, euro area money supply growth continued to accelerate in March. The 4.6% year-over-year pace (4.0% in February) is the strongest in six years. Moreover, private credit growth turned positive (0.1% from flat) which is the first such reading since 2012. This would seem to show improving financial conditions. Yet with the ECB's asset purchases program still in its early days and the distortions caused by negative interest rates still rippling through, it is difficult to separate the shift in portfolio preferences from the true underlying improvement.

Second, German states have reported April CPI figures. These support ideas that the EU-harmonized measure for the country can rise to 0.2% from 0.1% on a year-over-year basis. The euro zone flash CPI reading will be reported tomorrow (after the preliminary Spanish estimate is also released). The deflation evident in the negative year-over-year prints starting in December and running through March may end in April with a flat reading. This likely reflects the rebound in energy prices as the core rate is expected to remain unchanged at 0.6%.

Third, Sweden's Riksbank surprised the market by not cutting its -25 bp repo rate. However, it did extend its bond purchases by SEK40-50 bln and lowered the rate path. The comments from officials suggesting that inflation may have bottomed helped send the krona sharply higher. The dollar has fallen to SEK8.40, a seven week low before finding a bid. The euro has fallen nearly one percent against the krona to near the mid-April lows near SEK9.24. That said, the krona appears to be over-extended, and some paring of its gains seem likely.

Fourth, the Greek government is to submit legislation to parliament today to enact a number of reforms that have been agreed upon with the official creditors. It is necessary but not sufficient to open the purse strings next month. Separately, the ECB appears to have extended authorization for ELA borrowing by another 1.4 bln euros (to 76.9 bln). Next week's non-policy making ECB meeting will discuss the haircut on collateral that Greek banks are using to access ELA funds.

Fifth, while global equities are narrowly mixed, global bonds are under pressure. US 10-Year Treasuries are testing 2%, and this might be helping the dollar find a bid against the yen (Japanese markets on holiday today). European bonds have been hit hard with yields backing up 5-8 bp with Portugal and Greece getting hit harder (yields up 14-18 bp).

The Reserve Bank of New Zealand will announce its decision a few hours after the FOMC statement. The RBNZ is on hold, but officials have tipped a more dovish statement. The Bank of Japan meets on Thursday and is widely expected to soften its inflation forecasts in its semi-annual growth and inflation outlook. Nevertheless we expect the BOJ's Kuroda to continue to sound optimistic and in no hurry to expand the already aggressive QQE.