US dollar weakness was one of the key themes driving financial markets last week. The trade weighted dollar index traded as low as 88.438, its weakest level since December 2014, on the back of the US Treasury Secretary Mnuchin appearing to ‘talk down’ the dollar at the World Economic Forum in Davos and a perceived step up in protectionist trade measures with the imposition of tariffs on solar panels and washing machines earlier in the week. The renminbi also rallied against the US dollar reaching 6.3263 up 1.17% (spot return) on the week. Against this backdrop the yield on the 10-year UST was unchanged at 2.66%. The revised estimate on US GDP came in weaker than expected with Q4 GDP expanding at a 2.6% annualised rate when estimates had been looking for an increase of 3%: this reflected a drag from the inventories (-0.67%) and the trade component where net exports fell 1.13%. Consumer spending still remained strong expanding at a 3.8% rate.
The US started the week in government shutdown before the Senate passed a short-term funding bill late on Monday that lasts only until the 8th February. Meanwhile, In Davos, Treasury Secretary Mnuchin insisted that the US was open for business whilst welcoming a weaker dollar, believing that it would benefit the US economy. ‘Obviously a weaker dollar is good for us as it relates to trade and opportunities’ and that short term the value of the greenback was ‘not a concern of ours at all’. He went on to add ‘Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency. What's happening in the U.S. is a reflection of programs being put in place. As we look at U.S. growth, it continues to look quite good and is a very attractive place to invest’.
This set off a whole series of responses with Christine Lagarde reminding him that ‘The dollar is of all currencies a floating currency and one where value is determined by the markets and geared by the fundamentals of U.S. policy.’ Mario Draghi also commented after the ECB meeting on the euro move saying that while some of the strength was justified by stronger growth that members of the ECB’s Governing Council were concerned by Mnuchin’s comments: ‘The concern was broader than simply the exchange rate, it was about the overall status of international relations right now. This is also an additional concern. If all this was to lead to an unwanted tightening of monetary policy which is not warranted then we would have to think about our monetary policy strategy.’ Following this, Donald Trump’s comments took a more conciliatory tone stating he expects the dollar to strengthen and ‘ultimately I want to see a strong dollar’. But any dollar rebound was short-lived, especially after the weaker than expected US GDP figure.
While we prefer the US dollar curve as we think more has been priced in for rate rises euro denominated sovereign issuance continued to be readily absorbed by the market. For example, a €10bn 10-year benchmark issue by Spain at a fixed coupon of 1.4% received €43bn of orders despite the Catalan situation, although a rating upgrade to A1 by Fitch may have sparked some interest.
Looking ahead, this coming week is likely to be dominated by news-flow from the US: on Wednesday there is the FOMC meeting rate decision; there is no press conference after the meeting and no increase is expected at this meeting and it is Janet Yellen’s last meeting as Fed Chair. Other key US data releases include the PCE deflator for December along with personal income and expenditure, January’s ISM for manufacturing and January’s non-farm payroll data on Friday. The market is looking for 180,000 jobs to be created, the unemployment rate to remain unchanged at 4.1% and for average hourly earnings to remain at 0.3% mom.