A Weak Quarter End for the Greenback

Weak Quarter, End, Greenback, US dollar, US election, FED,  fell, Fundamental Analysis, fx trader, forex

31 Mar 2017

The US dollar fell against all the major currencies in the first three months of 2017. The weakness initially seemed to be a correction to the rally, which began before the US election last year. The dollar recovered in February, in anticipation of a hawkish Fed in March.

The Fed did hike rates, but the dollar fell as the earlier than anticipated hike did not appear to impact the anticipated pace of normalization. In fact, if anything, the market has discounted less of a chance of June hike than it did before the Fed's hike (50% vs. 54% according to Bloomberg's calculation).

The dollar also lost some luster as speculation emerged that the divergence theme that drove many bulls was now morphing to its opposite: convergence.  China raised some technical rates within hours of the Fed's hike.  Some officials (German and Austrians) suggested that maybe the ECB would raise interest rates (deposit rate, which in turn lifts EONIA) before finishing its asset purchases. A member of the BOE's Monetary Policy Committee voted for an immediate hike, while the patience of other members seemingly thinned. There as even some talk that the BOJ would raise its 10-year yield target. Late the quarter, doubts rose that US President Trump will be able to pass his economic agenda.

As the quarter ends, much of the convergence story has been undermined. There has been a push back against the hawkishness of some of the creditors in EMU. ECB's Knot was explicit. There was a logic to the sequencing of the exit from extraordinary monetary measures that the Federal Reserve executed. Finish asset purchases before raising rates. The hawk at the MPC is due to step down in a few months, and most of the MPC seems considerably more cautious, perhaps in the face of weakening wage pressures.

Japan reported its second consecutive increase in its core CPI in more than a year.  However, it stands at a mere 0.2%, with headline CPI at 0.3%. Tokyo core CPI, which reported with a smaller lag, was 0.4% lower than a year ago, twice the decline the market expected.  Having met with Japanese officials on my business trip to Asia, investors ought not underestimate the determination of the BOJ to continue to pursue its 2.0% inflation target.

The macro-conditions for raising the target of 10-year bond yields are similar not there in Japan. To be sure, Q1 growth looks firm, helped by industrial production ( Feb IP was reported today with a 2.0% rise, compared with 1.2% expectations) and exports. Yet despite strong labor market (it was reported today that Feb unemployment unexpectedly fell to 2.8% from 3.0%), household spending continues to disappoint. It fell 3.8% year-over-year in Feb, after a 1.2% decline in Jan. The median expectation (Bloomberg survey) was for a 1.7% decline. It has not risen on a year-over-year basis since Feb 2016, which itself was the first increase since August 2015.