Squared The Circle

The ECB said that it might,
According to their own foresight,
Be forced to increase
The pace that they cease
To buy bonds, thus making things tight

The euro responded with glee
Exploding past One and Twenty
If this is the plan
And not a straw man
The dollar, much lower, will be

And one other thing of real note
So many months after the vote
Seems Chancellor Merkel
Might have squared the circle
With new ministers to promote

Wow is all I can say this morning as the euro has virtually exploded higher during the past twenty-four hours. It started with the release of the ECB Minutes yesterday morning, which were read as quite hawkish. The belief that has gained widespread credence is that the time gap between the end of QE, now almost certainly to take place in September, and the first rate hike has been significantly shortened. Prior to the Minutes, the market was pricing in just a one-third chance of a 10bp rate hike by the end of this year. This morning that probability has jumped to almost two-thirds with a full hike priced in for March 2019 (it was December 2019 prior to the Minutes). It should be no surprise that the euro has rallied on the back of that change in sentiment. And in fairness, if the ECB is actually going to be more aggressive in their removal of monetary accommodation, it is the correct market response. Then, adding fuel to the fire was the announcement by Chancellor Merkel that after extensive negotiations between her CDU/CSP party and the center-left SPD, they have come to agreement for yet another ‘grand coalition’ government to lead Germany for the next four years. It has been over 100 days since the Germans went to the polls and concerns were growing that the much less palatable alternatives of either a minority government or a second vote were coming to fruition. But now, the market sees only blue skies ahead and the single currency has been the main beneficiary. In the past twenty-four hours, the euro has rallied 1.50% and is now trading at its highest level vs. the dollar since the beginning of 2015 (and at that point it was in the midst of a 25% decline!)

Of course, it remains to be seen if the ECB will follow through with the now mooted policy tightening, at least at the pace the market is expecting. Remember, while ECB policy is clearly still on emergency settings and almost certainly inappropriate for an economic area growing above trend, the Fed was in the same situation for several years before it finally started to get a bit more aggressive. Signor Draghi has not changed his stripes and remains a dove at heart, so while the pressure to tighten policy may well increase going forward, I continue to believe that he will do so only reluctantly and at a much slower pace than currently forecast. But for now, the euro bulls are in the ascendancy and I expect that the single currency has further room to run.

Meanwhile, on this side of the Atlantic, yesterday’s PPI data was shockingly weak, with both headline and core data printing at -0.1%, well below the +0.2% expectations and encouraging the narrative that the Fed was going to slow down its pace of tightening. This morning’s CPI data (exp 0.1%, 0.2% core) will be far more important, but it is certainly a disconcerting harbinger of today’s data. So adding it all up, the dollar has been under constant pressure since I wrote yesterday.

But there have been other things as well, notably Chinese Reserves data out overnight surprised everyone by showing a significant reduction in the pace of money growth and new loans. The government’s attempt to reign in leverage seems to be biting with expectations growing that Chinese interest rates are on course to rise soon. It can be no surprise that this data in combination with the largest Trade Surplus ($275B) ever recorded by the Chinese, and the softer US inflation data has resulted in a much stronger CNY. In fact, this morning the renminbi has gained 0.7% and is back at levels not seen since early 2016. But it’s not just CNY that has rallied in the emerging market bloc, virtually all of the space has outperformed. Not surprisingly, given the euro’s move, EEMEA has been the best performing region, but in truth we are seeing strength from all three regions.

So what are we to make of all this? In the constant ebb and flow of market activity, there is no question that things are pointing to a weaker dollar in the near term, at least before we see this morning’s CPI and Retail Sales data. If those numbers print as expected (Retail Sales exp 0.5%, 0.3% ex autos), then the dollar should remain under pressure for the rest of the day. Surprising strength in either of these data releases, especially CPI, however, could stop the dollar’s decline in its tracks. Given the narrative of increasing global growth, it seems hard to believe that suddenly the Fed will turn dovish. Rather, I would expect that we could see a hawkish turn from some of the centrists there, especially when they consider the situation elsewhere in the world. I continue to believe the Fed will lead the way in tighter monetary policy and the dollar will find support accordingly. But maybe not today.

Good luck