The ECB took great offense
Insisting their rules made much sense
But Europe still trails
As weakness prevails
And no one’s come to their defense
The dollar is rocking this morning, rallying against almost all currencies with some pretty large movements seen. It looks like the catalyst for this was the revision higher in Japan’s Q1 GDP report, up to an annualized rate of 4.1%. This has bolstered Abe and his policies, helped the Nikkei rally almost 5% and reinvigorated the idea that Japan may yet escape their morass. USDJPY is back to 99.00, a rally of ~1.5%, and as you all know, I continue to look for that move to 110 by year end. We continue to see significant volatility in Japan, but if Q2 growth can follow Q1, I believe that will help mitigate some of this price action. There is a long way to go before that, however, with the BOJ finishing their meeting this evening, (no policy changes are expected), the Upper House election on July 21, and uncertainty prevailing over what is happening in both Europe and the US. Receivables hedgers in Japan need to be taking advantage of this correction, for the long run trend remains for a much weaker yen.
In Europe, the biggest story has likely been the IMF’s mea culpa about how it handled the Greek bailout, now recognizing that perhaps their standard prescriptions were not so effective. I’m sure the Greeks, mired in a 6 year Depression, feel much better about those comments! To me, the interesting thing is that the Troika is being taken to task for its actions, yet the other two members are unwilling to admit any policy errors. In fact, Signor Draghi has been adamant that everything the ECB has done has been splendid. However, Europe is still in the grips of its longest recession since the EU was formed, 6 quarters and counting, and at best, the data remains mixed. While French IP was a bit better than expected, Italian IP was worse than expected. There is no consistent growth and thus far, no plans have been proffered that would change things. While the euro has held up reasonably well overnight, I continue to expect 1.25 before 1.35, with there being no good reason for the euro to rally on its own, and with talk of the Fed ‘taper’ likely to underpin the dollar for now.
So let’s discuss the taper. The Fed planted a John Hilsenrath article in the WSJ over the weekend to encourage more market discussion on the subject. What seems to be clear is that the Fed has become somewhat uncomfortable with just how large their balance sheet has become. The Krugmanesque idea of printing money ad infinitum may be reaching its conclusion. Certainly the Fed hawks; Plosser, Fisher and Bullard have been consistent in their criticisms, but it is the doves’ comments that lead one to believe there will be action this year. I have maintained that unless Berdudlen changes their tune, nothing will change, but Dudley seems open to an adjustment before the end of the year, and even Chairman Ben seems to have hinted at that in his last testimony. If Yellen makes any comments this month about tapering purchases, then I think we will need to re-evaluate the situation, but so far, despite some obvious misgivings on the FOMC, it seems they will continue to sop up $85 billion / month of paper. And Treasuries are still falling!
The dollar is benefitting in general from the taper discussion, with only CAD and NOK modestly stronger on the day in the G10 space, and pretty much the entire EMG space weaker vs. the USD. In fact, we have seen some pretty large moves, with ZAR down more than 2% and INR falling just under 2%, to a record low. The INR story is one of continued concern over its economic fundamentals, a growing C/A deficit, no budget control and rising inflation hindering the RBI’s room for maneuver to address the macroeconomic problems in country. ZAR seems to be responding to the consistently weaker commodity prices that we have seen since China released weaker than expected data over the weekend. (Exports were soft, Imports fell and IP was soft). Concerns over a continued slowing of Chinese growth are going to hit most EMG currencies, so keep that in mind for now. Longer term, I believe we see a rebound, but the market view for now is bail out and be happy.
With no US data today to drive things, and the week pretty light overall, I expect a modest continuation of USD strength.