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Monetary Policy – Is Divergence Really Against the Greenback?

Bob Mason
The Dollar’s on the back foot following stats out of China this morning. It may not last though if there’s a resolution to the trade war…

The Stats

Economic data released through the Asian session this morning delivered some unexpected results.

New Zealand saw softer inflation in the 1 st quarter, in spite of a new sales tax on cigarette and tobacco. Economic data out of China was not quite as bad as many had anticipated, in spite of the trade war…

Out of Japan, while the trade surplus widened in March, the trade balance fell into a deficit for the fiscal year 2018. The deficit was a first in 3-years…

Out of China, the economy grew by 6.4%, year-on-year, in the 1 st quarter, which was at the same pace as in the 4 th quarter. Quarter-on-quarter, however, the economy slowed to 1.4% from a previous quarter of 1.5%.

In spite of the mixed numbers, a jump in industrial production in March and a surge in retail sales softened the blow.

Elsewhere in the week, the RBA intimated a need to maintain a low-interest rate environment in the latest policy meeting minutes. The minutes were on the more dovish side even with the RBA holding back from talking of a possible rate cut.

For the Loonie and the EUR, there’s certainly been no reason for the pair to get too excited. Any gains have been reversed of late. Both the BoC and the ECB have maintained a particularly dovish stance. The Bank of Canada was somewhat late in shifting away from a hawkish stance but ultimately delivered.

With the Bank of England joining Britain and Brexit in the State of Limbo, it was left to the FED to fly the flag for the Hawks.

It’s hard to say where the pressure came to force the FED to hit pause. Either way, the influence of the Oval Office prevailed. Trump’s trade war with China saw to that…

Monetary Policy Divergence or Global Conformance

While this morning’s stats out of China will have eased any immediate concerns over Australian trade terms, the stats are unlikely to have an impact on the RBA.

High household debt, tepid wage growth, uncertainty over consumption, softer inflation numbers and falling house prices are all reasons why the RBA is going to need to be ready to hit the cut button.

The Aussie Dollar may have moved back through to $0.72 levels ahead of the European session, but a slide back to $0.70 levels would not be unsurprising should there be no shift in the RBA’s key areas of focus.

If this morning’s inflation figures out of New Zealand do incentivize the RBNZ to cut rates next month, the RBA may not be far behind.

The Game of Dominos

Moving from East to West, the RBA would likely follow an RBNZ rate cut. Next up would be the ECB. Cutting rates may not be an option, but tiered deposit rates for banks would certainly be a viable option. To be fair, however, if private sector PMI numbers don’t improve in April, it’s going to need more than tiered deposits.

The Pound is left out of the equation for now. Brexit is already having a longer-lasting effect on the Pound than a 25 basis point rate cut. With inflation sitting well below its post EU Referendum peak, the BoE will likely stand pat near-term.

Economic data has been good enough to support this status quo.

That leaves the Greenback… Since the decision in March to hit pause, risk sentiment has had a material impact on the Dollar.

The Risk on – Dollar off relationship will continue until there is an untimely return of the hawk. It’s unlikely to be Kashkari, but there are a number that could surprise in the next month or two. The danger of betting against the Dollar is the speed at which the doves turn…

Economic data out of the U.S hasn’t been great, but there’s a high bar set by the markets. Labour market conditions remain strong and, when considering consumption contribution to the GDP numbers, this is key.

The bad news for Trump would be the rising prospects of a rate hike. We’ve yet to see any particularly alarming stats out of the U.S, to support a rate cut.

All in all, the Greenback continues to move on the assumption of a continued pause through the year. In spite of this, divergence remains clearly in favor of the Dollar.

So, in summary…

Earnings results will influence the equity markets, consumer confidence and ultimately consumption.

Decent earnings would strengthen Trump’s case for a 2nd term for Trump. That said, the FED may also end up having to give rates a nudge upwards. Not a bad thing though, when considering the lack of a buffer at present…

This article was originally posted on FX Empire

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