ECB Preview – Here’s the Biggest Problem for Draghi

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ECB Preview – Here’s the Biggest Problem for Draghi

Daily FX Market Roundup 04.26.17

Before we preview tomorrow’s European Central Bank monetary policy meeting, its important to talk about what is affecting the U.S. dollar today. Treasury Secretary Steven Mnuchin outlined the President’s tax reform plans and the investors were disappointed. There was nothing new in today’s announcement and more importantly the market was not convinced that the tax cuts would “pay for themselves in growth, reduction in deduction and closing loopholes” as indicated by Mnuchin. Trump’s goal is to lower the corporate tax rate to 15% from 35% and reduce individual income tax brackets to 3 from 7 with the highest tax rate at 35%. This top rate is slightly higher than the levels previously floated around, which ranged from 25% to 33%. Also, instead of offering details outright, “throughout the month of May, Trump’s team will work with the House and Senate to develop the details of the plan.” In other words, this big announcement was not surprising at all and was virtually the same as the one released last fall. Having rejected the 50-day SMA near 111.80, USD/JPY is struggling to hold onto its gains.

There were no major U.S. economic reports released today but according to Paul Ryan, Congress is getting closer to health care reform, which is essential to tax reform but their number one priority right now is avoiding a government shutdown. We would be surprised if there wasn’t a deal reached by the midnight deadline on Friday. If lawmakers finalize a deal that would keep the government running through September it would be more favorable for the U.S. dollar than another stop-gap funding measure but according to Reuters, who quotes a House Republican source, we’ll probably get a one week government funding bill.

As the deadline approaches, the market’s focus will shift temporarily to the European Central Bank’s monetary policy announcement. Since the last monetary policy meeting, we’ve seen widespread improvements in the Eurozone economy. The following table shows how consumer spending, labor market conditions, manufacturing and service sector activity along with investor and business confidence increased in the month of April. Unfortunately the biggest problem for the central bank isn’t growth but inflation. Price pressures have been easing and the rising euro makes it even more difficult for the central bank to achieve their inflation target. Mario Draghi won’t be happy that the market interpreted his last monetary policy announcement as less dovish and went out of his way to say last week that there’s no confidence that inflation pick-up is durable and as such “a very substantial degree of monetary accommodation is still needed.” FX traders are holding out hope that Draghi will downplay inflation, focus on growth and suggest that rates could start rising soon. Although Draghi could recognize the improvements in the economy we do not think he will put a rate hike on the table.

All three of the commodity currencies traded lower against the greenback today despite steady commodity prices. Although a decline in retail sales prevented the Canadian dollar from rallying, reports that the U.S. is moving forward with leaving NAFTA with an announcement later this week or early next week according to Politico is the primary reason for the currency’s weakness. Canada and Mexico will be hit hard by the U.S.’ departure and even if Canada manages to negotiate a new trade deal, the near term uncertainty could weigh on the currency. The Australian dollar was hit by softer than expected consumer price growth. Inflation increased 0.5% in the first quarter, lifting the year over year rate to 2.1% from 1.5%. This was just under the market’s 2.2% forecast. Credit card spending in New Zealand rose but NZD fell in sympathy with AUD.

Kathy Lien
Managing Director

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