December Rate Hike Probabilities:
USD 87.1% + (Increasingly likely)
EUR 2.6% – (Think December 2019)
GBP 90.0% – (Done deal, probably in November)
CAD 30.2% – (Ain’t gonna happen now)
Fed Rhetoric 25bps
The ECB, yesterday, stressed
Inflation continues depressed
So bonds they’ll keep buying
As Draghi keeps trying
To show how much Europe’s progressed
The dollar has been the main beneficiary of yesterday’s ECB meeting, with a sharp rally against every currency in both the G10 and EMG blocs since then. The euro is lower by more than 1.6% in the interim, with the Skandies even worse off, down more than 2% each, as their central banks are now seen as more likely to delay any policy tightening until the ECB gets started. As I suggested, while the ECB reduced the QE purchase program to €30 billion/month for at least the first nine months of 2018 with the option to continue beyond that, Signor Draghi was emphatic in his description of the interest rate trajectory, which will remain at current levels well beyond the end of QE. I have been adamant that the ECB will not touch the interest rate structure for another two years, and it appears that Signor Draghi is in the same camp. Given this outcome, it can be no surprise that the euro fell sharply, nor that the dollar rose overall. After all, as I have also been discussing, the narrative took a hit on the news. Policy divergence remains the order of the day (Fed tightening, ECB still adding stimulus) rather than policy convergence. And the euro’s vaunted 12% rally since the beginning of the year, which has largely been predicated on the policy convergence story, is now likely to reverse somewhat further. As of now, the euro is at its lowest level since late July. Look for further declines. 1.12 anyone?
Looking to the pound, it too continues to suffer as the market becomes increasingly certain that the 25bp rate hike, that seems almost assured next week, is the only one for a long time. UK data has had a bad run lately everywhere except on the inflation front, with prices the only thing showing upward momentum. There is no way that Governor Carney can raise rates next year, or any time ahead of the Brexit resolution in Q1 2019 for that matter, as the UK economy will be gripped with uncertainty during that period. With the Fed still in tightening mode, the pound will find itself under increasing pressure going forward. As I have said repeatedly, receivables hedgers need to take advantage of prices above 1.30 because we are going to spend a long period of time below that level in the near future.
The last noteworthy story in G10 space has been in Australia where the High Court there ruled that five of the ruling party’s lawmakers were ineligible to serve because of their hitherto unknown dual citizenship status. While the issue seems technical, what happened is that PM Turnbull has lost his majority in Parliament and his ability to govern effectively has now called into question. As such, policy prescriptions that the market had seen as favorable and leading to more economic growth have been called into question, reducing the chances that the RBA will raise rates any time soon and undermining the currency further. Aussie has had a bad run of it lately, falling more than 2.25% in the past week. Given the evolving narrative, I think it has further to fall as well.
Pivoting to the emerging markets, it should be no surprise that the worst performers since the ECB meeting have been the CE4, all of which are down at least 1.7%. Given the tight relationship between these currencies and the euro, it is only natural they have followed the single currency lower. Away from this space, BRL has been the biggest loser in the EMG bloc, falling 1.7% since then, and 3.5% this week, on a combination of factors. Arguably, the big picture policy divergence story is giving an underlying bearish tone to all EMG currencies. But we also had the BCB cut its benchmark Selic rate to 7.5% yesterday, taking it below the rates of both Turkey and South Africa, two competitors for carry trade flows. Meanwhile, the Brazilians are trying to address their own pension crisis, with policy outcomes there likely to have an important impact on the economy and the currency by extension. The recent break above the 3.20 level has traders scrambling to cover exposures, further pressuring dollar short positions, and on top of it all, there is the hawkish Fed backdrop. It is not hard to envision a move back toward 3.50 in USDBRL as these issues play out.
This morning brings the most important US data of the week, with our first look at Q3 GDP (exp 2.6%) and its concurrent subcomponents, as well as Michigan Sentiment (100.7). Yesterday’s data was largely in line with expectations, although interestingly, the Pending Home Sales number I had highlighted came in much worse than expected at 0.0%, which is more in line with the trend we had been seeing prior to the hurricanes’ collective impact. Nonetheless, I continue to look for the US data to be sufficient to allow the Fed to maintain its hawkish tone and stay on track for a December rate hike and more next year. If pressed, my sense is that President Trump will name John Taylor as the next Fed chair, which will be perceived, at least initially, as hawkish as well. US Treasury yields continue to rise, helping to underpin the dollar as spreads to other government debt widen in the US’ favor. All signs still point to a higher dollar in my view. Hedgers, keep that in mind.
Good luck and good weekend