Corrective Tone Threatens FX Trends

The US dollar has been trending gently higher against the major currencies over the past 3-4 sessions but is trading heavier today. It is largely within yesterday's trading ranges. The two main drivers remain: Greece and the US economy.

Negotiations with Greece appear to have entered a final phase. Reports suggest there are still some differences on corporate taxes and pensions. The idea is that Greek Prime Minister Tsipras will be in Brussels today to close whatever gaps remain. The EU Summit (heads of state) begins tomorrow and, again, the hope is that they can simply sign off on the agreement. In practice, however, last minute compromises may be necessary by the heads of state.

We detect a subtle but significant shift. As late as 11:40 am EST yesterday, a Bloomberg article quoted IMF's Lagarde telling a Brussels audience that the Greek proposals "still lack specificity." Late yesterday, Lagarde told the IMF board that she was optimistic about a Greek deal.

Assuming there is a deal, confirmed by the EU Summit, then the next hurdle is a few parliaments. The two key ones are seen as Greece and Germany. Tsipras' concessions that make a deal possible are the very same concessions that antagonize the left-wing (Fundis, like in the German Greens) of the Syriza coalition. Depending on the number of defections, it seems reasonable to expect Greek centrists to support the deal.

Analysts will also focus on the defections within Merkel's CDU/CSU. Finance Minister Schaeuble gives voice to a faction that would just as soon prepare for a Greek exit. Ultimately, Merkel's European agenda has often required support from the rival but now coalition partners in the SPD. Moreover, it is difficult for German politicians to claim the IMF's assessment is important and then reject it. It is reasonable to expect the German parliament to approve the deal. It would not be asked to approve a deal without the IMF's blessings.

Revisions to US Q1 GDP are expected to show that what appeared as a 0.7% contraction on an annualized basis was closer to -0.2% when the new data (not incorporating any of the residual seasonal hypothesis) is incorporated. More important for investors is the performance here in Q2. The labor market has moved back toward its underlying trend. Consumption has improved, and we'll get confirmation of that tomorrow with the May PCE data. The manufacturing sector may have slowed. Yesterday, Markit's preliminary flash US manufacturing PMI slipped to 53.4 from 54.0, whereas the market had expected a small gain since October 2013. The details from the durable goods orders report, released yesterday, suggested that although Q2 began off slowly, capex looks to have bottomed.

At the same time, the headwind from the housing market has abated, and this is positive for residential investment. Atlanta Fed GDPNow raised its assessment of residential investment to 10% from 7%. This has helped lift their Q2 GDP Nowcast to 2%. But despite three Fed officials including Governor Powell, suggesting the possibility of two hikes this year, the December Fed funds rate is not fully pricing in one.

The implied yield is 32 bp. If there is one hike and the Fed funds rate effective average is in the middle of the new 25-50 bp range, as is the case now in the 0-25 bp range, that would imply a yield closer to 37 bp. The implied yield of the November Fed funds contract, which is after the September and October meetings, is 25 bp.

The BOE's Weale's comments were as hawkish as anything US officials have said. He warned of a hike as early as August in the UK. The market has generally shrugged this off as Weale is understood not to represent a majority. Since 2010 when he joined the MPC, Weale has dissented around a dozen times in favor of a hike, only to back down later. The September short-sterling futures contract implies a one basis point higher yield today (which is also bid-offer spread).

Sterling itself is higher against the dollar, but giving back a little of yesterday's gains against the euro. The euro itself has all but ignored the softer than expected IFO survey, which largely mirrored the ZEW results. That said, the flash PMI for Germany, out yesterday, gave a different and more positive take from surveys.

Lastly, though it is not to be found on most calendars, a procedural vote in the US Senate yesterday on Trade Promotion Authority points to its approval today. Parliamentary maneuvering managed to outflank the opposition in the House, and the "unrecoverable" blow to Obama will be reversed. This will pave the way for the completion of the TPP, perhaps in Q3.