The market’s movements are a bit hard to explain today.
AUD up and JPY down is a typical risk-on move, which is logical given the optimism surrounding the Kim-Trump summit. How then to explain a stronger dollar, which usually declines when risk sentiment improves? Neither US stocks nor bonds moved enough to sway the currency one way or the other.
The euro move was particularly perplexing. The currency gained in early European trading following the comments in the Sunday papers from the new finance minister pledging allegiance to the euro and downplaying the potential for issuing “mini-BOTs”. Italian bond yields plunged on the news, showing that investors were reassured about the country’s intentions. But EUR couldn’t sustain the gains, and especially around midnight GMT it weakened sharply vs USD, as did a number of other currencies.
There wasn’t any news out at that time to send the dollar up at that time. Rather, it looks like there was significant position-squaring aheaad of the summit in case any announcement was made.
Personally, I don’t think the summit is that important for countries other than Japan and of course South Korea (and KRW was up only 0.10% vs USD, a surprisingly small move, and it’s actually one of the very few EM currencies to fall over the last week). The reduction in tensions could be important for risk sentiment in Japan, but how will it help any country’s economy? Even if sanctions are lifted, North Korea’s economy is too small and the country is too poor to make much of a difference economically. The population of the country is estimated at 25.4mn, less than one-third the size of Iran (80.3mn) for example.
I expect that the FOMC meeting tomorrow and the ECB meeting Thursday, while much less dramatic, are much more important for the currency markets. In that respect, the euro’s sudden weakness may be a sign that investors may be giving more weight to the possibility that the ECB will delay a decision on ending its QE program until the July meeting. I expect though that they will announce at this meeting an end to the QE program and that the euro is likely to strengthen as a result.
GBP weakened after the trade deficit came in much wider than expected (-£14.0bn vs -£11.3bn expected, -£12.0bn previously) and industrial production fell 0.8% mom instead of rising 0.1% as expected. That plus the political minefield that PM May must walk today (see below) is hurting sentiment for the pound, as well it should. I expect sterling to continue to decline.
The day starts with the UK employment data. The figures are expected to show the same sort of mixed message that so many other countries face nowadays. On the one hand, the job market is quite strong: the unemployment rate is forecast to stay at the lowest level since May 1975 while the increase in the number of jobs, while expected to be less than last month, is forecast to be above the six-month average.
On the other hand, growth in earnings overall (including bonuses) is expected to slow, while growth base wages – that is, earnings excluding bonuses – is forecast to remain the same. So the strong labor market is not feeding through to higher wages, a phenomenon that we see in other countries as well. I think this should be negative for sterling.
Bank of England Monetary Policy Committee member Silvana Tenreyro said recently, “I expect that the tight labour market will continue to feed through into domestic cost pressures…” and that was one of the main reasons why she expects “a limited and gradual tightening in Bank Rate over the next three years.” But if we see that it isn’t feeding through as much or as rapidly as expected, then there’s no penalty for waiting a bit longer to raise rates.
Other UK events today include the start of a two-day debate in Parliament on the EU Withdrawal Bill, the law that’s supposed to take Britain out of the EU. The bill enshrines EU law into UK law, so that there aren’t any gaps when the UK leaves. The House of Lords added 15 amendments to the bill; PM May wants Parliament to overturn all of them except one. There is some concern that if she is defeated, this could lead to a general election that might even bring in a Labour government under the current Labour Leader, Jeremy Corbyn. That possibility could see the pound reaching parity with the dollar, in my view.
The ZEW survey is forecast to show a further gradual decline from the record high set in January (data goes back to Dec 1991). That’s only natural as the Eurozone economy did slow notably in Q1. The expectations index however is forecast to fall further below zero, indicating that the analysts and other experts polled are becoming more and more pessimistic about the outlook for Europe – not surprising, considering the tit-for-tat tariffs with the US, the Brexit negotiations, and the US reimposition of sanctions on Iran, which was becoming a nice business for many European countries.
The US National Federation of Independent Businesses (NFIB) index of small business optimism is expected to be largely unchanged from the previous month. That would be three months in a row at the same somewhat lower (but still historically high) level. The hiring plans index, which is already out, rose slightly. The report suggests that small businesses, which are the backbone of the US economy, remain healthy. This should be good news for the US economy and therefore good news for the dollar.
Finally, we get the main event of the day: the US consumer price index (CPI). Coming just as the Fed starts its two-day meeting, this is a crucial data point for the markets (even though technically this isn’t the indicator that the Fed uses to gauge inflation – they use the personal consumption expenditure deflator). In any event, both the headline and the core rate of inflation are expected to accelerate further above the Fed’s 2% inflation target, which may give some confidence to those FOMC members who are considering raising their “dot” a bit this time. USD-bullish
Note though that history suggests it’s unlikely the figure will beat expectations, which may temper the impact on the dollar. Since 2000, the headline CPI for May has beat the consensus estimate only 33% of the time. It’s missed the consensus four of the last five years. Similarly, core CPI has beat the consensus only 22% of the time and only equaled or missed four of the last five years.
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