FX: Dollar Continues to Push Lower
The US dollar's downtrend is extending. The euro traded above $1.16 for the first time since last August. With Japanese markets closed for the second half of the Golden Week holidays, perhaps participants felt less hampered by the risk of intervention and pushed the dollar to almost JPY105.50. Despite an unexpectedly large fall in the UK's manufacturing PMI (49.2 from 50.7), sterling has pushed to its highest level in four months (~$1.4770).
The Australian dollar is the main exception. It is off about 1% following the 25 bp rate cut that brought the cash rate to a new record low of 1.75%. Given the OIS and indications from other derivative markets, the market seemed set for a symmetrical response. Even the surveys showed a nearly evenly divided outlook. Twelve of 27 in a Bloomberg expected a rate cut.
We had not be persuaded that last week's soft Q1 CPI was sufficient to put the RBA over the edge. However, in explaining the decision, Governor Stevens recognized that while inflation had been low for some time, it was exceptionally low now (CPI actually fell in Q1), and the outlook had diminished. He also noted the "very subdued" growth in labor costs.
Before the RBA's announcement, the Australian dollar had climbed to $0.7720. Recall it finished last week near $0.7600. However, after the cut, the Australian dollar fell a little below $0.7560. The government forecast a little more than an A$37 bln deficit that was in line with expectations and set the stage for a national election in early July. This consideration may have also pushed the RBA into action today. If the election is called, as widely expected, the June 7 RBA meeting and the July 5 RBA meeting may be too close.
Investors have been well aware the UK economy has lost some momentum. This understanding was confirmed by last week's estimate of Q1 GDP (0.4%). Nonetheless, today's manufacturing PMI was a surprise. It fell below the 50 boom/bust level at 49.2, and the March series was revised lower (50.7 vs. 51.0). Export orders were weak, and costs and output prices fell. The construction and, more importantly, the service PMI will be released in the coming days. Both are expected to generate a consistent signal that after slowing in Q1, the UK economy is slowing further at the start of Q2.
Sterling remains firm. This has been the recent pattern. There are at least two explanations offered. First is that there has been some relaxation of fears of Brexit. We are not convinced of this as many polls continue to show results near the margin of errors, suggesting a close decision. In addition, two-month volatility remains elevated at almost 14.4%. A five-year high was set in late-April near 14.5%. Also, the skew in options pricing (25-delta risk-reversals) remains near its extreme. At the most, in late-April, puts were at a 3.95% premium to calls. Today, indicative prices suggest a 3.81% premium. The second explanation is that sterling's strength is better understood as a reflection of the weak dollar.
China's Caixin manufacturing PMI was a touch weaker than expected at 49.4. March's 49.7 was a 13-month high. It does not seem like there is much new information here. The Caixin survey picks up more small and medium businesses than the government's measure. During this phase of slowing, the small business is having a more difficult time of things. The government's estimate (50.1 from 50.2) reflected a slowing, but giving the imprecision of such metrics, it supports ideas that the economy is stabilizing--with the help of a continued strong expansion of credit.
The PBOC fixed the yuan at its strongest level of the year against the US dollar (CNY6.4565). Still it appears to be lagging behind its trade-weighted basket. It seems that when the US dollar is soft, the PBOC tracks the dollar more than the TWI. Some officials think this protects China in case the US was seeking to devalue the dollar for competitive purposes. On the other hand, when the dollar is strong, the PBOC appears to track the TWI closer than the greenback. This mayprotect it from claims of competitive depreciation.
Ahead of tomorrow's ADP employment estimate, ISM services, and factory orders, the US reports April auto sales. Sales are expected to have ticked up in April to 17.4 mln vehicles at an annualized rate. Three Fed Presidents speak. Mester moderates a panel on monetary policy and liquidity. Williams is on Bloomberg radio, and Lockhart addresses a World Affairs Council in Florida. There is not much that can be said that will influence investors' expectations for next FOMC meeting in June.