US Treasury Semi-Annual Report on Foreign Exchange: None named as currency manipulator, but criteria thresholds change

US Treasury Semi-Annual Report on Foreign Exchange: None named as currency manipulator, but criteria thresholds change          

• The US Treasury releases its Semi-Annual Report on Foreign Exchange overnight and while there are no major trading partners listed as a currency manipulator, they do change the thresholds for the currency manipulation criteria as follows – (1) partners meeting at least $40bn total bilateral goods trade (vs 12bn before); (2) same bilateral trade surplus with the US at $20bn; (3) material current account surplus at 2% of GDP (vs 3% before); (4) persistent one-sided intervention in FX markets, net FX purchases 2% of GDP (as before) and persistence of net FX purchases  at 6 of 12 months (vs 8 of 12 months); Included in the report: "China should make a concerted effort to enhance transparency of its exchange rate and reserve management operations and goals."  The monitoring list includes: China, Japan, Korea, Germany, Italy (NEW), Ireland, (NEW) Singapore (NEW), Malaysia (NEW), Vietnam (NEW) but removes Switzerland and India.    

USD sentiment still mixed despite selected overnight gains          

• USD gains overnight are concentrated against EM and the euro bloc while weakening against the safe havens (JPY in particular) as traders continue to follow US data closely for clues on Fed rate cut signals. A strong US May consumer confidence report (134.1 versus 130.0 consensus) initially leads to USD gains but are pared back an hour later by an  unexpected fall in the Dallas Fed manufacturing activity index for May to a 5 month low of -5.3 versus +6.2 expected with details showing the softest readings for business activity and company outlook measures since December 2018 along with multiple mentions of tariffs and the trade war in the press statement. This is a similar reaction to last week’s drop in US May regional manufacturing Markit PMI, linked to the deepening US – China trade dispute.       

• With clear evidence that USD sentiment is now focused on the trade related weakening US manufacturing outlook (as investors react even to 2nd tier data), upside momentum now seems to be waning. Citi analysts also see USD structurally weakening as (1) US fiscal stimulus fades and US growth outlook slows markedly in 2020 that could compel Fed to cut rates, and (2) as the longer term historical pattern typically suggests USD depreciation (vs. G10) tends to be the longer term norm, occurring in bursts of around 10 years, interrupted by bouts of USD strength for 5-6 years at a time. USD now seems to be in that period where longer term deprecation could occur.            

EUR mired by multiple political risks post the EU parliamentary elections and weak euro zone data       

• EURUSD’s overnight 40 pip decline to the 1.1160 area is blamed on –  (1) Italy as Italian BTP/German Bund spreads continue to widen post the EU Parliamentary elections; (2) In Germany, Chancellor Merkel now sees her heir-apparent, Annegret Kramp-Karrenbauer (AKK), as no longer “up to the job” of succeeding her as head of CDU. This could open the door for a more right wing successor emerging (potentially Friedrich Merz); (3) Rising risks of a “No Deal” Brexit following the strong showing by the UK’s Brexit Party in the EU Parliamentary elections.  

• Italy appears to be a particular concern as Italian BTP-Bund 10y yield spreads spike as high as 288.7bps overnight on concerns the EU Commission may open a disciplinary process for Italy on June 5 that could assign a USD4bn penalty for failure to reign in 2018 debt levels. This comes even though EU Commissioner for Economic and Financial Affairs Pierre Moscovici says he does not favor sanctions at this time. Nevertheless, market sentiment remains nervous given Italy Deputy PM Salvini’s triumph at the European Parliament elections that could now potentially (1) see snap elections in Italy (either late July or late September/ early October); and (2) possibly a full blown clash between Italy and the EU on the Italian budget, a risk long discussed by Citi analysts who point to a bumpy road ahead. Rating agencies are also expected to express their views between July and October and the sustainability of Italian debt might soon be back at the center of investor focus at a time when Mario Draghi is set to leave the ECB.  

• Markets also now eye the ECB June 6th meeting where a decision about (1) TLTRO lending rate likely to be less generous as per recent ECB speak, and (2) a possible extension to the calendar-based part of forward guidance on interest rates though with euro short rates now pricing the first ECB hike in Q4’2021, an extension of ECB forward guidance is unlikely to have much impact. However, with euro zone (especially German) manufacturing data weak and leading to the continuing decline in market based longer term inflation expectations to 2016 lows (reflected in German Bund yields now at -16bp and only 4.4bp away from the 2016 record lows), it is difficult to see how the ECB can be anything but dovish at its June 6th meeting – likely to limit any rebound in EURUSD until then.     

Commodity Bloc: Week Ahead – BoC board meeting tonight

• Citi analysts expect the BoC to be largely neutral at its meeting tonight. While there are some small hawkish risks, the meeting could underwhelm markets looking for a potential turning point for a significantly more hawkish BoC. The release of Q1 GDP will confirm overall soft activity to start 2019.

Asia EM FX to also remain under pressure    

• PBoC has signaled a desire to stabilize RMB and USDCNH has dropped 400 pips (peak 6.95 to trough 6.91) in one of the biggest pullbacks in the last three weeks. Moreover, CNY daily fixes over the last week have printed stronger than consensus. However, all bets are likely to be off should the US – China dispute escalate to the next level that sees additional US tariffs on Chinese USD300bn of imports. Most analysts (including Citi) see USDCNY heading towards 7.25 under this scenario. 

• This is an extract from the Daily Currency Update, dated May 29, 2019. Please approach a Citigold Relationship Manager if you would like more information.