The Dollar Goes Nowhere Quickly

The US dollar is little changed, though with a slightly heavier tone against most of the majors and emerging market currencies. Weekly initial jobless claims and durable goods orders today are expected to be consistent with the expanding US economy, but not sufficient to generate much of a change in the statement by the FOMC at the conclusion of its meeting next week. 

Signals from the ECB, with Draghi and Knott having already spoken today and Constancio due later, have not changed. The ECB is prepared to do more, but there is no strong sense of urgency that would encourage a view that action will take place in May. Next week’s flash reading of April’s CPI is the next event that could prompt a change in views. 

The flash PMI reading suggests the euro zone economy is continuing to recover and also ease anxiety. Fears that events in Ukraine and sanctions on Russia would slow the German economic locomotive have eased this week. Yesterday’s strong flash PMI readings for Germany have been followed by a stronger than expected IFO survey today. All three components, climate, conditions and expectations improved.

The other important development in Europe has been the sharp fall in excess liquidity in the euro system. It fell 22.5 bln euros yesterday. It now stands below 100 bln euros (92.9 bln) for the first time yesterday since 2011. The risk is that overnight rates become more volatile and elevated, a tightening of financial conditions. While the Fed is tapering and the US economic recovery is well ahead of the euro area, the fact of the matter is that the overnight interest rate in the euro area (EONIA) is twice the US (effective Fed funds). 

In addition to this and the region’s growing current account surplus, there continues to be strong foreign demand for European assets. Spain today sold a 10-year bond at record low yields. The decline in inflation and the sharp fall in redomination risk, amid a world of low returns, the yields offered in the periphery have drawn investors. In addition to sovereign, corporate and bank bonds, reports suggest keen interest in bad loan portfolios and other distressed assets. Today’s reports that General Electric is in talks to buy France’s Alstom for $13 bln (or more), which represents a 25% premium over current market value is indicative of the wider flows into Europe. 

Separately, as widely expected the Reserve Bank of New Zealand hiked its cash rate 25 bp to 3.00%. The statement that accompanied it was a bit more hawkish than many, including ourselves, expected, sent the New Zealand dollar to almost $0.8640 (from ~$0.8590). The bears have not given up. The Kiwi could not sustain the gains as the June hike (and two more this year) have been nearly fully discounted in the OIS market for some time and has returned to levels seen prior to the hike. A break now of the $0.8560 area would be an exceptionally bearish development. 

The US dollar has been confined to a JPY102.20 to JPY102.70 for the fifth consecutive session. Comments from Japanese officials and anecdotal reports suggest, like the ECB, the BOJ does not appear to be in a particular hurry to ease policy further. Tomorrow’s CPI reading, not so much the national March report, the April figures from Tokyo, will be the first official report since the sales tax increase. There have been some press accounts of Japanese businesses raising prices on top of passing through the tax increase. Seasonally, Japanese businesses tend to review prices at the start of the new fiscal year.