Wednesday's Drivers: China Growth Slows, UK Employment Grows

The US dollar is firmer against the yen and dollar-bloc currencies, but is weaker against the euro and especially, sterling.  Sterling has been lifted by an unexpected decline in the unemployment rate to below 7%, the threshold under the previous forward guidance framework. 

The news spurred a rise in UK rates and sent sterling toward its four-year high set in mid-February near $1.6825.  Assuming this level is breached, many will set their sights on the $1.70 area.   

The euro extended yesterday's advance to test short-term retracement targets in the $1.3850-65 area.  Its gains did not appear to have a fresh impetus, but the balance of payments news helps explain the euro's strength.  The region reported a nearly 22 bln euro current account surplus for February, which is down a tad from the 25.4 bln surplus recorded in January.   

While economic textbooks teach that, all things being equal; the current account surplus should lead to currency appreciation, the most important impetus did not take place in the trade of good and services, but in the capital account.  Between direct and portfolio investment, the region recorded an inflow of more than 56 bln euros in February, up from about 10.3 bln euros in January.   Between the current account and capital account surpluses, almost $100 bln flowed into the euro area in February.  

Separately, the March CPI was confirmed at 0.5% year-over-year, though the monthly rise was revised to 0.9% from 1.0%, and the core rate was shaved to 0.7% from 0.8%.  The softness of the core rate seems to belie arguments that the decline in energy prices is a major culprit of the disinflation.  These revisions do not really matter much from a policy point of view.  

March inflation was known to be soft and partly weighed by a distortion caused by a calendar effect and is expected to be corrected with the April report (flash due at the end of the month).  With this uptick expected, and a consensus still not elusive on the ECB, we have suggested a move in June is more likely than in May and this also coincides with new staff inflation forecasts, which some officials have pointed to for clarification.  

China reported that the world's second largest economy expanded by 7.4% in Q1, which is slightly stronger than the consensus expected, though is the slowest in six quarters.  However, what many observers have focused on is that 1.4% quarterly pace, which when annualized is less than 6%.  Speculation that this may prompt some easing of policy from the PBOC helped depress money market rates. The 7-day repo rate fell 68 bp to 2.73% on a weighted basis but touched 2.59%, the lowest in a month.  That said; we see GDP as a lagging indicator and suspect the Chinese economy may have already begun to improve.

Separately, we note that the PBOC set the yuan's reference rate (fix) at its lowest level since last September, while the offshore yuan (CNH) touched a 14-month low yesterday.   The PBOC was seemingly unmoved by the US Treasury report out late yesterday expressing "particularly serious" concerns about the yuan, which is said (contrary to the IMF) remains significantly under-valued.  

The New Zealand dollar is the weakest of the major currencies today, losing a little more than 0.5% against the US dollar.  The  main driver was a soft CPI report (Q1 at 0.3% rather than 0.5%) and another large drop in milk prices.  The fortnightly auction saw a fifth consecutive decline that has seen prices fall about 18% to their lowest level since February 2013.  

The market continues to price in with full confidence a 25 bp rate hike at next week's meeting and is aggressively pricing in more than 100 bp of tightening over the next 12 months.  However, some players apparently having second thoughts about the timing and a follow up hike in June has begun to be questioned. 

The yen is the second weakest of the major currencies.  The dollar appears to have carved out a bottom against the yen in recent days, and the impressive recovery in US stocks yesterday (the biggest reversal in the NASDAQ in five years) helped lift the Nikkei 3%, its biggest advance in a couple of months.  The dollar was buoyed and is testing a retracement objective near JPY102.40.   Above there, a band of resistance is seen in the JPY102.55-70 area.  

Although not a market factor, today, we think comments from Japanese officials suggest that the BOJ will not be in a hurry to provide more stimulus, though polls show a large majority expect this by July.  Yesterday, we noted reports suggesting some businesses are raising prices beyond what the retail sales tax hike, and this risks a larger jump in inflation, which would also seem to diminish pressure on the BOJ to do more. 

Today, Finance Minister Aso opined that the drop in demand after the tax hike seems less than expected. This is a surprising conclusion after two weeks of observations but is still telling.  The BOJ's Kuroda opined that the labor market is getting tighter.  This does not mean that the BOJ is going to step back from its aggressive monetary stimulus, but rather pressure to do more many not be as acute as many believe.  

The North American calendar is full today.  In terms of US economic data, March housing starts are expected to bounce (consensus 7.0% to 970 mln units) back as the adverse weather eased.  Industrial production and manufacturing output likely continued to expand (consensus 0.5-0.6%).   The Beige Book, ahead of the month-end FOMC meeting, is likely also to report better activity as the spring thaw sets in.   Four Federal Reserve officials are slated to speak today, and the highlight will be Yellen's speech before the NY Economics Club.  She is expected to focus on explaining the current Fed stance rather than reveal new information.  

The Bank of Canada meets today.  No one expects a change in interest rates.  The focus will be on the statement.  We suspect the Bank will look past the recent soft economic data and see stronger activity in Q2.  It may be slightly more relaxed about the recent low inflation readings than it has been.  We have identified the CAD1.1020 and then CAD1.1070 as the upside risks for the greenback, while support is seen near CAD1.0955.