Dollar’s new post-election low is also due to euro strength
MBA mortgage applications confirm strong home-buying interest
Weekly EIA report
Dollar’s new post-election low is also due to euro strength — The dollar index in the past three sessions has dropped sharply to post a new 6-month low and has now fallen by a total of -5.5% from the post-election 14-year high of 103.82 posted in early January. The dollar index on Tuesday closed down -0.806 (-0.81%) at 98.105, just +0.3% above the pre-election level of 97.78.
Meanwhile, EUR/USD has been even stronger, rallying to a new 6-month high of $1.1097 on Tuesday and closing the day up +0.0108 (+0.98%) at $1.1083. EUR/USD closed +0.4% above the pre-election level of $1.1040.
While the current sell-off in the dollar index seems rather severe, it is important to recognize that the sell-off so far appears to be more of a correction of the 2014/16 rally rather than the beginning of full-blown bear market. The dollar index still has strong underlying fundamental factors such as the solid U.S. economy and expectations for the Fed’s multi-year rate hike regime to continue and for the Fed in 2018 to start drawing down its balance sheet.
Nevertheless, the dollar index has been moving steadily lower in the past several months with progressively lower lows and lower recovery highs, the hallmark of a downward trend. There are two main reasons in our view for the dollar’s weakness. First, the markets are less optimistic about the Republican growth agenda with the White House seemingly unable to drive a legislative agenda and with Congressional Republicans having difficulty finding common ground on health care and tax reform legislation. The White House controversies may also be causing some capital flight from the U.S. among some of the more skittish foreign investors.
Second, and more importantly, yield differentials have been moving against the dollar and in favor of the euro. As seen in the nearby chart, the spread between the German and U.S. 10-year government yields has a high correlation with EURUSD. The German-US 10-year yield spread has risen by about +15 bp in the past month, providing a strong boost for EURUSD.
The German 10-year bund yield has risen since the April 23 first round of the French election because Emmanuel Macron’s victory in the French presidential race gave the ECB the green light to start planning its QE exit and eventually a rate hike. Meanwhile, the U.S. T-note yield has moved lower due to reduced inflation expectations and the slow-moving Republican growth agenda.
The dollar has also seen weakness on the flip side of some important bullish factors for the euro. First, the Eurozone economy is steadily improving and the Q1 Eurozone GDP growth rate of +2.0% (q/q annualized) was stronger than U.S. Q1 GDP growth rate of +0.7%. Second, the ECB is moving towards cutting back the extraordinarily easy monetary policy that it has had in place since the financial crisis and the European sovereign debt crisis. The market consensus is that the ECB will tighten its interest rate guidance at its next meeting in June and will then announce in September that it will taper its QE program down to zero in the first half of 2018.
Eurozone bond yields and the euro have so far shown relatively modest strength but could potentially still see their own version of a taper tantrum when the ECB’s QE tapering gets closer. It is important to remember that the bulk of the dollar’s gains came during, and just after, the Fed’s QE3 tapering. Since early 2015, the dollar index has seen only modest additional gains despite three Fed rate hikes, suggesting that QE tapering may mean more to the FX markets than rate hikes.
MBA mortgage applications confirm strong home-buying interest — The MBA mortgage purchase sub-index has risen steadily since late 2016, indicating strengthening interest in buying a home. The MBA purchase sub-index has risen by 19% since the Nov 2016 election and posted a new 1-1/4 year high in last week’s report.
The increase in purchase applications has been consistent with strong home sales. U.S. existing home sales in March rose by +4.4% to a new 10-year high of 5.71 million units. Demand for home purchases has been rising due to strong consumer confidence, a strong labor market, and pent-up demand following the Great Recession. Potential home buyers are also likely trying to lock in on a new home and mortgage now before mortgage rates rise even farther over the next two years or so.
Weekly EIA report — The market consensus for today’s EIA report is for a -2.75 million bbl decline in U.S. crude oil inventories, a -1.0 million bbl drop in gasoline inventories, a -1.25 million bbl drop in distillate inventories, and a +0.5 point increase in the refinery utilization rate to 92.0%.
U.S. crude oil inventories fell sharply by -13.018 million bbls (-2.4%) in the past five weeks, which has brought U.S. crude oil inventories down to +27.2% above the 5-year seasonal average versus the near record high of +40.7% above average seen in February. U.S. crude oil inventories have now fallen to the lowest level relative to the 5-year seasonal average in 1-3/4 years. Meanwhile, product inventories remain ample with gasoline inventories at +9.1% above the 5-year seasonal average and distillate inventories +16.2% above average. Meanwhile, U.S. oil production last week rose by another +0.2% w/w to post a new 2-year high of 9.314 million bpd. Since the OPEC production cut agreement on Nov 30, 2016, U.S. oil production has risen by a total of +615,000 bpd (+7.1%), offsetting more than half of the 1.2 million bpd OPEC production cut.