Divergent Impulses Spur Dollar's Comeback

The US dollar extended its recent gains against the major currencies. The euro returned to its break-out level near $1.1060 after approaching $1.15 at the end of last week. In three sessions it has surrendered more than 38% of its bounce off the low set in mid-March. The 50% retracement comes in just below $1.10.

The dollar also traded above JPY121.00 for the first time since March 20. A rallying Nikkei and U.S. 10-Year bond yields near 2.30% provided the fuel.

Sterling, which as of yesterday had fallen 3.5 cents from last week's high, is recording an inside day, helped by the BOE minutes. The minutes showed two MPC members are considering a near-term hike, while others agreed that the remaining slack in the economy will be absorbed over the next year.

Contrasting news streams have been the main impetus to the dollar's recovery. The Dollar Index is up about 3% this week and is above its 20-day moving average (~95.05) for the first time in nearly a month.

Investors have learned this week (from the San Francisco Federal Reserve) that a seasonal quirk probably lies behind part of the repeated weakness reported in Q1 growth. Yesterday, the US reported a 20.2% month-over-month rise in April housing starts and an upward revision to March. Permits, a leading indicator, rose 10.1%. Starts are up 9.2% year-over-year and permits are up 6.4%. Talk that had been creeping in of a new recession in the US is wide of the mark. Weekly initial jobless claims (tomorrow) are near cyclical lows. The unemployment rate (narrow and broad measures) is falling. This is not the stuff recessions are made of.

In contrast, ECB officials have indicated that asset purchases will be front-loaded in May and June due to seasonal considerations. Despite the easing of deflationary forces (governing council member Ewald Nowotny says deflation has been averted) and better growth numbers, talk of early tapering has also been dismissed. Yesterday, France's central bank head Christian Noyer warned that instead, the bond purchase program can be extended past September 2016 if needed. This is not so much new as a timely reminder. Nearly every country that has implemented QE has had to do more than what it initially anticipated.

At the same time, Nowotny echoed previous comments by the ECB's Draghi that warns of the limitations of monetary policy. A cyclical recovery is helpful, but long-term growth requires structural reforms. Low and negative rates are not permanent, he says. Still, not being permanent and ending any time soon are two dramatically different things.

Japan reported stronger than expected growth in Q1. The 0.6% quarter-over-quarter expansion was half again as much as the consensus forecast (0.4%). The 2.4% annualized pace was the strongest in a year. The consensus was for a 1.6% increase after a 1.1% pace in Q4 '14. Business spending was up 0.4% following a flat Q4 figure. Personal consumption was up 0.4%, twice what economists had expected. Inventory accumulation was strong and this is seen as a headwind for Q2.

The Nikkei gapped higher for the second consecutive session and recorded new multi-year highs (since 2000). With the help of a weaker yen and lower oil prices a high number of Japanese companies (autos, airlines, manufacturers) are reporting record profits. Japanese companies are also paying out more money to shareholders via dividends and share buybacks. Next month is traditionally when many Japanese companies hold shareholder meetings and more of the same can be expected. At the same time, as part of the BOJ's version of QE, it is buying equity ETFs, and Japanese pension funds are diversifying away from JGBs and into equities (and foreign markets).

The highlight of the North American session will be the FOMC minutes from the April meeting. Given the cacophony of voices, we argue the minutes have a high noise-to-signal ratio. The two points of interest are how the temporary weakness of the US economy is understood and what are the conditions needed for lift-off. The minutes are unlikely to challenge the new consensus of a September rate hike. Given the large dollar moves in recent days and the technical levels reached, it would not be surprising to see a consolidative tone in North America today.