EUR jump after EU leaders reached an agreement on how to deal with migrants. The countries agreed to set up “controlled centers” to process migrants' asylum claims. Those deemed eligible for asylum would then be distributed among member states that offer to take migrants. The key point is that it’s all voluntary: countries are required neither to set up these centers nor to take any migrants. That’s a major concession to the Eastern European countries. The EU will also look into establishing "regional disembarkation platforms" to process migrants outside of Europe, a major demand of several countries, including Austria, which takes over the EU Presidency. The agreement takes a lot of the pressure off not just the EU as a whole but specifically off German Chancellor Merkel, who was under intense pressure from her interior minister to do something to stem migration. The agreement probably means no further worries about her coalition falling apart. It’s therefore positive for the euro.
CAD jumped as oil gained further and the odds of a rate hike at the 11 July Bank of Canada meeting rose sharply. The market now sees a 68% chance, up from 55% at the beginning of the week. Following a speech yesterday, BoC Gov. Poloz told reporters expects to continue raising interest rates in spite of mounting trade tensions because inflation has alrady hit the BoC’s 2% target. This is Poloz’ last public appearance before the meeting and so it’s his last word.
“We’ve said clearly that, given where the economy is, we’re in a situation where the economy will warrant higher interest rates,” he said, while also emphasizing that this would be a “gradual process.” He also played down the impact of trade threats. “We’re data dependent, not headline dependent,” Poloz said. “We’re not going to make policy on the basis of political rhetoric or any of that.” The conclusion is unambiguous: Canada is likely to continue hiking rates. This should support CAD going forward.
How high could Canadian rates go? A simple Taylor Rule estimate would put them at 4.75%, vs the current 1.25% level. That would mean 350 bps of tightening to come – quite a change! But as you can see, the Taylor Rule has pretty consistently given too high an estimate of actual BoC rates.
The swaps market is pricing in about 82 bps of further tightening – two rate hikes and a 50-50 chance of a third.
By this way of calculation, Canada has among the most scope for tightening over the next three years among the major currencies – this should keep the currency underpinned, so long as oil holds up and the NAFTA dispute doesn’t derail the economy.
Meanwhile, JPY was the worst performing major currency, proving (as if it needs proving) that Japanese economic statistics have almost no impact on the currency market at all. The Tokyo CPI beat expectations, both at the headline level (+0.6% yoy vs +0.4% expected, +0.4% previous) and core (+0.4% yoy, +0.3% expected, +0.2% previous). The job-offers-to-applicants ratio unexpectedly rose and the unemployment rate unexpectedly fell to a 26-year low. All those figures should boost hopes that wage rises will accelerate and inflation will pick up, which should be good for the currency. Moreover, industrial production fell less than expected. Finally, the Bank of Japan reduced its bond purchases for the third time this month as it continued its “stealth taper,” another move that should be positive for the currency.
Nonetheless, JPY fell sharply. Nor can the decline be attributed solely to the usual JPY-stocks correlation, because the stock market was up only 0.25%. It shows that JPY is dominated nowadays by overall risk sentiment, not Japanese economics. As you can see from the graph, although USD/JPY (the orange line) was moving higher already along with the improved tone in global risk, it jumped up along with EUR/USD (the white line) when the news about the EU agreement on migrants was announced, even though of course that has nothing to do with Japan.
USD was also lower despite a higher stock market and higher US bond yields. Go figure. It seems fairly random to me.
Today is the second day of the EU Summit. With the talks on migrants out of the way, I expect to hear more about Brexit, which can’t be good for sterling. At a working dinner last night, UK PM May argued that the EU’s rules on sharing information with countries outside the bloc would prevent Britain from working with the EU on security. EU members see complaints like this as just part of Britain’s attempt to pick and choose which parts of Europe it wants to belong to, and are generally met with disdain. EU leaders arriving at the meeting yesterday had nothing good to say about Britain: Ireland PM Varadkar said it was “unlikely but possible” that the two sides would be unable to reach an agreement on post-Brexit relations and Britain would just crash out of the EU.
As for the data, we start off with German unemployment. The data are expected to show a continued decline in unemployment, however at a steadily declining pace and well below trend. Meanwhile the unemployment rate (or claims rate, in Germany) is forecast to be unchanged. In short, it’s forecast to show the improvement in the employment situation is gradually tapering off. That’s not a good sign when the incumbent government is already struggling. Moreover, there’s nothing to make people fear migrants more than a tepid job market. EUR-negative.
(Actually, German retail sales come out before the unemployment data, but I don’t find much connection between that data series and the subsequent movement of the FX market.)
Bank of England mortgage approvals are expected to be down slightly (-0.4%). However, UK Finance mortgage approvals, which were released on Tuesday, showed a stronger-than-expected rise of 2.4% (+0.3% expected). The two series move in the same direction 85% of the time, so we could get a positive surprise that might be a bit GBP-positive.
The third and final revision of UK Q1 GDP will be released. No change is expected.
EU consumer prices (CPI) are forecast to rise at a slightly faster pace at the headline level, but a slightly slower pace at the core level. Which one matters? Which one does the ECB use? Funny you should ask that. Just Tuesday, the ECB published a report, “Measures of underlying inflation for the euro area.” It noted that the ECB’s formal target was stated in terms of headline, but unfortunately they also monitor a wide number of other measures (see table from the report).
In fact, when we do a regression analysis of the surprise in the data against the subsequent movement of EUR/USD, we find that neither series is particularly significant, and even worse, the sign for the headline figure is backwards – that is, EUR/USD tends to rise when the headline figure surprises on the downside. This doesn’t make sense. The sign for the core figure is at least correct and EUR/USD tends to rise (i.e, the euro strengthens) when inflation is faster than expected. So I would suggest looking at the core figure.
The lack of a significant market reaction may be because by the time the EU-wide CPI is released, we’ve already gotten the German, French Spanish and Italian CPIs. With these four, we can predict the EU-wide CPI with slightly over 99% accuracy. Thus it may not matter at all by the time the figure is released.
Next out is a more significant inflation figure – probably the most important figure of the week: the US personal consumption expenditure (PCE) deflators. As the ECB’s table shows, this – not CPI – is what the Fed uses as an inflation target. The table says the Fed uses the “total PCE deflator,” but it’s widely assumed that they use the core measure. In any event, the headline figure is forecast to vault past the 2% target, while the core measure is expected to inch its way closer to it. Given that the Fed has more than achieved its employment target, it only has to hit its inflation target to declare “misssion accomplished.” That would pave the way for further rate hikes back to a theoretically neutral level and therefore be positive for the dollar.
The US personal income and personal spending figures, which grab most of the headlines, aren’t as significant for the FX market as the PCE deflators, which come out at the same time. In any event, both incomes and spending are expected to be up a solid 0.4% mom, which should enable consumer activity to expand steadily this quarter.
The Bank of Canada’s quarterly business survey does have a number attached to it – the “business outlook indicator,” as well as a variety of other indices – but there are no forecasts available. This important survey is like a cross between the Fed’s Beige Book and Japan’s tankan.
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