In Europe, according to Knot
QE has done all that it ought
So lets end it soon
While it’s opportune
Ere data is worse than we thought
Klaas Knot is the President of the Dutch Central Bank and a member of the ECB Governing Council. His is a name that doesn’t get much press, but he is certainly well known amongst the finance community. And he is also one of the dyed-in-the-wool monetary hawks on the ECB. On Saturday in a television interview he was quoted as saying about QE “The program has done what could realistically be expected of it. The program is fixed until September, [and] we don’t have to communicate yet that it will be over after September, but I think that’s where we’re headed.” It strikes me that Signor Draghi has a bigger messaging problem in his own house than he does with the comments last week from Treasury Secretary Mnuchin. Arguably, what is more surprising is that the euro, after an early bump up in Asia has actually given back some more ground and is now down 0.25% this morning.
But let’s step back for a moment and try to look at a bigger picture for the dollar. Much has been made over the fact that last year the dollar fell about 11% on a trade-weighted basis and more than 14% vs. the euro. But is the dollar actually ‘weak’? Let’s consider a couple of statistics: the euro initiated trading in 1999 at 1.1715 or so. It has ranged between 0.86 and 1.60 during its life, and clearly those extremes are just that, significant over and undervaluation of the dollar respectively. But 1.24 hardly seems like the end of the world. And while much is made of the fact that the dollar is at its weakest point in the past three years, that conveniently ignores the fact that for the three years prior, it averaged ~1.39. All I’m saying is that 1.24 is hardly the end of the world when it comes to the dollar’s valuation, and the hysteria that has accompanied the recent movement seems a bit overdone.
However, the question we try to address here is how it will behave going forward. There is no question that the current momentum is for the dollar to continue to decline. The narrative continues to focus on the idea that traders have already priced in further Fed tightening while we are just getting started at the ECB and BOJ and that activity from those central banks is going to change the dynamic. In that scenario, the Mnuchin comments certainly added fuel to the fire, but the dollar had been falling long before he opened his mouth. And last week, we heard from both Kuroda and Draghi, with both sticking to their script that they were not going to change anything, and in both cases, the market refusing to believe them. But this is a new week with both a critical data point this morning (Core PCE is released at 8:30 and expected to print at 1.6%) and then the FOMC meeting on Wednesday, and we have payrolls on Friday as well! The narrative also dictates that the Fed will do nothing at this meeting; likely not even change the language of the statement. But I disagree with the narrative, and will feel even more confident if the PCE data continues its recent ascent.
I believe it is a mistake to assume the Fed is going to do nothing here, and I expect to see a more hawkish bias from the statement. I continue to look for measured inflation to rise more rapidly than the mainstream forecast, for the Fed to be more aggressive than currently priced by markets and for the dollar to ultimately gain traction. One noteworthy feature this morning is that 10-year Treasury yields have jumped up to 2.72%, their highest level since the taper tantrum in 2013, and appear set to continue to 3.0% and beyond. That too, will ultimately support the dollar. But it will take time for the narrative to be broken. Given the strength of its signal, we will need to see a lot of contrary evidence to change trader and investor opinions. So for now, though I continue to expect the dollar to strengthen eventually, it will be tough sledding.
And that is really the entire FX story, as it is entirely dominated by the dollar, with every other currency along for the ride. I’m sure that at some point soon we will be looking at individual currency issues again, but for now, it doesn’t seem relevant.
So here is this week’s data rundown:
|FOMC Announcement||1.25%-1.50% (unchanged)|
|Unit Labor Costs||0.9%|
|Average Hourly Earnings||0.3%|
At this point, I feel this morning’s data could be quite significant. A stronger than expected Core PCE print should be dollar positive, should pressure Treasuries further and may well undermine equities slightly. But the narrative will not be changed easily. We will need to see a series of convincing data over the next several months to get it to move. For now, let’s see what prints this morning but the market will give the benefit of the doubt to data that weakens the outlook, not strengthens it.