Daily Comment (May 20, 2016)

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Markets were quiet overnight.  The G-7 meeting, being held in Japan, is probably the most important event going on at the moment.  So far, Japan has been politely discouraged from using tools to weaken the JPY.  We suspect that after this meeting ends, Japan will take steps to weaken the currency regardless of G-7 opposition.  We believe we are in a world where every nation wants a weaker currency.  Since that is mathematically impossible, those nations with the potential for currency strength, such as the U.S., are trying to use moral suasion to discourage other nations from using policy to create currency depreciation.  Since the Fed appears ready to lift rates, don’t be surprised to see the dollar strengthen over the next few weeks.  A stronger dollar would weigh on commodity prices and emerging markets.  In fact, a rising currency tends to act as a form of monetary policy tightening, so if we are right about a recovery in the greenback, it would act as a force multiplier to any Fed action to lift rates.  We don’t expect anything of substance to emerge out of the communiqué at the end of the G-7 meeting tomorrow.  However, we will be watching Japan closely after the meeting ends and expect some moves to weaken the JPY.

It appears that the EU will extend Russian sanctions.  We expected Putin to work harder to get sanctions lifted, but he may be facing a bandwidth problem.  Because he doesn’t seem to delegate well, he probably was so consumed with the Syrian operation that he was unable to take the time to woo EU governments to change their stance on sanctions.  At the same time, the EU is usually plagued with inertia.  It was difficult to get sanctions in place to begin with and, once in place, it takes almost the same effort to end them.  Continued sanctions will keep pressure on the Russian economy and leave it at the mercy of oil prices.

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