The Third Arrow

While GDP growth
Has impressed, the ‘Third Arrow’
Is all that remains

The dollar continues to be the primary beneficiary of the current combination of market events and economic releases. While the movement overnight has been relatively limited, there has been precious little retrenchment in the dollar’s recent strength.

Overnight the biggest news was Japan’s Q1 GDP release, with growth of 0.9% (3.5% annualized), the strongest number for any of the G7 nations.  This appears to be a testament to the success of the Abe government’s aggressive actions thus far.   In my view, it is also reason to believe that there will be no changing of the Japanese QE program any time soon.  Coming tomorrow, PM Abe is to announce the ‘Third Arrow’ of his plan, which is to address structural reform and regulatory issues in Japan.  These are going to be critical if Abe-san is going to be able to implement long lasting change in Japan.  However, given the depth of entrenched interests, especially the agricultural community who will likely be very significantly impacted by these changes, it remains to be seen just how much change is in the offing.  As of now, the market continues to believe in the Abe government, and the yen continues to slide in response.  But until the Upper House elections in July, there is unlikely to be any great change in the regulatory framework.  The BOJ will have to continue to carry the load itself, and that means further weakness for the yen.

In Europe, things are less uniformly positive, although early this morning we saw the EU Trade balance expand to €18.7 Billion in March, much larger than expected.  However, the market reaction was pretty unimpressive with the euro actually lower now than when we went home yesterday.  As we have seen over the past several sessions, the dollar remains king in the current market, and I sense that this is simply the dollar’s dominance rather than any specific euro weakness.  That said, given the Eurozone’s extremely weak near-term prospects for growth, I would look for the dollar to continue its ascent going forward.  So receivables hedgers, you need to be nimble for any short term rallies in the single currency.

Politics has been the story in the UK, with more than 100 Tory backbenchers voting against PM Cameron’s proposed economic program as a protest on the EU situation.  There remains a large group of MP’s who are pushing for the UK to exit the EU, although it remains highly controversial.  The thing is, all the uncertainty seems to be weighing on the pound of late, as it slips alongside the euro.  While the growth situation seems to have stabilized, at least, and may be improving more rapidly than previously expected, this issue is likely to be a background weight on the pound until there is some final resolution.  The problem is that may not come for another 4 years and the proposed ‘in or out’ referendum.  My sense is that the pound will underperform most other European currencies for quite a while going forward.  Not collapsing mind you, just lagging.

In the US today we get a plethora of data, mostly at 8:30, led by Initial Claims (exp 330K); Continuing Claims (3000K); Housing Starts (970K); Building Permits (941K) and CPI (-0.3%, core +0.2%); and finally at 10:00 we see Philly Fed (exp 2.0).  So lots more for us to learn about the US economy to see if we remain on the right track.  My thought is we will see better data across the board here, and the dollar will benefit in response.

In Commodity land, the CAD continues to hold on to its relative strength despite a weaker than expected Manufacturing number yesterday and the overall USD strength story.  As I mentioned yesterday, Canada’s proximity and reliance on the US remains a key positive for the currency as long as the US growth picture remains upbeat.  Aussie, meanwhile, continues to suffer from perceptions of slower growth in China and its own central bank’s clearly dovish bias despite fairly robust recent data.  I continue to believe that AUD has further to fall from current levels than CAD.

Finally, in the emerging markets, ZAR has been the big mover, with USDZAR rising 1.3% overnight.  It appears that a combination of general dollar strength, gold weakness and ongoing strife in several mining communities has been sufficient to drive the ZAR to its weakest level in 4 years.  But aside from that move, the space has been fairly quiet, with modest USD strength the underlying theme.