Dollar-Bloc Shines

The dollar-bloc has outperformed in the aftermath of the ECB's move last week. The hawkish Reserve Bank of New Zealand extended this move, lifting the New Zealand dollar about 1.4% today, which helped underpin the others. Over the past 4 sessions, each was up about 0.6%.

The RBNZ as widely expected hiked the official cash rate 25 bp to 3.25%, but what really sent the Kiwi higher was the signal that there may be no pause in the cycle, as many, including ourselves, thought possible as early as next month. However, officials argued that growth has become self-sustaining, low rates were no longer appropriate, and inflation expectations were, well, expected to increase. Officials would like a weaker currency, but its wishes are more than offset by the interest rate differential. The Kiwi approached $0.8700, but does not look like it is done. The high for the year was set a month ago near $0.8780.

For its part, the Australian dollar is trying to establish a foothold above $0.9400. The year's high was recorded in April near $0.9460. Australia's jobs report was not nearly as week as the 4.8k loss of jobs (consensus was for +10k) as it may appear. There were 22.2k full-time jobs created more than the revised 13.8k in April. The index of hours worked also recouped most of April's loss (1.7% vs. -2.2%).

We argue that it is not the so-called commodity status of the dollar-bloc currencies that have underpinned them, but their status as high yielders. While oil prices are firm, (largely geopolitical tensions such as Iraq and Libya) commodity prices are largely flat. The CRB Index is at the lower end of its 6-week range, after the rally in Q1. The Journal of Commerce-ECRI Industrial Price Index also is near two month lows.

This helps explain sterling's strength as well. It has also outperformed over the last five sessions and is the only European currency that has not lost ground against the dollar. The strong RICS House Price Balance rose to 57% (percent of participants that see higher prices) against expectations for 52% (from 55% in April). There is some evidence in this report that the housing price increase may be spreading, even if it begins stabilizing in the south.

Later today Osborne and Carney will deliver their Mansion House speech. Two years ago the Funding for Lending scheme was unveiled. While no new initiatives are expected, we suspect that Osborne's tone will be more celebratory. The UK economy is expected to surpass the pre-crisis peak this quarter. Sterling faces immediate resistance near $1.6845, last week's high and just beyond the trend line we have noted, drawn off last months highs.

The euro itself continues to trade heavily. Although the US-German 2-year interest rate differential was decoupled for the euro-dollar exchange rate earlier this year, the two are move aligned now. The US premium has risen to 40 bp, the highest since 2007. The euro looks poised to challenge the $1.3475, lows for the year set in February. A break of that area would target $1.3375-$1.3400. This week upticks have been brief and shallow, which is encouraging the bears, as the effects of last week's ECB initiatives are expected to be felt more next week.

The week's dearth of tier 1 data from the US ends today with May retail sales. Strong auto sales and chain store sales should underpin the headline and the GDP-component is expected to rise 0.4% after slipping 0.1% in April. Separately, as strong rebound in import prices (+0.5% year-over-year form -0.3% in April) likely presages an uptick in US inflation readings (PPI tomorrow and CPI next week). That said, yesterday's services spending survey pointed to larger than expected decline in health care spending in Q1. In the GDP estimates, it has been assumed to be stronger. The Affordable Care Act is thought to be behind this development. It has negative implications for revisions to Q1 GDP revisions. In the latest iteration, the economy contracted 1% in Q1 and now it looks like something between -1.6% and -2.0%.

Lastly, we note two other events today. First, the US Senate will likely confirm Fischer (vice chair) Brainard and Powell (new term) to the Federal Reserve. This will allow them to participate at next week's meeting. We expect Fischer and Brainard's dot plot to be near Yellen and Dudley. Yet, because of the more dramatic contraction in Q1 than anyone expected, this year's GDP forecasts will have to be revised lower, something we suppose on the magnitude of -0.3%-0.5%.

Second, the US Supreme Court will consider taking Argentina's case against the hedge fund holdouts to its debt restructuring of nearly a decade ago. If it does decide to hear the case, the decision is expected relatively quickly. A decision not to hear the case would allow the lower court's ruling in favor of the hedge funds stand, which, of course does not necessarily mean that Argentina will adhere to the decision.