External risks likely to support dollar; euro clocks steady gains

Sterling pound remains under pressure mounting amid Brexit risks

United States

The market continues to price out Fed tightening and the dot plot has followed through. As the ECB, BoJ and the PBoC remain in a monetary expansionary mode and are likely to continue on the same path in 2016, the divergence in rates between the US and the other G5 countries continues to widen.

The existence of external risks despite the induced low volatility environment from central banks, are likely to keep an upward pressure to the US dollar.

During a speech this week, Yellen struck a dovish tone mentioning the uncertain inflation environment in the US. With consumer price index moving higher in the US in comparison to the other G5, she is still not convinced about the stickiness of the latest increase in inflation.

Internally, US employment data in Q1 remain robust and housing although volatile remains in an expansionary mode. The main economic drag and concerns in Q1 was on the back of the manufacturing and industrial sector, coming from high levels of inventories build and lower factory orders.

Weak external demand, due to dollar strength and subdued global growth, continue to weigh on the economy and are likely to continue being a drag, even with the service sector doing the major lifting to compensate for the weakness in the manufacturing sector.

Externally, a weaker dollar has helped China avoid extreme market pressure on the currency front, a hard landing and provided more monetary flexibility. A weaker US dollar has also helped the global credit cycle, reduced EM reserve erosion and supported commodity prices in the first quarter of 2016.

Having seen the short term benefits of a lower dollar, Yellen provided a firm reminder that the Fed is not going to be tightening further, at the same time attempting to calm market over the possibility that the Fed could move in April and June as some of the previous Fed speaker comments.

Since the beginning of the year, the US dollar index has lost 4.2% and almost 5% since the Fed hiked in December 2015. Historically, the US dollar depreciated by on average 5.6% during the last 3 cycles six months following the first fed hike.

The Fed outlook seems to price much bigger global risks than what we have witnessed in the past month. If China were to remain stable, the Fed will have to turn more hawkish again. For now, the Fed is likely to continue to attempt to push out any rate hikes until investors find clarity from Asia and emerging markets. Fundamentals for the US however remain solid, however, a neutral to lower dollar continues to help all global players

On the foreign exchange side, the Euro gained across the week starting on Monday at 1.1163 to reach a high of 1.1438. The currency ended the week at 1.1391

The Sterling Pound remains under pressure and has been the G10 laggard since the beginning of the year amid mounting Brexit risks. The downward pressure isn’t likely to go away for now, and likely to intensify as we get closer to the referendum date in late June. After starting the week near the low of 1.4132, the Pound rallied on the back of a weakening US dollar to close on Friday at 1.4227.

On the commodities side, after a strong five week’s performance, commodities seem to reach an exhaustion point for now. Oil markets seem to find a stable phase around the current levels on hopes for an output freeze by major producers. Brent closed the week at $38.67, while West Texas at $36.79. Sentiment continue to swing on news that OPEC and non-OPEC producers will hold a meeting in Doha on April 17.

On the precious metals front, Gold remains well supported this week’s. The latest Janet Yellen’s speech has reignited demand for Gold. The solid job report however brought the metal down to close the week at $1,222.

Janet Yellen reiterated the Federal Reserve’s cautious outlook this week in a speech at the Economic Club of New York. She highlighted the risks posed to the US by a global economic slowdown. Owing to weaker-than-expected growth overseas and a cloudy domestic inflation outlook, Yellen reiterated a need to “proceed cautiously” in lifting interest rates.

The main focus was on her comment that the committee would proceed cautiously in adjusting policy. Yellen also highlighted that the outlook for US inflation had become ‘somewhat more uncertain’ and that recent readings on the US economy are ‘somewhat mixed’. She also went as far as to say that the committee has ‘considerable scope’ to ease policy if necessary and that the Fed has tools at their disposal that can be used to effectively strengthen the recovery from the Great Recession and would be used again if needed. Both China and volatility in Oil prices were also made mention to several times as risks to the US outlook

Charles Evans, president of the Fed reserve bank of Chicago, said that he expected the US economy to be strong enough to justify raising rates twice this year. Evans did come across as a little more cautious with regards to his views on inflation saying specifically that he was a ‘bit uneasy’ on hitting the 2% target. The Fed President also said that ‘it is too early to tell whether the recent firmer readings in the inflation data will last or prove to be temporary volatility and reverse in coming months’, while also signaling that is important for the Fed to take the recent decline in inflation expectations, as perceived by the market, seriously.

