Dollar Slips In Consolidation, but Extends Recovery Against the Yen

As the market heads into the weekend, the US dollar is trading
softer as it consolidates. 
 It is within yesterday’s ranges
against the major currencies but the Japanese yen.  
The dollar has made a
dramatic recovery against the yen. 
 It traded near JPY108.80 in the
middle of the week and pushed through JPY111 in late in the Tokyo morning.
 The greenback is above its 20-day moving average against the yen for the
first time in a month.  
It is not clear what
triggered the dollar’s recovery. 
 There is some thought that the
driver is Japanese investors taking advantage of the yen’s strength to step up
their foreign bond buying.   US 10-year yields, to which the dollar-yen
exchange rate is sensitive, has recovered from the midweek dip to 2.10%.
 However, at 2.17%, the yield is still off by three basis points on the
The BOJ meet and as widely
expected kept its full complement of unorthodox policies intact. 
 It is clear from the central bank meetings over the
past two weeks that the BOJ intends to lag behind the other major central
banks.  This has been our
conviction, but it was strengthened by Governor
Kuroda’s comments.  He was reluctant to talk much about the exit
except to note that such a discussion is premature and could lead to confusion.
Outside of the BOJ and the
SNB, other central banks, like the European Central Bank and the Bank of Canada
have begun preparing the market for a less accommodative stance.
  The ECB is expected to announce a
reduction of its purchases (currently 60 bln euros a month) in September as it
extends its purchases into the first part of 2018.  The Bank of Canada
signaled it too is reconsidering the
extent of accommodation needed given the pick-up in economic activity and
strengthening of the labor market.    
The three dissents at the
Bank of England was surprising, and this sent sterling higher. 
Nevertheless, many, including ourselves, doubt that with a backdrop of political uncertainty, weakness in
earnings and a pullback by consumers, a rate hike is unlikely.  In fact,
we suspect price pressures will ease as the 8% decline in sterling last June
drops out of year-over-year comparisons.  
The dollar is not finding
nearly the same traction against the euro as it has against the yen.
  European interest rates are rising, and this has eroded the US premium.
 Consider that the German two-year yield is up nine basis points this
week, while the US is flat.  The German yield is at it highest since last
November.  The US premium has fallen below 200 bp for the first time since
late May.   After two Fed hikes this year, at 198 bp, the premium is three
basis points above where it finished 2016.  
At the 10-year mark, the US
premium narrowed about seven basis points this week.
  German yields rose.  US yields
fell.  At 186 bp, the US premium is the smallest since May 26, which
itself was the least since in seven months.  It is difficult for the
dollar to gain traction when the premium is shrinking.    Resistance
ahead of the weekend is seen in the
$1.1200-$1.1235.  That said, as we noted yesterday, the euro’s technical
tone has weakened as short-term operators have grown frustrated with the euro’s
inability to take out $1.13.  
The news stream is light as
the weekend approaches.
  The second round of the French
parliamentary elections will take place Sunday.  Macron’s new party is
expected to cut a large swathe of the middle of the French political spectrum.
 As we noted, both of Macron’s predecessors, Sarkozy and Hollande,
campaigned as reformers only to see their programs frustrated.  It is hoped that Macron’s experience can be
different if he has such a strong parliamentary position.  However, the
resistance to Sarkozy and Hollande was not so much in parliament as in the
broader society, including trade unions and rent-seeking interests.  
The US political situation
has not lifted. 
 Developments have shifted attention
from the Senate investigation to the Justice Department’s special counselor.
 It seems clear that the investigation into Russia’s attempt to influence
the US election and efforts to the cover-up
of what has yet to be shown to be criminal will take several months at least to
get closure. One of the fears investors have is the political maelstrom
bogs down the legislative agenda.  It may, but at this stage in the
process, the key issues, like health care reform, tax reform, lifting the debt
ceiling and renewed spending authorization is not so much in the executive
branch, but in Congress.   There is progress in committees that is not
making it to the front pages of the press.  
There are large options that
expire at 10:00 am ET today. 
 There are 1.9 bln euros of a $1.1150
strike that will be cut.  There are an additional 3.3 bln euros struck at
$1.12 and another 2.7 bln euros at $1.1250 strikes.  There are $2.5 bln
linked to a JPY112 strike that rolls off today.  There is about GBP1.1 bln tied to options struck
between $1.2740 and $1.2760.  The CAD1.3250 strike has $790 mln expiring today and another $850 mln in
CAD1.3295-CAD1.3300 strikes.  Lastly, the $0.7615 strike has A$427 mln being cut

The US reports May housing
starts and permits and the University of Michigan’s consumer sentiment
preliminary June reading. 
 Housing starts have fallen for two
months and in three of the first four months of the year.  A modest 4%
bounce is expected. If so, starts
would rise to 1.22 mln, which would be
best since February.  Permits, a leading indicator are also expected to
recover from April’s weakness.

Arguably the most important
component of the University of Michigan’s report the measure of long-term
inflation expectations. 
 It has been flat for three months at
2.4%, just above the historic low in December of 2.3%.  The market’s
response may be asymmetrical; more sensitive to a weaker than a stronger number.  


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