Dollar Slips but Dip may Offer New Opportunity

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Marc Chandler
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Overview: The US dollar is offered today. It is trading softer against all the G10 currencies, with the yen the notable exception, and it is flat. The Antipodean are leading the way, taking out last week's highs, as has the euro. That said, the intraday momentum indicators are stretched as NY dealers return from the long holiday weekend. The Scandis are also trading above last week's highs. The yen, sterling, Canadian dollar, and Swiss franc are still inside last week's ranges. Most emerging market currencies are trading with a firmer bias today, as well, led by central European currencies. The Chinese yuan is also slightly firmer after banks cut the five-year loan prime rate by 25 bp. A handful of Asian currencies are softer, including the Thai baht following the Prime Minister's call for a special central bank meeting to cut rates.

Some profit-taking was seen on Japanese stocks. South Korea's Kospi and Australia's ASX also traded off, but most of the other large bourses in the region rallied. The Stoxx 600 in Europe is threatening to snap a four-day advance and is nursing minor losses in late morning turnover. US equity indices are trading softer. European bonds are rallying. Benchmark 10-year yields are off mostly 2-4 bp, though the yield of the 10-year Gilt is off seven basis points. The US 10-year Treasury is slightly below 4.27%, about a single basis point lower. The softer dollar and softer rates are lifting gold to a five-day high above $2027. Last week's high was a little above $2031. April WTI is consolidating between about $77.55 and $78.55.

Asia Pacific

Chinese bank cut the five-year loan prime rate by a record 25 bp to 3.95% today. It was the first cut since last June. The one-year loan prime rate was unchanged at 3.45%. The lower rate could allow a decline in the minimum mortgage rates. However, the average rate of new mortgages in December were already a record low of slightly below 4% in the major cities.

The PBOC last cut the benchmark one-year Medium-Term Lending Facility rate by 15 bps last August. The large state-owned banks have not fully passed it through to the prime rates. The one-year prime rate was cut by 10 bps, and the five-year rate was not cut at all. This would seem to suggest that the large state-owned banks do not always do what Beijing wants. The same is true for lending to the property sector. We think this gap is important. It means that despite the ownership structure, Beijing does not have absolute control. It suggests that Beijing, like other governments, may struggle to coordinate and implement some of its edicts. 

The dollar remains in the range set last Tuesday of approximately JPY149.25-JPY150.90. The daily momentum indicators may be trying to turn lower, but the recent consolidative price action looks more like a continuation pattern than a reversal. The US rates may still be the key and it does not look like the 10-year Treasury yield has peaked. The Australian dollar is rising for the fifth consecutive session today, matching the longest advancing streak since last June. It is trading at its best level since the February 2 US jobs data, reaching $0.6560 in the European morning. Nearby resistance is seen near $0.6565. Having initially fallen through yesterday's lows (~$0.6525), a close above yesterday's high (~$0.6550) would help lift the tone. The RBA minutes showed that while a rate hike was discussed, the decision was to leave policy steady earlier this month. The US dollar continues to knock on CNY7.20. Both in January and now in February, the dollar has hovered slightly below CNY7.20. The price action may spur speculation that this the in new cap. The PBOC set the dollar's reference rate at CNY7.1068. The upper end of the 2% range is near CNY7.2490. The average projection in Bloomberg's survey was CNY7.1979. 

Europe

A vicious cycle is threatening Europe. As growth forecasts are cut, the projected budget deficits, as a percentage of GDP widen, prompting governments to cut spending. Last week, the EC cut this year's growth forecast by a third to 0.8%. As we noted yesterday, the French government cut this year's growth projection from 1.4% to 1.0% and reduced spending. The Bank of France and the IMF are slightly lower, at 0.9%. The median forecast in Bloomberg's monthly survey is for 0.7%. The French budget deficit was about 4.8% of GDP in 2024, and the EU sees it at around 4.4% this year. The Bundesbank warned yesterday that the German economy is likely to contracting here in Q1. Last week, the German government slashed this year's growth forecast to 0.2% from 1.3%. It also took a knife to next year's projection, cutting it to 1% from 1.5%. Last week's updated EC forecast now sees German growth at 0.3% this year and 1.2% in 2025. The budget deficit was about 2.2% of GDP last year and may fall to 1.6% this year. The EC predicts that the Italian economy will grow by 0.7% this year and 1.2% next year, which is largely in line with the IMF's forecasts. The budget deficit is expected to fall from about 5.0% last year to 4.4% this year, according to the EC. The central bank of Spain projects 1.6% in 2024 and 1.9% in 2025. The IMF's forecast is for 1.5% and 2.1% growth, respectively. Last year's budget deficit, which was a little more than 4%, is expected to narrow to about 3.2%, according to the EC. The poor economic backdrop is likely to impact the June EU parliament elections and the composition of the new European Commission. The preliminary signs point to a shift to the right.