US home prices in 20 major metropolitan areas climbed 5.7% in January compared to a year ago, according to the S&P Case-Shiller report, matching expectations of 5.7%. Prices were up 0.8% in January from December slightly higher than estimates of a 0.7% pace. Housing sector remain robust despite the Federal Reserve’s move in December to increase interest rates.

Europe & UK

Since the launch of the ECB quantitative easing programme in 2015, the Euro has strengthened almost 2%. Today, the Eurozone inflation remains a major concern. Even with monthly purchases of 80 billion Euros, and placing the ECB deposit rates further into negative, the currency remains on the strong and growth on the weak side. The 5 years inflation expectations in Europe have dropped significantly to 1.40% while the ECB target is at 2%.

In addition to the sticky low inflation environment, additional European risks come in 2016. Whether on the political front with the latest terror attacks and the refugee’s problems, financial risk in the Eurozone was the main market focus in the first quarter of the year. The ECB tackled the later thanks to the large injection of fresh new money through the announcement of four years new TLTROs.

On the data side, Europe economic surprise index remains into negative, which is likely to keep the ECB on the intervention side whether verbally or reducing further rates into the negative.

Retail sales in Germany declined slightly in February. The data came below expectations at 0.4% in February after a drop of 0.1% in January. On an annual basis, the data was much more positive increasing by 5.4% from February 2015. German inflation on the other hand came at 0.8% from the 0.3% in February. Year on year, inflation is also up, rising by 0.3% from February’s drop of 0.1%.

Elsewhere in Europe, Spanish Consumer price inflation increased lessthan-expected in February. CPI in Spain increased to 0.6% compared to -0.4% recorded in January. Although a sizable increase, it still failed to meet market expectations of 0.7%.

French Consumer price inflation was also out increasing a more-than-expected rate in February at 0.7%, from the 0.3% recorded in the previous month.

The upcoming UK referendum on EU membership contributed to the Pound weakness in the first quarter of 2016. Moreover, fears about the current account, Britain’s credit rating and the global economic conditions have been drivers of the pound’s recent fall.

The longer term effects of Brexit are also likely to be adverse. According to economists, growth would suffer as a detailed analysis from the Bank of England last October found that EU membership had benefited the British economy

In the first quarter of the year, UK growth has slowed and downside risks remain on the back of renewed fiscal tightening. Economic data however have been coming stronger than expected in the past month with inflation moving higher on the back of stronger commodities prices

The UK’s manufacturing PMI came in at 51 compared to expectations of 51.2 in March. The employment subindex has now been in negative for six of the last eight months. According to the report, the data suggest hiring at small and medium-sized companies failed to offset job shedding at larger manufacturers.

On a different more positive front, the UK house prices increased in March as rental investors rushed to purchase property before a tax increase.

The average price of a home rose 0.8% from February. The annual rate of growth surged to 5.7%, the strongest in more than a year.

A shortage of homes for sale is being aggravated by landlords trying to buy investment properties before a tax change on second homes takes effect this month. With demand also being boosted by low borrowing costs, the Bank of England has warned that risks in the property market are rising.

Asia

People’s Fears of a sharp Chinese slowdown were the main market attention in the first quarter of the year. Markets in March proved that these worries were overdone and not supported by macro data which continued to point to a very gradual slowdown. This week, Chinese PMI came on the strong side beating market expectations. The data came at 50.2 while economists expected 49.4.

The government efforts as well as potential further fiscal easing have generated the short term results that the government was looking for.

The problem remain the fact that deceleration continues in the export sectors, and it seems that the investment led growth model has reached its limit

In the first quarter of 2016, the Yen broke below the 115 level needed to sustain the up-trend we have seen since 2012. The Japanese currency was mainly supported on the back of the weak global risk appetite and a continued risk aversion. Additional gains were also due to the fiscal year-end repatriation of funds.

In March, the global positive sentiment helped the currency stabilize around the 113 level; however Yellen’s dovishness gave a boost to the currency.

On the data front, industrial production came weak, falling 6.2% month-onmonth in February, exceeding expectations for a 5.9% drop.

We believe that further deterioration in the local economic conditions would pressure the government to intervene verbally and further adopt new easing actions to limit the yen’s appreciation in order to defend Abenomics policies ahead of the July election

Kuwait

The USDKWD opened at 0.30165 on Sunday morning.