Dollar Remains Heavy

The dollar is softer against most of the major currencies to cap a poor weekly performance.  The Dollar Index is posting what may be its biggest weekly loss since last November.  

The combination of the Federal Reserve not signaling an acceleration of normalization, while the market remains profoundly skeptical of even its current indications, and perceptions that the ECB and BOE can raise earlier than anticipated weighed on the dollar.  The PBOC surprised many by lifting some operational interest rates.  It also contributed to the sense that the divergence theme has run its course.  

We are somewhat skeptical of the sustainability of that new narrative, but recognize it has emerged while the short-term market was carrying significant long dollar (and short Treasury positions).  We expect EMU headline inflation to peak in the coming months.  Similarly, we expect UK data to soften and not give the MPC a compelling reason to lift rates.    Next week's numerous Fed officials are speaking, including Yellen.  Given the market's reaction to the statement and forecasts, it would not be surprising to see some push against the dovish hike interpretation. 

Comments from Austrian central bank governor Nowotny showed where the ECB hawks are trying to lead.  As we heard recently, some ECB board members have chosen now to talk about an exit process that still seems premature for a majority.  The argument is that the US sequence of finishing QE before increasing rates may not be suitable for Europe.  Nowotny went a little beyond earlier comments to suggest that not all rates would necessarily rise.  The deposit rate, for example, could be raised without having to lift the refi rate.  EONIA would likely adjust to such a development.

Nowotny's comments reinvigorated the euro's advance.  The single currency is rising for third sessions, the longest streak since late January.  It is the third weekly advance.  The euro is approaching the early February high near $1.0830.  Above there is the high from the ECB's December meeting and the taper and extension, set near $1.0875.     The two-year rate differential has narrowed nine basis points this week to one-month lows (2.09%)

In addition to Forbes and Nowotny, US Treasury Secretary's comments late yesterday were also important, even if the market's response was mute or overshadowed by other developments.  Mnuchin's remarks sounded very much like many of his predecessors and not from an administration that seemed intent on breaking from American tradition.  The US Treasury Secretary endorsed the strong dollar, saying it was good for the US in the long-term.  

That he recognized that the strong dollar could pose problems in the short-run is not so different from the G7/G20 caution against excessive volatility.  Still, it would be even more helpful, if Mnuchin decoupled the strong dollar policy from prices, and endorsed the original intent:   a commitment not to weaponize the dollar, which made possible the new orthodoxy of letting markets determine exchange rates.   

Mnuchin also seemed to embrace the process that the Treasury Department had developed to determine manipulation in the foreign exchange market.  If the criteria are maintained, it suggests that China will not be cited as a manipulator in next month's report.   Meanwhile, Trump and Merkel will meet, after the initial timeframe for earlier this week had to be postponed due to weather.  Trump has been critical of Germany and Merkel personally.  Trump's protectionist rhetoric, doubts about NATO, possible overtures to Russia, and efforts to dilute financial regulation don't set well with the German Chancellor.   However, expect a "very good" and "productive" meeting even if not "tremendous."  

Another draft G20 statement may be leaked, but the impact on the market is likely to be modest at best.  Its importance lies with changes from the last G20 statement as the most important change since then is the new US administration.  

The US reports industrial production and manufacturing output.  The former is to bounce back after a 0.3% decline in January.  Manufacturing employment rose more than expected (28k, matching January 2015 high, which itself was the highest since August 2013).  The median from the Bloomberg survey is for a 0.5% rise in manufacturing output.  The University of Michigan reports consumer sentiment and inflation expectations.  The Conference Board reports February leading economic indicators.  The LEI averaged 0.2% increase a month in 2016.  The average over the past three months has doubled that, and it will rise further if it rises another 0.5% today. 

Still, remember that Q1 growth in the US has been notoriously poor since the crisis and has not a material impact on subsequent performance.  Specifically, Q1 GDP has averaged 1.04% since 2010.  The other quarters average 2.5% (2.5% Q2, 2.7% Q3 and 2.3% Q4).  The Atlanta Fed GDPtracker is estimating 0.9% for Q1 17, and estimate we suspect will be raised as the US consumption is not as weak as the early data suggests.  

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