FX DAILY: The carry trade comeback suggests Dollar bulls will have to wait a while longer

12th May 2014

  • Self-proclaimed leaders in the Donetsk and Luhansk regions are going ahead with the vote despite Russian’s President Putin’s call to postpone it.” (The BBC)
  • German Chancellor Merkel and Frech President Holland declared the referendum illegal and warned of further sanctions against Russia. (Dow Jones News)
  • Pro-Russian separatists claim nearly 90% voted in favour in the Donetsk region. (The BBC)
  • Russian majority owned Gazprom “keep ratcheting up the bill for Ukraine, increasing the economic pressure in Kiev along with military presence along Ukraine’s eastern border. (The New York Times)
  • The latest survey from the Chartered Institute of Personnel and Development says the outlook for jobs in the UK is at its brightest in 6 years, with little sign of the employment “boom” abating. (The FT)
  • Although unemployment in the UK is falling faster than forecast, there still appears to be a problem with underemployment, with data from Markit suggesting 40% of part-time workers are looking for additional hours. (The Independent)
  • The BoE Inflation Report, released this Wednesday, is “expected to lift growth forecasts, extending the longest sustained run of upgrades since 1997.” BoE’s Carney “is likely to rubber stamp market expectations that the first rate rise will come in the first quarter of 2015.” (The Sunday Times)
  • Ex-EU advisor Philippe Legrain said “Europe needs to restructure its banking system, essential as the first part of a three-pronged strategy to get Europe back on track.” (Sunday Telegraph)
  • The head of Thailand’s pro-government red-shirt movement said any attempt by the Supreme Court and the Senate to set up an interim government as called for by the PDRC would be unlawful and would steer the country towards civil war. (Bangkok Post)
  • Japan’s March Current Account Balance fell to Y116.4B, versus expectations of Y347.7B and Y612.7B previous. Australia April NAB Business Confidence rose to 6 from 4.
  • New Zealand REINZ House Sales fell -20.2% on the year in April, versus -10.0% previously.

Friday’s Census Bureau report on wholesale inventories provided further evidence that the US’s dire Q1 GDP report could be revised higher in subsequent updates. The measure of wholesale inventories expanded 1.1% on the month in March and the report contained a back revision to February’s data, taking inventories levels to a 0.7% increase on the month from 0.5%. Overall inventories subtracted 0.6% from annualised first quarter growth in the preliminary release so subsequent upgrades to the data is very welcome news. The dollar gained on the report, extending a rally as the greenback continued to benefit from the euro’s sell-off. The S&P 500 climbed higher, closing up 0.15% on the day. The Dow Jones Industrial Average broke a new record high, apparently impervious to the Ukrainian risk. However 10 year yields stayed pinned to the 2.6% range, managing to inch up only 2 basis points while 30 year yield was stuck at 3.46%.

The US economy is thawing out after a harsh winter with broad based indicators rebounding in March in line with the improvement in weather. Will a return to a more temperate climate and economic growth finally bring about a stronger dollar? A rebound in March durable good orders, regional survey indicators as well PMI reading certainly silence any rumours that the US’s Q1 stagnation was anything more than weather related. More significant, however, is evidence of a fundamental recovery underway with impressive rebalancing. The US current account balance is at its smallest since the 1990s and the expected 2014 budget deficit is only 2.8%. The new US economy is defined to greater energy independence courtesy of the shale gas boom. This is feeding through to a narrower trade gap and smaller current account deficit. US Consumer Credit also show that Americans learnt their lesson after being burnt by the GFC as there is still little improvement in credit card lending.

While a real US recovery is underway, Fed Chair Yellen’s testimony last week shows that the US is no nearer to tightening policy though we can take tapering as a given. With a commitment that rates will stay low for longer and the US confined to a 2-3% growth range, the carry trade is back in fashion and there is temptation fro investors to leverage up. In FX terms this means the dollar will stay weaker in the medium term until we get some indication of a change in Fed policy.  Dollar bulls will have to wait a while longer. The fundamental recovery in the US argues for a stronger long-term view on the dollar but in the short term currencies whose economies are amped up on fast money and government stimulus policy coincidentally right before a general election will continue to enjoy short term demand…sterling-dollar at $1.70 anyone?!