Softer Dollar Tone

It seems rather ironic.  On the day that US Treasury yields are at their highest level (~2.55%) in nearly three weeks, the dollar itself is sporting a somewhat softer profile.  Admittedly, the real signal from the foreign exchange market was one of consolidation as most of the major currencies are within yesterday's trading ranges ahead of the North American open.  

The Australian dollar is the strongest  of the majors, gaining about 0.3% against the US dollar.  It was bolstered by a central bank statement, following the decision to leave the rate on hold; that did appear to step up its efforts to take the currency down, while offering an economic assessment that seemed optimistic in the face of recent data that showed a fall in consumer confidence, moderating housing and a topping of building approvals.  

Separately, Australia reported a smaller Q1 current account deficit (A$5.7 bln vs. consensus expectation A$7.0 and a revised A$11.7 bln in Q4).  This reflected a A$3.59 bln trade surplus which had been a A$610 mln trade deficit in Q4.  This means that net exports contributed more to Q1 GDP than previously expected and, in turn, this warns of upside risks to tomorrow GDP report.  The consensus is for a 0.9% quarter-over-quarter expansion and a 3.2% year-over-year rate.  

The Aussie was may have also been aided by China's PMI news.  The official service sector PMI came in at 55.5 in May, which is a six month high. That HSBC's manufacturing flash PMI was revised down to 49.4 from 49.7 was of little consequence.  It not only shows a pick up from April's 48.1, but it is also at a four month high and is consistent with our sense that with the help of new albeit modest initiatives, the Chinese economy has stabilized. 

The main event of the week is the ECB meeting.  Inflation, or indeed the lack thereof, is understood to be a key spur for official action.  At the end of last week, both Spain and Italy reported soft CPI figures. Yesterday Germany did.  The fact that the flash euro area estimate came in today at 0.5%, down from 0.7% in April and below the prior consensus of 0.6% is not surprising.  It simply reinforces confidence that the ECB will cut rates on Thursday.  In addition, the consensus also expects some new targeted lending facility.  We note that the core rate, which for the ECB simply exclude energy prices fell to 0.7% from 1.0%.  This suggests the decline in energy prices is not the main culprit behind the drop in euro area inflation. 

Separately, the euro area April unemployment rate ticked down to 11.7% from 11.8%.  Earlier today, Italy reported its unemployment rate was unchanged at 12.6% following the March revision to 12.6% from 12.7%.  Of note, youth unemployment rose to 43.3% from 42.9%.  Spain reported that its May unemployment fell 111.9k, which was a little less than expected and virtually matched the decline in April.   

There is much talk of large option expires today struck at $1.3600 and $1.3650.   Over the last five sessions, including today, the euro has carved out a low near $1.3565.  Although there is great uncertainty over precisely what the ECB is going to do on Thursday, a 10-15 bp cut in the entire rate corridor is expected, and a targeted funding for lending scheme is anticipated.  Given the way the dollar traded around QE announcement and the technical condition of the market, we suspect that the market is at risk of having sold euro on speculation of ECB action, it may buy it back on the fact. 

After kissing $1.67 last Thursday, sterling has edged higher and with today's push a little above $1.6780, it recorded a four-day high.  This also says something about the narrow ranges.  The construction PMI, like the manufacturing, pulled back more than expected but remains at lofty levels.  It stood at 60.0 in May after 60.8 in April.  The Bloomberg consensus called for a 61.0 reading.  Separately, Nationwide house price index ticked up to 11.1% from 10.9% in April, which represents a new high for this series.  The BOE's Financial Policy Committee meeting later this month is the forum out of which macroprudential measures will emanate to address the risks emanating from housing, rather than a hike in the base rate.

The US reports the NY ISM, April factory orders and auto sales.  These are not the typical market movers.     Although many pundits are having a field day with the ISM sanfu yesterday, investors are best served looking through the noise and to the underlying signal.  That underlying signal is that the US economy is continuing to recover from the contraction in Q1.  

The fact that the economy contracted points to the need for the Federal Reserve to lower this year's GDP forecasts, which it will likely do at this month's FOMC meeting.  It is largely an accounting function, not new forward guidance.  Meanwhile,  the prices paid rose more than expected and at 60 is at the end of where it has been for the last couple of years.  The take away here is that it appears that US inflation has bottomed.  It may not rise very quickly as wage growth, a key driver of core inflation remains subdued, but the downside pressures appear to have eased.