EC Looking Forward: May Monthly

Euro

After falling for each month of the first quarter, the euro traded higher in April. The pullback in US yields and some position adjustment helped the euro find better traction. In the larger picture, the euro's pullback in Q1 may be seen as a correction to last year's rally. That correction may not have been completed and the April bounce stalled around where it had to for the view to hold.

Momentum indicators are stretched and recognizing the importance of initial conditions, we see potential toward the 200-day moving average of around $1.1950. The vaccine rollout is improving, and this promises to lift growth going forward.

Barring a new shock, at the June 10 ECB meeting, the staff will upgrade its growth forecasts, and this may be sufficient cover to ratchet down the bond purchases from the accelerated pace in Q2. Still, the ECB will argue that conditions continue to require extraordinary levels of monetary support. The national ratification of the EU's Recovery Fund may be more protracted than desirable, but it will likely be able to begin making distributions in Q3. 

Here are the end of March 2021 indicative prices, previous prices are in parentheses.

  • Spot: $1.2020 ($1.1730).
  • Median Bloomberg One-month Forecast: $1.2010 ($1.1830).
  • One-month forward: $1.2025 ($1.1735). One-month implied vol: 5.3%  (5.8%).   

Japanese Yen

The dollar's 1.3% decline against the yen needs to placed in the context of its nearly 4% drop in March, the biggest monthly advance since the 9.2% gain in November 2016. Rising US interest rates seemed to be the most important driver, though Japanese investors' appetite for foreign assets seemed to have been dampened by the weaker yen. The dollar pared its losses against the yen as the US 10-year yield rose.

In February, speculators in the futures market began trimming the net long yen position in the futures market. The move accelerated in March and swung to the largest net short position in more than a year, where it remained through late April.

The formal emergency in Tokyo and other areas in the first part of the year, a fire at a semiconductor chip factory, and a powerful earthquake point to a possible contraction of 4%-5% in Q1 before a rebound in Q2. The third formal emergency in Tokyo and three other prefectures runs through May 11. While the JPY109.60-JPY110.00 may offer stiff resistance, rising US rates could lift the dollar back to the late March high around JPY111.00.

  • Spot: JPY109.30 (JPY110.71).
  • Median Bloomberg One-month Forecast: JPY108.60 (JPY109.30)  
  • One-month forward: JPY109.00 (JPY110.65). One-month implied vol: 5.5% (6.4%).

Sterling

The vaccine rollout is keeping the UK on track to allow a full economic re-opening on June 21. The recovery seems to be taking hold, though the extensive government support may conceal the scarring. The social restrictions in the first part of the year warn that the UK economy likely contracted in Q1 (GDP due May 12) by as much as 2% quarter-over-year. However, the high-frequency data suggest the upside momentum is building.

The Bank of England will likely recognize this. Although it will standpat, we suspect it could taper the bond purchases in Q3. Local elections are on May 6, and it will be partly be seen referendum on the government's handling of the public health crisis. At the same time, a strong showing by the nationalists in Scotland will hasten the confrontation with Britain over a formal referendum.

Sterling rallied about 10.75% from early last November (~$1.2855) through late February (~$1.4235). It consolidated mostly in the $1.3670-$1.4000 range while trading in March and April, and its attempt to push through the top was again rebuffed. This warns of the likelihood of a test on the lower end.  

  • Spot: $1.3820 ($1.3780).
  • Median Bloomberg One-month Forecast: $1.3860 ($1.3825).
  • One-month forward: $1.3825 ($1.3785). One-month implied vol: 6.9% (7.0%).

Canadian Dollar

Between the fiscal support of Ottawa and Washington, the Bank of Canada became the first G7 bank to announce a slowing of its bond purchases (to C$3 billion a week from C$4 billion), with an eye toward ending them -- and brought forward the six-month to mid-2022 range, wherein it projects that the economic slack will be absorbed.

This, in turn, encourages the market to price in a rate hike late next year. Canada's two-year yield is near 30 bps, only behind Norway among the high-income countries. Meanwhile, the government's fiscal support remains strong, with over C$100 billion for new initiatives, including childcare, which will likely also serve as a re-election platform for the minority government.

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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