Dollar Heavy into the Weekend

The US dollar had begun the week on a firm note, but those gains have been trimmed in the second half of the week.  The confirmation that a June hike was highly unlikely coupled with some softer US data took a toll.  The UK's surprisingly strong retail sales report lifted sterling.  The greenback had tested the upper end of its range against the yen, nearing JPY121.50 but ran into profit-taking as US yields softened.  

There are three developments to note today.  First, after lowering its GDP forecasts and delaying when the inflation target will be reached, at the conclusion of its meeting today, the BOJ upgraded its assessment of the economy.   The precise significance of this may be elusive, but it does seem to confirm that ideas that the BOJ was going to soon expand its QE operations are premature.  Many observers are pushing that expectation into the second half of the fiscal year.  Initial support for the dollar is seen in the JPY120.50 area.  A break could signal losses toward JPY119.80 into early next week.  

Separately, as we had previously discussed, yesterday Japan's Prime Minister Abe did commit to $110 bln new regional infrastructure spending over the next five years.  This needs to understood in the context of China's AIIB (initially thought to be capitalized with $50 bln has apparently been increased to $100 bln).    Although many observers often speak about a race to the bottom, the rivalry over developments funds seems more to be a race to the top.   

Second, Germany's IFO survey was a little better than expected, but still down from April.  The overall business climate slipped to 108.5 from 108.6.  The consensus was for 108.3.  This was driven by the expectations component that eased for the second consecutive month.  Still the 103.0 read is still fairly elevated and above the Q1 average.  The assessment of current conditions ticked up to 114.3 from 114.0.  It is the highest reading since last June.   We suggest that the take-away from the IFO is that there is a sense that Germany is near a peak.  That while things are good, it is hard to envisage things getting better.  

Separately, Germany confirmed Q1 GDP at 0.6%, but the details and revisions for Q4 were somewhat surprising.  Consumption was in line with expectations at 0.6%.  Q4 was revised to 0.7% from 0.8%.  Government spending 0.7% in Q1.  The consensus for a 0.2% gain.  Q4 was revised to 0.3% from 0.2%.  Capital investment rose 1.5%, which was twice the consensus expectation. However, Q4 capex was cut to 0.8% from 1.2%.  Domestic demand came in at 0.5%, the 0.7% the consensus forecast, but Q4 was revised sharply higher to 1.1% from 0.5%.  Exports were stronger than expected, growing 0.8% instead of the 0.5%.  Export growth in Q4 was revised to 1.0% from 1.3%. Lastly, imports rose by 1.5%, a touch less than expected.  Q4 import growth was revised to 1.9% from 1.0%.

The euro tested the previous breakout area (~$1.1060) in the middle of the week.  Since it held, the euro has been creeping higher.  It is now testing the $1.1200 resistance area, which extends to $1.1220.  A move above there would encourage a push to $1.13.  For its part, sterling is consolidating yesterday's sharp gains.  It is holding in a narrow range (a little more than half a cent) near yesterday's highs.  

Third, once again Greek optimism has hit a wall.  Greek Prime Minister Tsipras was hopeful that a political breakthrough was at hand.  French President Hollande also seemed cautiously optimistic that a special Eurogroup meeting would be held to discuss the progress.  However, Merkel seemed to play down by emphasizing that greater efforts are needed and that there is "a whole lot to do."  One of the stumbling blocks that have emerged over the past week or so is the conflicting demands of the EU and IMF.  Germany, which was not keen on the IMF's participation initially, now says no deal is possible without the IMF.  

As we have noted before, everyone seems to be cognizant of the moral hazards of the debtor, if concessions are made, but very few are considering the moral hazard of the lenders.  The IMF overrode its own rules on lending to Greece, over the objections of some of its senior staff.  Back in 2010-2011, prior to the EFSF and ESM, countries in EMU were so fearful of the impact of a Greek default on their own financial institutions that they lent money to Greece, not for Greece's sake or based on its ability to repay, but as a way to support their local institutions.   

In any event, the developments in Riga sent Greek bonds lower after gaining earlier this week. The 23 bp increase in 10-year yields, puts them up 13 bp on the week.  On the other hand, Greek stocks are up about 0.5% for a 4.7% rise on the week, which is one of the stronger performances in Europe this week.  

Turning to the North American session, the US reports April CPI and Yellen speaks on the economy. The Fed's Chair will not be entertaining questions, and her economic views seem to be clear.  The headwinds on the US economy are largely transitory and that stronger growth is expected. The bar to a hike is continued improvement in the labor market (note that the 4-week average of initial jobless claims slipped to new cyclical lows this week) and "reasonable confidence" that inflation will move towards the 2% target in the medium term.  In March all but two Fed officials (governors and regional presidents) expect lift off this year.  Note that US savings rose $125 bln in Q1.  This coupled with income associated with job growth is expected to provide the fuel for consumption in the period ahead.  

That said, today's CPI figures might go slightly in the wrong direction.  The consensus expects the year-over-year headline pace to ease to -0.2% from -0.1% and the core rate to 1.7% from 1.8%. The core CPI runs a bit higher than the core PCE deflator. The core PCE deflator was 1.3% in March. The April report is due out June 1.  

Canada reports April CPI and March retail sales.  Deflationary winds are not the problem for Canada that they are for many other major economies.   Canada's headline inflation may ease to 1.0% from 1.2%, while the core is expected to hold steady at 2.4%.  

March retail sales, are expected to slow after the heady 1.7% rise in February.    The consensus expects a 0.3% rise on the headline and 0.4% excluding autos.  We think that the risk is on the downside.  The impact on the Canadian dollar may be limited.  The US dollar recorded a range of CAD1.2130 to CAD1.2250 on Tuesday and has been in that range since then.  When the break does come, we are more inclined to expect it on the upside for the US dollar.