Euro showdown coming
The 14 June meeting of the European Central Bank will be critical in signalling further QE tapering and interest rate hikes. Board members have been quiet on “normalization” in light of the rapidly shifting scenery. One issue is weak growth, illustrated by a broad fall in May’s flash purchasing managers’ index. Another is weak inflation. Given the soft patch, no one would be surprised by an ECB pause in hawkishness. With economic worries haunting, the risk is increasing that an anticipated June or July message of a tapering (to end quantitative easing) might be delayed.
Meanwhile, political risk and hype is building in Italy, Spain and Greece that might change the ECB’s mind. A recent, sharp rise in interest rates on the periphery suggests tighter financial conditions for the region’s weaker nations. This might warrant delay in “normalization”, however, we suspect it will only strengthen the ECB’s desire to get rates off the bottom. The bank has few options to manage a crisis. Interest rates are already negative and bond buying is already running into supply issues. We suspect markets are under pricing the ECB’s commitment to “normalization.”
Trade war discussions take centre stage
The positive dollar sentiment that followed the publication of the solid May job report did not last long. On Monday morning, the greenback fell across the board and lost ground against all its G10 peers amid mounting trade war concerns. Commodity currencies rose the most with the NOK and the AUD rising 0.86% and 0.75%, respectively. The single currency climbed back above the 1.17 threshold, while the Swiss franc showed modest gains with USD/CHF sliding to 0.9550, down 0.30% on the session.
In spite of the publication of key economic data this afternoon, the focus will remain on political developments. April factory orders is expected to have contracted 0.5%m/m, compared to an extension of 1.6% in the previous month. The final figures for April durable goods orders are also due later today (first estimate of 1.7%m/m).
Even though market participants will pay more attention to the trade war developments, and especially potential retaliation measures from European Union, we do not rule out a dollar reversal should the data come well above first estimates. However, the G7 summit in Quebec could potential be the biggest market driver, as trade tariffs discussions will take centre stage.
Long rupee
Despite expectation that higher oil prices would force the Reserve Bank of India to increase interest rates, the banks will hold at its June meeting. Economic growth has accelerated to 7.7% in Q1, significantly stronger than expected. Momentum at this early stage of recovery indicates further improvement due to consumption and investment growth. The monetary policy committee will likely highlight risks of higher commodity prices and widening current account deficits (forcing INR weakness against USD). The call will be close, given the bank’s inflation-fighting mandate, but it will opt to watch further before tightening. With US yields reaching an inflection point and global tensions decelerating, we are constructive on INR. USD/INR’s strong break of its 21-day moving average indicates a bearish corrections toward 66.
