What Kind of Currency Bounce is This?

Overview:  It seems clear that the world's two largest economies slowed before the tariff truce ended.  Many investors believe that the tariff truce helped stop the equity market meltdown through most of Q4 18.  The net result of weaker stocks and lower bond yields seems reasonable.  The dollar is an anomaly. It began off strong yesterday.  The euro slid to a new 18-month low.  Sterling approached $1.26, which it has not seen since the flash crash. The Dollar Index made a new since May 2017.  However, in dramatic price action, the major currencies reversed higher.  The question is whether the move is fundamentally driven, perhaps by weak data and a sharp drop in oil prices boosting confidence that the Fed will cut rates in H2, or a short-squeeze ahead of the large option expiry today (1.4 bln euros) at $1.1100, and catching the market wrong-footed ahead of the European Parliament election, where the results will not be announced until Sunday, and the US is on holiday on Monday. The dollar is sporting a softer profile against all the major and emerging market currencies today, though follow-through selling appears limited.  Equity markets are mostly firmer today.   Korea and Australia are exceptions.  The Kospi's 0.7% decline pushed it into the red on the week, while Australia's fall pared this week's gains.  While the MSCI Asia Pacific Index finished lower for the third consecutive week, Indian market boosted by the election added more than 3% on the week and Indonesia rose over 4% in the best gain in nearly a year amid hopes that the election results will lift the policy uncertainty.   European markets paring yesterday's losses, and the Dow Jones Stoxx 600 is up 0.7%, recouping about a third of this week's decline.  The S&P 500 is also called higher.  The key may be the gap (~2836.7-2866.9) created by yesterday's sharply lower opening. Oil prices are steadying after yesterday's biggest plunge of the year (-5.7% WTI for July delivery and -4.5% for July Brent).  

Asia Pacific

Japan reported April CPI firmed to 0.9% from 0.5%.  Even when fresh food is excluded to derive the core measure the BOJ targets, rose to 0.9%.   If energy is also excluded, the pace slows to 0.6%, but it is still the strongest since mid-2016.   It had limited impact on the market because it does not change policy expectations because investors focus is on the dramatic decline of equities and just as dramatic rally in bonds.  There are still downside risks to measured inflation due to cuts in mobile service fees and some government-provided education for young children.  

Separately, Trump will visit Abe over the weekend.  Suggestions that some trade agreement could be struck heard earlier from Washington contacts is being played down in recent days.  The low hanging fruit was thought to be granting the US the same terms that Japan granted the new TPP and the free trade agreement with Europe that began earlier this year, and especially on agriculture.  The US demand for either "voluntary" export restrictions of some kind of quota/tariff regime in the next six months casts a pall over the talks.  

Some US officials some of the time try to separate the security issues posed by Huawei and the broader trade talks.  However, they are not consistent, and President Trump himself blurs the line.  Consider the precedent set with ZTE, which were removed from the "no-trade list," as "a favor to Xi," Trump lifted the prohibitions in for a fine, a change in management, and some security guarantees.  After denouncing Huawei again, Trump suggested that it could be part of a broad trade agreement with China.  

The dollar is consolidating yesterday's losses against the yen and remains in the trough.  It has largely been confined to a JPY109.50-JPY109.75 range.  There are several sets of options expiring today.  The roughly $1.7 bln in the JPY109.40-JPY109.50 range may be offering support.  There are another $2.1 bln or so in options struck between JPY109.60 and JPY109.85.  The intraday technicals, the sense that bond and equity moves yesterday were exaggerated give the dollar potential to recover more ahead of the weekend, but sentiment remains fragile.  The Australian dollar posted a potential key reversal yesterday by making new lows for the move before reversing higher and closing above the previous session high.  However, follow-through buying was limited to less than a handful of ticks.  There is an A$510 mln option at $0.6900 that expires today.  The Chinese yuan finished fractionally firmer on the day to snap a two-day decline.  On the week, it finished 0.2% higher, and officials in both word and deed are resisting downside pressure.  

