IB FX Brief: Welcome to the Hotel California!
For all its fiscal warts and admittedly little potential for any nearby change in monetary policy, the dollar is staging a remarkable performance against its peers. The dollar staged a rally against the euro after a monthly report from Germany’s central bank warned over a dimmer growth outlook, while growth sensitive currencies limped to the sidelines after interest rate expectations were further dashed by a one-two combination of lesser inflation and a slide in retail sales north of the border. It would seem that investors are becoming increasingly concerned that the dollar isn’t the only currency struggling to check out from its stay at the Hotel California.
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U.S. Dollar – The dollar could conceivably have faced a difficult week in the sense that monetary exit seems no closer. However, the deeper discussion of a monetary exit in the late April minutes released this week has kept up a buzz in the market. The fact that the Fed can perhaps check out but never leave its Hotel California is a moot point at this juncture given the data from other nations, whose policymakers face a rethink over tough talk on inflation. The dollar index rose Friday to 0.3% to 75.37 although well of its Monday peak at 76.00.
Euro – The inflation-fighting German Bundesbank said Friday in its monthly economic assessment that the heady 1.5% pace of growth was unsustainable and likely stoked by catch-up restocking orders and inventory building. It warned that the pace of growth in the Eurozone’s heartland was “likely to ease somewhat in the foreseeable future” and that the recent data “considerably overstates the underlying economic momentum.” The past two IFO business confidence surveys taken March and April both slid reflecting deterioration in the outlook. Admittedly today’s comments don’t address inflation nor whether the Bundesbank’s ECB governing council members would be more or less likely to encourage monetary tightening in light of the dimmer growth outlook. But the foreign exchange market was quick to jump to the conclusion that the euro was more likely to join the dollar and check in for a stay at the Hotel California. The euro slid to $1.4212 with dealers happy to cut the weekly rebound for the single currency to a penny despite having earlier peaked at its best level of the week at $1.4345.
Canadian dollar – The Bank of Canada was already half-checked in to the hotel ahead of today’s economic reports. It’s a well-known fact that the Bank doesn’t want to allow the yield spread between official U.S. and Canadian rates widen excessively for fear of fuelling the local dollar resulting in a cramping for exports. That official short-term yield gap of 75 basis points translates into a 95 basis point gap at the three-month horizon, while dealers expect that to widen further by year end to 125 basis points according to implied rates in the futures market. A standstill in April retail sales took dealers by surprise on Friday with the forecast calling for a 0.9% advance. There was also good news on the inflation front with the monthly CPI slipping from a 1.1% March advance to just 0.3% leaving the annual rate unchanged at 3.3%. The Bank’s core rate eased to 1.6% and between the two reports the evidence points to less rationale for the central bank to press the policy levers again. The Canadian unit took a thrashing on the exchange sinking to $1.0262 U.S. cents having somewhat optimistically reached $1.0359 cents ahead of the data.
Japanese yen –The Japanese probably bought the Hotel California in a real estate deal back in the late ‘eighties and are permanent residents. The slide back into its third recession in a decade as confirmed in Thursday’s GDP data means that the yen is highly unlikely to ever leave its room with scope for more ingenious monetary easing at the top of the agenda at the bank of Japan. The dollar was nevertheless pushed back from an advance to ¥82.00 Friday although still sits on a comfortable gain for the week at ¥81.65.
British pound – The story remains the same for the British pound where the clever trade is to sell that European strength and wait for interest rate bulls to quickly come to their senses. The situation facing the Bank of England is toughest on account of the rampant 4.4% pace of inflation, which makes legitimate calls for higher interest rates, until you look at the outlook for growth, employment and consumption. The central bank, or at least the majority of the MPC, has made plain its case for extending its stay on the west coast. The pound jumped to $1.6274 cents earlier before the dollar advanced pushing it back to $1.6187. At this rate the pound is vulnerable to a weekly loss below $1.6178 and look out for an acceleration of selling below there.
Aussie dollar – Where would we be without risk-on/risk-off – especially with both rearing their heads repeatedly within the same session? Despite its inherent advantage of being a high-yielder with a 4.75% short-rate set by the reserve Bank the Aussie continues to frustrate those looking for evidence that the Bank can further widen its premium. The Aussie rose to its highest point of the week at $1.0702 U.S. cents before reversing course and heading for a row with Thursday’s low. Currently the Aussie trades down at $1.0626.
Senior Market Analyst
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