In aggregate, the eurozone budget deficit narrowed from about 3.6% of GDP in 2022 to about 3.2% last year. The EC expects it to narrow to around 2.8% this year. Recall that the US budget deficit in FY23 was about 6.3% of GDP (~5.4% in FY22). The Congressional Budget Office expects the budget deficit to narrow during the current fiscal year to 5.4%, assuming a 1.5% GDP growth. The reason the US has a significantly higher budget deficit is not because of some "exorbitant privilege." After all, the US pays considerably higher interest rates than the eurozone (~190 bp more than Germany on 10-year yields, 80 bp more than Greece, and almost 40 bp more than Italy). The difference is ideological. Former ECB President Draghi once quipped that ordoliberalism is part of the central bank's DNA. The same could be said about the EU. Ordoliberalism rejects the Keynesian use of fiscal policy to manage demand and the "normal" business cycle. The US has been a net creditor throughout its history, with only a couple of exceptions. Pax Americana was built with debt. 

The euro has poked above last week's high, slightly above $1.08, in the European morning. It traded in about a quarter-cent range yesterday and made a marginal new four-day high slightly below $1.0790. It has not closed above $1.08 since February 1. The euro is also fraying the 20-day moving average, which is also a little below $1.08. The single currency has not closed above the 20-day moving average since January 2. It briefly traded below $1.07 in the middle of last week. Three-month implied volatility is at a new two-year low a little below 5.80%. The next technical target may be in the $1.0820-30 area. With its own four-day high yesterday (~$1.2630), sterling met the (61.8%) retracement of the leg down seen after the US CPI last week. It is trading quietly but firmer and trying to re-establish a foothold above $1.2600. Sterling looks set for more consolidation. Three-month implied vol has also fallen to a fresh two-year low below 6.4%. A close below around $1.2565 or above $1.2650 would be notable. 

America

With the sole exception of February 2022, the US index of leading economic indicators has fallen since the end of 2021. It will be reported shortly and is expected to have fallen by 0.3% last month. In past cycles, the duration and pace of decline has been associated with economic contractions. We cite this to illustrate the uniqueness of this business cycle. Bloomberg's monthly survey conducted in late January found a median forecast of 1.1% growth in Q1 24 at an annualized pace. While it is still early in the quarterly data cycle, the Atlanta Fed GDP tracker stands at 2.9%.

Canada's headline CPI fell in the last four months of 2023 (-0.6% at an annualized rate). Today, it reports January CPI. The median forecast in Bloomberg's survey is for a 0.4% increase. Yet, owing to the base effect (0.5% increase in January 2023), the year-over-year rate may ease to 3.2%-3.3% from 3.4%. In February-May last year, Canada's CPI rose at an annualized rate of 6%. With a conservative assumption that headline CPI rises by 0.3% a month on average in the Feb-May period this year, the headline rate will slow to around 2.5%. More importantly and troublesome for the Bank of Canada, the underlying core rates have made little progress in recent months. The weighted median was 3.5% in October, 3.6% in November, and 3.6% in December. The trimmed mean was 3.6% last July and stood at 3.7% in December. The simple core rate (excluding food and energy) fell from 5.3% at the end of 2022 to 3.2% in September 2023 and finished last year at 3.4%.

The swaps market has about a 90% chance that the first Bank of Canada cut will be delivered in July. As recently as mid-January, the market had three quarter-point cuts discounted by then. Late last December, the swaps market discounted approximately 160 basis points of easing this year. By the first part of last week, it had fallen to around 60 bp and now is a little over 80 bp. Despite the dramatic adjustment in Bank of Canada interest rate expectations, the Canadian dollar has traded heavily. It is off about 0.4% this month after falling by 1.4% in January. Canada's two-year yield is at a 35 bp discount to the US, virtually unchanged since the end of last year. 

The US dollar rose a little above CAD1.3500 earlier today before reversing. It slipped below the CAD1.3480 in Europe. Still, the US dollar has forged a shelf near CAD1.3460-5 in the past few sessions. If this area holds, the risk is for another push higher. The three-month high recorded last week was near CAD1.3585. We suspect the risk extends toward CAD1.3625, the (61.8%) retracement of the losses from Q4 23 decline (~CAD1.3900 to CAD1.3175). The Mexican peso traded quietly yesterday. The dollar spent the session inside the pre-weekend range (~MXN17.03-MXN17.10). Today, it has slipped below last week's low, to make a new marginal new low near MXN17.02. The greenback has settled within the MXN17.00-MXN17.25 range since the middle of January with one exception. It has not traded below MXN17.00 since January 16. There are options for almost $545mln struck there that expire today. The dollar has been in band against the Brazilian real, as well. Since mid-January, with a couple of exceptions on an intraday basis, the dollar has traded between BRL4.90 and BRL5.0. Options for about $450 mln struck at BRL5.0 expire today. The peso is less volatile than the real (three-month implied is about 9.6% and 10.7% respectively). The peso has held up better than the real (~-0.4% vs. -2.1%). The overnight target rates are both at 11.25%. Mexican equities are off almost 1% this year, while the Bovespa is off about 4%.