Europe

Prime Minister May has offered to resign on June 7 after Trump's state visit (June 3-5).  She wants to be the caretaker until the Tories complete their leadership contest to pick a replacement.  This will be negotiated over the next few days, and it is not yet set in stone.  May is leading the Tory Party into a third electoral defeat, having lost the Parliament majority she inherited, the loss in the local elections was of historic proportions, and in the EU Parliament election underway, the Tories are set to come in third and possibly in fourth place.  Her Brexit strategy is in tatters.  The success of the Brexit Party in the EU election, though it might not get much more than a third of the limited turnout, the lesson that many Tories will draw from the results is that only pursuing a harder Brexit will it be able to outflank Farage.  Sterling initially rallied on the confirmation of May's intentions, which were leaked late yesterday, but the gains were quickly sold into, and sterling returned to the session lows. 

The UK's economic performance takes second fiddle to Brexit, but today's April retail sales held in better than expected after surging in March.  Headline retail sales were flat though many economists expected a decline a 1.2% rise in March.  The year-over-year pace stands at a healthy 5.2%.   Excluding petrol, sales slipped 0.2% after a 1.4% shopping spree in March (initially 1.3%). In broad terms, the UK economy has performed better than many feared, given the uncertainty for businesses and investors. 

The EU parliamentary election results will be known before the markets open next week.  It may take some time to work through the implications for the new leaders of Parliament and the Commission.  Perhaps one metric to look is whether the two main groupings, the center-right People's Party (PP) and the center-left Socialist and Democrats (S&D) hold retain a majority.  

What appears to be a short squeeze in the euro fizzled out in late Asia just above $1.12, completing to almost the tick the 61.8% retracement of the euro's decline from around $1.1265 on May 13.  Several large options that are expiring today and this may serve to keep the euro in a range ahead of the long holiday weekend for the US.    Between $1.1150 and $1.1200 there roughly 5.7 bln euros in expiring options.  Sterling is trying to end a three-day decline against the dollar.  It is finding intraday support near $1.2660, and a break could send it back to $1.26.  On the upside, the brief push above $1.27 (where a GBP350 mln option will be cut today), may have exhausted the short-covering bounce.  

America

The US reports April durable goods orders.  Boeing's problems may be evident.  The headline may fall around 2%, but when transportation is excluded, a small gain is likely.  The aircraft manufacturer and its supply change will weigh on other metrics, like shipments as well.  Meanwhile, the combination of trade conflict with China and the poor flash Markit PMIs boosted speculation of Fed rate cuts in H2.  The implied yield of the January 2020 Fed funds futures contract fell 9.5 bp yesterday, one of the largest moves of the year to 2.04%.  The current effective average rate is 2.39%.  None of the Fed officials that spoke this week, nor the FOMC minutes, showed any wavering over the patience and wait-and-see stance. 

The Trump Administration wants to give US companies the right to seek tariff protection from imports from countries that are found by the Treasury to be pursuing a competitive devaluation.  Despite threats from nearly every candidate that has run for president in the recent election to cite China as a currency manipulator, the US has not.  It has cited no country since 1994.  However, it is too early to dismiss this because there may be some effort to broaden the definition to include under-valued currencies.   This is a can of worms because it begs the question of by what metric and duration. Countries that are booming and with an external surplus ought to have appreciating currencies and those with weak economies and external deficits ought to have weak currencies.  That is how textbook adjustment process.  However, even without these questions being answered, the impression is one of economic nationalism and the implicit threat of weaponizing the foreign exchange market.   

In the past two sessions, the US dollar has covered its full range against the Canadian dollar.  It briefly slipped through CAD1.34 in middle of the week and poked through CAD1.35 yesterday.  It remains stuck in the range.  Better equities and firmer oil can see the greenback drift toward the lower end of the range again.  The dollar is trading quietly against the Mexican peso, hovering a little above MXN19.00.  The high real and nominal yields continue to provide a good bid for the peso on pullbacks.   The final Q1 GDP report is too old to matter much, but the April trade figures may draw some attention though it was before the steel and aluminum tariffs were lifted.  The broader risk appetite may be more important than the economic data for the peso.   

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