In fact there seems to be little correlation between the dollar and risk sentiment, as gauged by the S&P 500. The correlation in changes between the two this year is -0.16%, meaning that in general, when the S&P 500 rises, the DXY index falls slightly – but very low correlation. As you can see from the scatter graph below, there’s little connection, as indicated by the R2 of 0.027, which means there’s little correlation between the two. They’ve moved in the same direction 50.8% of the time this year, which is exactly what you would expect if the correlation were random.
Furthermore, while the US economic indicators were generally better than expected on Monday 25th of June 2018, they were mixed on Tuesday 26th of June 2018. The headline durable goods orders figure fell less than expected but excluding transportation, it was much worse than expected (-0.3% vs +0.5% expected) and core capital goods orders fell instead of rising as expected. Pending home sales were disappointing (-0.5% mom vs +0.5% expected).
The big surprise though was a narrowing in the US trade deficit as exports rose sharply while import growth slowed. The deficit narrowed to -$64.8bn, whereas it had been expected to widen to -$69.0bn. The previous month was revised to -$67.3bn from the initial -$68.2bn. Perhaps under the current administration, trade is having an outsize impact on FX.
It appears that the message from last week’s Commitment of Traders report was correct: the market has capitulated and is bullish USD.
Both Bank of England Governor John Carney and Bank of Canada Governor Stephen Poloz echoed Federal Reserve Systems (Fed) Chair Jerome Powell’s recent comments highlighting the risks to the economy from trade tensions. Governor Carney noted that, “trade tensions have intensified…the question is the extent to which these measures start to affect business confidence…it’s one of the potential triggers for a broader risk-off attitude or adjustment to risk appetite in financial markets.” Governor Poloz stressed that the bank “cannot mechanically follow the rate path provided by our models because there is simply too much uncertainty in the world…these include the degree to which uncertainty about trade policy is holding back business investment…we expect these issues to figure prominently in our upcoming deliberations.” The message is clear: trade is no longer affecting FX just via stock markets but directly through expectations for monetary policy. The comments suggest that measures of business confidence will have more weight in monetary policy deliberations than before and will therefore be more important for FX market participants to watch.
NZD fell further after what was interpreted as a modestly dovish Reserve Bank of New Zealand meeting. While the main points and the forward guidance were basically the same, some of the details had a dovish tilt, for example when Governor Robert D. Orr said that the weak Q1 growth “implies marginally more spare capacity in the economy than we anticipated,” and that the fiscal impulse would be “also slightly lower and later than anticipated." He also referred to the trade tensions. With the currency having been beaten up so much recently, it could be in for a modest recovery on short-covering if risk sentiment returns.
EU Summit: migration, Brexit, trade and other topics
The two-day EU Summit starts today. The summit will take up a number of difficult topics:
- The hardest one is probably migration. The question of migrants and asylum in Europe has always been a source of disagreement among the EU countries, but now it’s an even bigger crisis as German Chancellor Angela Merkel’s coalition is starting to fall apart over the issue. There was a “mini-summit” on Sunday 24th of June 2018 to prepare for today’s discussions, but that event ended in disarray as the new Italian government demanded a total rethink of the EU’s rules for dealing with migrants. If this meeting can’t come up with a position that’s acceptable to all sides in Germany, her coalition may crumble. That would probably mean new elections in Germany in a few months. The increased political uncertainty would be negative for the euro.
- As for Brexit, the EU’s view is that there’s not much new to discuss, that Britain still hasn’t put forward a viable position for the two sides’ relationship after Brexit. There probably won’t be much disagreement within the EU side about the issue, but the conclusion is likely to be negative for Britain and the pound, in my view.
- The summit will also discuss trade with the US. The EU leaders are likely to take a hard stance in opposition to the US’ talk of more tariffs, with the result of a further “risk off” mood pushing the dollar down and JPY and CHF up.
- Finally, they will discuss measures to strengthen the Eurozone’s fiscal stability, such as a common Eurozone budget to fund investment programs and provide financial support for countries facing recession; a banking union; and transforming the European Stability Mechanism(ESM) into something resembling a European Monetary Fund (EMF) to better address future crises.
Getting back to today’s indicators, German Consumer Price Index (CPI) (to be specific, the HICP, or harmonized index of consumer prices) is expected to rise only modestly on a mom basis, while yoy growth is forecast to decelerate. Nonetheless the market expects tomorrow’s EU-wide CPI to accelerate somewhat (although core CPI is forecast to slow). Since 2009 the German HICP and EU-wide HICP have moved in the same direction 73% of the time, but that still leaves 27% of the time that they don’t – meaning it is possible for the former to slow and the latter to pick up. Nonetheless, a slowdown in German inflation would be seen as a warning for the rest of Europe and could be negative for the euro.
The third revision of US 2Q Gross Domestic Product (GDP) is expected to result in the figure remaining unchanged. However, the the Quarterly Services Survey (QSS) indicated that there was less spending on services than previously assumed. That could lead to a downward revision, which would be negative for USD if indeed it does happen. But as the graph shows, the third revision of US GDP hasn’t shown much change in the last several years. Since 2015 the average of the absolute values of the revisions has been about 25 bps. Still, a 25 bps downward revision (actually it would be 20 or 30 bps) would be enough to move USD, at least temporarily.
Bank of England Chief economist Andy Haldane will deliver the Academy of Social Sciences Annual Lecture on productivity. Haldane was third person who joined the two regular hawks in dissenting at the latest Bank of England (BoE) Monetary Policy Committee meeting. The speech will give him an opportunity to explain his dissent. That could be positive for GBP, although with the EU Summit starting today, politics may outweigh economics for GBP. Sluggish productivity growth has been a major concern for the BoE for some time, although the Eurostat data suggests Britain’s productivity growth is no worse than Germany or France, and much better than Italy’s.
Overnight there are a number of indicators out for Japan. The most important of these is the Tokyo CPI. Inflation is expected to remain sluggish, with the headline rate of change forecast to stay at the previous month’s rate, while core CPI is forecast to perk up but by an insignificant degree. That news could be negative for JPY if indeed anyone cares any more about inflation – even the Bank of Japan seems to have given up hope that it will ever return to the 2% target.
Japan’s unemployment rate and job-offers-to-applicants ratio are both expected to remain unchanged.
Australia’s private sector credit is expected to rise at the same mom pace as in the month before, while the yoy rate is forecast to be almost the same. In that case, we can expect an impact on AUD only if the actual deviates notably from the forecast. This could be neutral for AUD.
The Fundamental Analysis is provided by Marshall Gittler who is an external service provider of Claws and Horns (Cyprus) Limited, an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.