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Draghi maintains dovish stance to prevent further EUR appreciation
No Surprise from Draghi, buy USD
Yesterday ECB rate decision and press conference in our view provided no real surprises. As with the BoJ, the ECB is more confident about the threat to growth outlooks but inflation remains an uncertainty. For any adjustment, we would have expected the ECB to have materially shifted their view on the mid-term inflation outlook. The message was around growth positive with risk retreating “towards a more balanced configuration”. The language used around inflation was basically unchanged. In our view the most obvious modification was Mario Draghi's comment that no debate was held on the ECB's monetary policy stance, which changed slightly from the perceptions in March that early discussions on possible exit strategies were had.
To keep everything neat and tidy, Draghi undoubtedly linked any future decision on monetary policy to inflation forecasts. Given the direction of inflation, we anticipate the ECB will be challenged with a decision to make by September, so Euro bulls will need to wait. Clearly the market was disappointed with Draghi’s avoidance of any suggestion of tapering in the near term. Today 1Q 2017 GDP growth data from the US should highlight marginal slowdown, yet US PCE data should be supportive of Fed expectations. With sustained accommodation from the ECB (and BoJ) and repricing of Fed interest rate path, we should see further EUR (and JPY) selling against the USD as the Fed remains the only G10 central bank in tighten mode.
USD/JPY subject to upside risk
As widely expected, the Bank of Japan held its monetary policy unchanged on Thursday. Its short-term interest rate target was maintained at -0.1%, while the central bank will continue to drive the 10-year JGB yields close to zero. The size of its asset purchase programme was also left unchanged at ¥80 trillion a year. The market was therefore more focused on the BoJ economic outlook, in particular inflation expectations.
The institution revised its GDP growth forecast for fiscal year 2017 to 1.6% compared to 1.5% in January. On the price front, the picture is not that rosy as the BoJ revised its inflation forecast to the downside - headline CPI down to 1.4% y/y from 1.5% - but Governor Kuroda warned it will just be a temporary setback. Obviously, the central bank maintained its optimistic view on the price outlook as it still believes inflation will reach the 2% target through fiscal 2018.
We believe that the BoJ is overly optimistic, especially in regards to the inflation outlook, meaning that we are far from hearing any discussion about tapering any time soon. USD/JPY is still stuck below its 50dma (currently at 111.76) and was treading water at around 111.20 this morning. We believe there is further upside for USD/JPY as rising US rates will soon attract investors again.
Trump trade escalation hype fades
We have seen President Trump fire up the extreme populist platform of protectionism in an attempt, in our view, to score some quick points as his first 100 days milestone approaches. First Trump slapped Canada with up to a 20% tariff on lumber imports, then he forced Canada and Mexico to agree to renegotiate NAFTA. He closed the week threatening to “terminate” Korus, the US-S.Korea trade deal (potentially a tactic to get S.Korea to pay for THAAD). Traders were quick to sell the underlying currencies CAD, MXN and KRW on the escalations in trade tensions. However, as with much of Trump’s actions, we suspect that recent moves will be short-lived as real underlying policy initiatives are unlikely. In the case of Mexico, events in Venezuela should provide a stark warning to the potential effect of destabilizing measures. The Trump administration is unlikely to push Mexico too hard, opting to have a safe, friendly cushion between the US and South America.
MXN has had a difficult time with weaker oil prices and rumours that President Trump has ordered a draft letter to leave NAFTA. The news injected some volatility into MXN as the currency came under significant selling pressure against the USD. Yet, Trump’s sudden reversal from withdrawing from NAFTA to renegotiation should be MXN positive. The partial unwinding of the extreme risks of protectionism will lower concerns that Emerging Markets currencies are heading towards a correction. The MSCI Emerging Market Currency Index is trading just below its two-year high. From a macro perspective, the affirmations that the ECB and BoJ will maintain their accommodating policy for the foreseeable future indicates that risk-taking and yields-seeking behaviour should resume. Given our current view on global conditions, we anticipate MXN will recover lost ground. We anticipate that USDMXN, despite is slightly oversold positioning, will retest 18.50 lows.