Dollar Slips Marginally, Dollar-Bloc Remains Heavy, Market Awaits Fresh Push

Fresh dollar positive developments have not materialized.  Moody’s did not downgrade France before the weekend. ECB’s Visco played down the need for additional stimulus after last week’s disappointing TLTRO.  Iwata, formerly at the BOJ, cautioned against continued yen declines, suggesting that the JPY90-JPY100 range reflects fundamentals.  

The dollar’s pullback has been quite modest, and it remains well within the ranges seen before the weekend.  The divergence between the US and UK on one hand, who are expected to raise rates next year, and the eurozone and Japan, on the other, which are easing and may ease further, remains a dollar bullish story.  

US yields have also eased in recent sessions.  The 10-year yield is trading near 2.56%, down 8 bp from the recent high, and near a five-day low. European bonds have also rallied, and spreads have narrowed against Germany.  This is especially true of Italy and Spain.  

In a weekend interview, Bundesbank’s Weidmann left no doubt that he opposed the ECB’s recent decision to cut interest rates and introduced an asset-backed securities purchase program.  Weidmann argued that it posed moral hazard for banks.  Being able to sell ABS to the ECB allowed banks to transfer risk from themselves to taxpayers.  This is the point that most observers stress, but Weidmann’s critique is broader.  

Weidmann argues that this is exactly the opposite direction that officials have agreed to move.  He argues it is bad politics in that it takes pressure of government’s to implement structural reforms.   If the ECB would stop trying to “rescue” EMU, the governments, especially in France and Italy, would be more incentivized to enact the reforms that create the conditions for growth and stability.  

Therein lies the rub.  ECB words and deeds have helped push down interest rates to incredibly low levels.  This eases the debt servicing burden, and in turn, allows the issue of structural reforms to be demoted to only important, and no longer urgent.  Yet, if Draghi and the ECB did not do anything, the existential issues, like the sustainability of EMU itself, would overwhelm policy makers and investors.