Brief Thoughts on the Dollar

The US dollar starts the North American session narrowly mixed. Sterling, the Australian dollar, and Swiss franc are enjoying small gains.  The Scandis, the New Zealand dollar and euro are nursing small losses.  

The main talking point the improved signals from the US and the more cautious tone from Europe. In the US, there is talk of a compromise on health care reform a week after the bill was pulled to avoid defeat.  In some ways, the issue comes down to whether a compromise can be found between the Freedom Caucus, a conservative group within the Republican Party, and the Tuesday Group of more moderate  Republicans.   Meanwhile, there is continued efforts to prepare for tax reform, and there are some reports suggesting the infrastructure initiative could be brought forward into this year from next.  

At the same time, signals from the Trump Administration suggest moderating views on reform of NAFTA (and the peso has responded favorably), and that the US reluctance under Obama to regard China as a market economy (for WTO purposes) may be reconsidered.   If these do come to fruition, it underscores advice to recognize that unlike comments from other heads of state, Trumps remarks to a great extent should be regarded as negotiating ploys.   The bark may be worse than the bite.  

Separately, in recent days, at least three regional Fed Presidents (Rosengren, Williams, and Evans) seemed to suggest upside risks to the Fed's view.  To be sure, the Fed's leadership (Yellen, Fischer and Dudley) is more cautious, but even the two hikes that Fischer confirmed were likely over the remainder of the year are not fully discounted.  The market has serious doubts.    According to Bloomberg, the market does not have more than a 45% chance of one more hike discounted.  The probability that Fed funds target range is 1.25%-1.50% at the end of this year is about one in three.  

In Europe there has been a push against the hawkishness that had begun creeping into the market, encouraged by some official talk.  The softer inflation numbers from Spain and Germany ahead of tomorrow's flash reading for the eurozone as a whole helped underscore the less hawkish signal from the ECB.  Spain's CPI fell to 2.3% from 3.0%.   German inflation fell to 1.5% from 2.2%. Even if the base effect from last year's early Easter played a role in the decline in these inflation readings, the point Draghi and Praet make is that eurozone inflation is still not on a convincing path higher.  Core inflation bottomed at 0.6% and may have slipped back to 0.8% in March form 0.9% in February.  

The euro is trading lower for the third consecutive session.  It reached almost $1.0730 after having traded a little above $1.09 on Monday.  There are several technical targets in the $1.0710-$1.0720.  A convincing break seems unlikely now, if it does yield, the $1.06 area would be the next target.  

The US 10-year yield is struggling to resurface above 2.40%, and the dollar is struggling to gain much above JPY111.00.  The high for the week was set earlier today just below JPY111.50.  

Sterling dipped briefly below $1.24 yesterday and is holding above there today.  A move above $1.25 is needed to lift the tone.  It seems to early to put much importance in the initial banter between the UK and the EU.  Although Prime Minister May has reject the "hard" or "soft" exit that observers use, but it does not change the fact that the EU is going to drive a very difficult negotiation in which it is difficult to envision a way for the UK to maintain access to a single market without significant concessions on the freedom of movement.