You’d Better Think Twice

If you thought Lagarde doesn’t care
About how her euros compare
To dollars in price
You’d better think twice
‘Cause she is acutely aware

This morning, her colleague, Klaas Knot
Was clear when explaining they’ve got
The tools they may need
To help them succeed
In cooling a euro that’s hot

With the FOMC meeting on tap for later today, the market is mostly biding its time until they hear if anything will be changing at the Mariner Eccles Building.  However, that seems highly unlikely at this time given the following factors:  first, the last we heard from Chairman Powell was that now is not the time to consider removing any policy accommodation, even if things seem to be looking up; and second, it is not clear that things are looking up.  While certainly there are some parts of the economy that are doing well, notably housing and manufacturing, the service sector remains under severe pressure as lockdowns pervade the country.  True, it appears that some of the more draconian lockdowns may be coming to an end, but the hit to the employment situation has been turning much worse.  Recall, the December NFP data printed at a much worse than expected -140K, and Initial Claims data has been running higher lately than back then.  Too, remember that the Fed modified their mandate to seek to achieve “maximum employment” which means declining NFP data is more likely to drive further policy ease than tightness.

So, in truth, today’s FOMC meeting is likely to be a pretty dull affair, with limited market expectations for any movement of any sort.  On the other hand, the ECB, which met last week and took no further action, remains concerned about the euro’s strength.  I have been quite clear in my warnings that the ECB would not allow the euro to trade higher without a response as they simply cannot afford that outcome.  Remember, the ECB’s playbook (and in truth, most central bank playbooks) defines the reaction function for specific conditions.  According to the book, too low inflation requires lower interest rates and a weaker exchange rate.  In fact, one of the primary reasons to lower interest rates is to weaken the exchange rate.  The idea is that a weak currency can help import inflation while simultaneously helping the competitive stance of that nation’s export community.  The problem with this strategy is that it was designed to be used in isolation.  So, if one country is behaving in that manner, it has a chance to succeed.  Unfortunately, the Covid pandemic has resulted in virtually every country trying to use these tools at the same time, thus canceling out each other’s efforts.

Of course, one player is much larger than the others, namely the Fed.  The Fed’s ability to ease policy seems to be outstripping that of the ECB, and every other country as well.  Adding to that has been the extraordinary fiscal policy ease we have seen here, which has been larger than elsewhere, and with the still robust expectations of another $1.9 trillion of fiscal support coming, has been one of the defining features of the bearish dollar outlook.

Which brings us to this morning’s comments from Klaas Knot, the Dutch Central Bank President and ECB Governing Council member.  He was quite clear in explaining the ECB has the necessary tools, including interest rate cuts, to prevent any further strengthening of the euro which could undermine inflation.  “That is something we, of course, monitory very, very carefully.  It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going.”  In other words, euro bulls need to understand the ECB is not going to sit by and watch the single currency rally unabated.  It should be no surprise that the market responded to these comments by selling off the single currency, which is now down 0.4% on the day.  Adding to the bearish euro scenario was the release of the German GfK Consumer Confidence survey, which printed at -15.6, its third lowest reading in history, trailing only the May and June readings post the start of the Covid crisis last year.  Once again, I will reiterate my view, while eventually the dollar will decline more sharply as real yields in the US fall into further negative territory later this year, for now, the dollar’s decline seems to be on hold.

Ok, let’s quickly look at markets.  Risk is starting to become more suspect as the morning wears on, with European equity markets now all sharply in the red vs. their earlier little changed price action.  In the wake of the Knot comments, the DAX (-1.55%), CAC (-1.0%) and FTSE 100 (-0.8%) have all sold off hard.  Asian markets, which had closed before the comments, had a more mixed day, with the Nikkei (+0.3%) recouping a little of yesterday’s losses, but the Hang Seng (-0.3%) and Shanghai (+0.1%) doing little overall.  As to US futures, the DOW (-0.9%) and SPU (-1.0%) lead the way down with the NASDAQ (-0.25%) still outperforming after some pretty good earnings data last night from Microsoft.

It should be no surprise that bond markets have found a bid, with Treasury yields lower by 1.4bps, while Bunds (-1.4bps) and OATs (-1.0bps) are also now trading higher.  Again, earlier in the session, yields had actually crept a bit higher, so this reversal of risk attitude is growing.

Commodity markets are being impacted as well, with oil back to flat on the day from early session gains of 0.5% and gold is actually lower by 0.5%.  Only the ags remain well bid, as I guess everyone needs to eat, even during a pandemic.

Finally, the dollar is stronger across the board, with the strength becoming more evident after the Asian close.  In the G10, NOK (-0.9%) is the leading decliner as oil prices have turned, but we are seeing weakness throughout the commodity bloc (AUD -0.6%, NZD -0.4%, CAD -0.4%) as well.  In fact, even the havens are weaker today with both JPY and CHF off by 0.2%.  Today is just a dollar positive day.  In the EMG bloc, the few green spots on the chart are all APAC currencies with very modest gains (KRW +0.2%, TWD +0.1%).  On the other hand, all the markets that are currently open are showing sharp declines led by ZAR (-0.9%), MXN (-0.85%) and RUB (-0.8%).  It is remarkable how closely these three currencies trade to each other.  But really, everything else is weak as well.  There are no specific stories of note here, it is just a day to reduce risk.

On the data front, this morning brings Durable Goods (exp 1.0%, 0.5% ex transport) and then the FOMC statement at 2:00 followed by the Powell press conference at 2:30.  It seems unlikely that the market will react to the Durables data, so things seem to be shaping up as a dollar up day, at least until we hear from Jay.  However, I don’t foresee the dollar exploding higher, just continuing this drift, at least vs. the G10.  EMG is always a different story, so be careful there.

Good luck and stay safe