The tale of two nations’ concerns
Has taken surprising new turns
Frau Merkel can’t find
Enough folks aligned
With her, while some others she spurns
In England Prime Minister May
Keeps searching for ways to allay
The Irish up north
So she can go forth
And get EU members to play
The dollar is having another fine day in the markets as the political confusion elsewhere in the world seems to be outweighing the political confusion here at home. The story from Germany continues to be the inability of Chancellor Merkel to form a working coalition government after the September elections. Three months on, and in the wake of the unsurprising failure to bring the Green Party and Free Democrats together, she is now wooing the SPD. The center-left Social Democrats had vowed to remain in opposition immediately after losing badly in the election. They felt that their previous time spent as the junior partner in government resulted in a loss of identity. But now, Merkel’s options are limited. She has rejected outright, along with the rest of the parties, working with AfD, the far-right party that won nearly 12% of the vote. She has refused to create a minority government, as she believes it will be too unstable. And nobody really wants new elections as, first, polls show the results would be similar to September’s outcome and not advance the process; and second, a bigger concern that any new election would allow AfD to garner an even larger minority, something which is anathema to everyone who doesn’t actually support AfD. While she currently manages a caretaker government, the loss of German leadership in the Eurozone seems to be taking a toll. While the bloc’s data has remained generally quite good, the lack of initiative for the future seems to be an issue. Even though the euro is only lower by 0.1% this morning, this marks five consecutive sessions of decline totaling roughly 1.5%.
Next week both the Fed and ECB meet and expectations remain that the Fed will raise rates 25bps while the ECB will make no changes at all. I think the bigger questions are what updated forecasts will look like from both banks, including any tips to changes in policy trajectory. And there is one more thing to consider, market technicals are starting to point to a lower euro in the short term. Essentially, the short-term trend has reversed course from its recent upward trajectory and is now pointing to further losses in the currency. Keep an eye as we head into the ECB meeting next week.
Meanwhile, poor Ms. May finds herself at odds with nearly everybody else in the UK. Ostensibly, she will be presenting modified language to her Northern Irish allies shortly, in an effort to smooth over the Irish border issue I discussed yesterday. The thing is, the positions of Ireland and Northern Ireland seem irreconcilable. Ireland refuses to accept any type of border, which given the UK’s pending exit from the customs union will be impossible unless the North agrees to the same rules as the EU. At the same time Northern Ireland refuses to do just that, adamantly preferring to stay within the UK. Keep in mind that these two sides have been at odds since the early 1600’s over myriad different issues. It cannot be a surprise that changing the status quo in what had been the most peaceful period in 400 years might rekindle age-old differences. While there is still a chance of some fudged agreement, I would estimate there is at least a 50% probability that this issue is never resolved and Brexit occurs with no trade deal and limited prospect of one in the near future. Once again, I will reiterate that the pound will suffer with this outcome and that current levels remain attractive for hedgers despite the pound’s nearly 2% decline from recent highs. The combination of uncertainty and creeping inflation will continue to undermine the currency.
But the dollar’s strength is broader today, with the biggest losers being the commodity bloc. It appears that oil prices may have topped for now, as the OPEC-Russia accord seems to be fully priced and recent data showed significant increases in product in storage. But we have also seen softness in the metals space and agricultural prices are under pressure. In other words, whatever stuff you mine, drill or grow, you’re getting less money for it today. With that as a backdrop, it can be no surprise that the leading G10 decliners are AUD and NZD while in the emerging markets, BRL, ZAR and MXN are leading the way lower. All of these would fit within the commodity sphere.
As to the data front, yesterday saw the ADP number exactly at the expected 190K, although Productivity and Labor Costs were both a touch soft. This morning we see Initial Claims (exp 240K) and then Consumer Credit ($17.0B) this afternoon. Neither of these will cause even a minor fluctuation. Tomorrow, however, we get the payroll report and that has the potential to be far more interesting. While the Fed’s move next week is baked in the cake, there is still ample opportunity for the market to price more movement for 2018, an area where Fed rhetoric remains well ahead of the futures market. As to the rest of today, I see no reason for the dollar to reverse its recent modest uptrend.