Not Apropos

So Peter Praet let us all know
That even though Europe’s growth’s slow
He still thinks it’s right
To make money tight
For doves though, it’s not apropos

“It’s clear that next week the Governing Council will have to make this assessment, the assessment on whether the progress so far has been sufficient to warrant a gradual unwinding of our net asset purchases,” Praet said in a speech in Berlin on Wednesday.

The euro is higher this morning (+0.4%) after a number of comments by ECB officials indicated that despite what has been a clear moderation in the growth trajectory in the Eurozone, they are ready to discuss the timing of the end of QE at next week’s meeting to be held in Riga, Latvia. In addition to Praet’s comment above, we heard from Germany’s Weidmann and Klaas Knot of the Netherlands that ending asset purchases by the end of the year was both “plausible” and “reasonable”. In addition, Ardo Hansson, the Estonian council member, told us to be alert for a faster pace of rate hikes once QE is over. All this is extremely hawkish commentary relative to what we have been hearing, although the speakers are all known hawks.

One needn’t be too cynical to consider that the reason for this sudden show of hawkishness is the concern that if the ECB delays the decision further, the data will start to contradict their efforts. After all, while last month’s inflation reading was surprisingly high, it was clearly due entirely to the recent rise in oil prices, as evidenced by the fact that the core rate remained at 1.1%, which has since moderated significantly. In addition, the initial comments from the new Italian government demonstrate that they are not backing down on their goals of flouting fiscal restraint by both cutting taxes and increasing spending. The concern there is that bond markets are unlikely to take kindly to that type of policy and that Italian BTP’s could sell off quite sharply again. Remember what happened just last week when the market was concerned that a new election would bring even more populists into the governing coalition. The point is that it would seem difficult for the ECB to be tightening policy at the same time the Italian government bond market was falling sharply. So as both these issues present a very real potential future, and as the ECB staff is ready to release their latest economic forecasts, next week may be the only opportunity for the ECB to guide policy before the September deadline. This will certainly be the thrust of the discussion in markets until then.

Beyond the ECB story, the pound has benefitted (+0.3%) from news that the Labour Party has put forward an amendment to the Brexit legislation designed to insure the UK maintains full access to the EU’s single market after the process is complete, a decidedly softer outcome than has been discussed until now. Of course, it is not clear what the benefit of the entire process would be if the UK followed this road, as the key elements they were seeking from leaving the EU, maintaining sovereignty over immigration and legal jurisdiction, would likely be compromised by this stance. And keep in mind this is just a proposed amendment, not a new law, and can still be voted down. In the meantime, though, the pound is higher.

Generally speaking, most currencies are firmer against the dollar this morning, although much of the movement seems to be in sympathy with the euro, rather than because of any specific news. One exception to this idea is INR, where the rupee has rallied 0.35% after the RBI unexpectedly raised rates by 25bps to 6.25%. While they were careful to indicate this was not the beginning of a tightening cycle, given the reality that inflation in India, at 4.8% is well above their midpoint target of 4.0%, it is hard to believe that a single 25bp move will be sufficient. As well, given the rupee has been the worst performing APAC currency this year (-5.0%), and the fact that the Fed continues to tighten policy, it seems that this won’t be the last rate hike we see here.

On the other side of the ledger, BRL had a dismal day yesterday, falling 1.70%, as concerns over yet another populist election outcome grew. The real has been the worst performing currency this year, falling more than 22% so far, and this has forced the central bank into the market to try to stem the decline. Yesterday, they offered an additional $1.5 billion in their weekly swap program, which had only a temporary positive effect. Given the dollar’s underlying weakness this morning, it would not be a surprise to see the BRL perform better today, however, given the driving force seems to be local politics, and that there will be no resolution for another couple of months, I suspect that a test of 4.00 cannot be far away.

Looking forward to today’s session, it brings the bulk of the week’s data from the US with the Trade Balance (exp -$49.0B), Nonfarm Productivity (0.7%) and Unit Labor Costs (2.8%) all released at 8:30. However, we will need to see something extraordinary to drive markets. At this point, the market continues to focus on next week’s central bank meeting bonanza, with the big 3 (Fed, ECB and BOJ) all scheduled. It seems entirely reasonable that given the underlying drivers of today’s movement that the dollar continues to suffer today. However, recent price action across the G10 seems much more like consolidation ahead of next week’s central bank decisions. So hedgers might want to take advantage of the modest recent weakness in the dollar during this period of mild volatility and consolidation.

Good luck