The US dollar is trading broadly lower. The ECB meeting looms
large. Many, like ourselves, expected that when Draghi said in July that
the asset purchases would be revisited in the fall, it to meant after the summer recess, not a legalistic
definition of when fall begins. Still, there have been some reports, citing unnamed sources close to
the ECB, that have played down such expectations, and warn a decision on next
year's intentions may not be announced
until October or even December.
Such reports have helped steady the euro below $1.20. It traded
above there only on one day (August 29). It had appeared that at the end
of last week, the euro was heading there after the disappointing US jobs data,
but was turned back by one of those reports citing anonymous officials.
Despite the poor close last week (~$1.1860), the euro has recorded higher lows
each day thus far this week and higher highs.
The ECB meeting provides new staff forecasts. The supposed
leaks warn that GDP may be tweaked higher, but inflation shaved. Lowering
inflation forecasts is more dovish than raising GDP is hawkish. Barring a hard stop, which has been dismissed as potentially disruptive, the ECB must extend its
purchases. The evolving language of the ECB's statement suggests a tapering. We suggest that the
consensus view of a reduction of monthly purchases to 40 bln euros for six
months would be a dovish signal as it points to continued purchases in H2 18,
while a cut to 30 bln euros would give officials flexibility to end the program
at mid-year.
The failure of the ECB to make such an announcement today could spur
pullback in the euro, but it may prove short-lived if the delay is just until
next month. There is little doubt that Draghi will address the
strength of the euro. And even if he discusses it in his prepared
remarks, surely reporters will pepper him with questions about it at the press
conference. Draghi, as other ECB officials have done, will
likely recognize that part of the euro's appreciation is a function of better
economic and political prospects in the euro area. We imagine he
will also caution that continued appreciation could pose a headwind to the
recovery.
There are two large euro options that
expire today 90 minutes after Draghi's press conference starts.
Based on DTCC data, there are nearly 730 mln euro struck at $1.1950 that will be cut today, and 920 mln euros struck at
$1.20. The two-year high set at the end of August was $1.2070, and we
have suggested the $1.2170 area as the next key target, which corresponds to a
61.8% retracement of the euro's decline from the mid-2014 high near
$1.40.
Sweden's Riksbank seemed to pay no heed to the fact that the ECB may
taper. It stuck with its dovish tone, suggesting no hike until the
middle of next year. Its current asset purchase program is slated to continue
until the end of this year. The dovish posture saw the krona ease.
The euro traded to almost SEK9.55, a level it has not closed above since
mid-August. Of note, the Riksbank announced it was shifting its preferred
inflation measure from the headline to the underlying rate (CPIF) which
excludes mortgage costs. There are no policy implications.
CPIF rose 2.4% year-over-year in July, while the headline stood at 2.2%.
On September 12, Sweden will report the August figures.
Only the New Zealand dollar is trading weaker than the krona
today. The Kiwi has been underperforming. It is the
only major currency that has lost ground (2.2%) against the US dollar over the
past month. The key driver appears to be prospects that the September 11
national election leads to a new Labour government.
In the UK, Parliament will take up
the Great Repeal bill today. It is the first reading. It is
mostly theater. It is Monday's second reading that will be more
dramatic. It is there that the cost of the loss of the Tory majority will
be most acutely felt. The prospects
for a longer transition phase than the Tories have pushed seem to have helped sterling this week. Yesterday it reached
a one month high a little above $1.3080, which is also the 61.8% retracement of
the down move since the early August high near $1.3270. Technical
indicators suggest the odds favor a return toward the highs.
The Canadian dollar is consolidating its outsized gains scored yesterday
in response to the 25 bp rate hike. There was not the "buy the
rumor sell the fact" activity we thought likely. Instead, many read
the short statement that accompanied the hike to signal a low bar to another
hike. A move at the October 25 meeting would seem particularly
aggressive. It would be the third hike in as many meetings. Rather,
barring a marked change in
conditions, further accommodation, which was said to be considerable before yesterday's hike, would
likely be removed in December (BoC last meeting of the year is December
6).
The Bank of Canada attributed the strength of the Canadian dollar to
favorable developments in Canada and negative developments for the US.
The Canadian dollar is the strongest currency in the world over the past three
months. It has risen 10.7% against the US dollar. The Scandis are
next (NOK +9.3% and SEK +9.0%), followed by the Chilean peso (+8.2%).
At the same time, some reports have suggested that Cohn will not be named to replace Yellen. The press reports suggest Cohn's criticism of the White House handling of recent events involving white nationalism irked key decision makers. On the other hand, we had seen the changes slip when the White House moved away from initial plans to offer a detailed blueprint for tax reform. Tax reform has seen a Cohn's main task. Outside of Cohn and Yellen, former Fed Governor Warsh is seen as a third candidate.
The second main development in the US relates to fiscal policy. It appears that a deal is in the works to extend the debt ceiling and spending authorization until mid-December. This saw an immediate adjustment to the T-bill market. In our understanding of the dollar's decline since March, the drawing down of the Treasury's deposits, which helped end the H2 2016 dollar shortage, had an under-appreciated role. The Treasury may replenish those funds over the next three months, allowing another round of maneuvering (drawing down cash) after mid-December. However, we understand that the Treasury's cash position needs to be about the same as it is now. That means that debt to be issued is simply to cover expenditures. The agreement also removes a possible hurdle to the Fed's plans to allow the balance sheet to begin shrinking in Q4.
US Treasury yields rose 4.5 bp yesterday to 2.105% after falling 10.5 bp on Tuesday. The yield is a little softer today as it struggles to sustain a rise above 2.1%. When yields rose yesterday, the dollar recovered toward JPY109.40, but with yields back off today, the dollar is back below JPY109. There are about $1.2 bln in options struck at JPY108.75 and JPY109 that expire today.
Lastly, we note that Chinese reserves rose for the seventh consecutive month in August. The value of reserves rose $11 bln (to $3.009 trillion). It is nearly three times more than the Bloomberg survey suggested. The yuan itself had the best month in many years, rising nearly 2.1% against the dollar, which fell about 0.6% against the euro and 0.25|% against the yen. As China's reserves have increased, so has its appetite for US Treasuries.
Disclaimer
ECB Focus for Sure, but not Only Game in Town
Reviewed by Marc Chandler
on
September 07, 2017
Rating: