Blue Wave Adds to the Dollar’s Woes

  • The Democrats appear to have retaken the Senate; Blue Wave trades are picking up steam; FOMC minutes will be released; ADP private sector jobs estimate will be today’s data highlight
  • Eurozone final services and composite PMI readings fell modestly; German December CPI will be reported; while the US election results are mostly positive for EM, we think the balance of risks could shift against Russia
  • Final services and composite PMIs across Asia were mixed; the takeaway here is that while Asia has led the global recovery so far, momentum appears to be slowing a bit as we move into the new year; in oil markets, the OPEC+ impasse was broken by Saudi Arabia

The Blue Wave is adding to pressure on the dollar.  DXY made a new cycle low today near 89.209 and shows no sign of turnaround. We continue to target the February 2018 low near 88.25 but with the unexpected showing for the Democrats (see below), we need to start thinking about the next target that comes in somewhere near late-2014 lows near 85.  The euro is on track to test the February 2018 high near $1.2555.  After that is the late 2014 high near $1.29. As we expected, sterling is lagging and has yet to break above this week’s high near $1.3705. It will likely struggle to break above the April 2018 high near $1.4375 and so EUR/GBP is likely to continue climbing. USD/JPY continues to edge further below 103 and remains on track to test the March low near 101.20.

 

AMERICAS

The Democrats appear to have retaken the Senate. The two Georgia Senate runoff votes were held yesterday and Democrats are ahead with 98% of the votes counted. Democrat Raphael Warnock is ahead of Republican Kelly Loeffler by a margin of 54k (50.6-49.4%), while Democrat Ossoff is ahead of Republican Perdue by a narrower margin of 16k (50.2-49.8%). Early signs of light in-person turnout yesterday were not a good sign for the Republicans, who needed to offset a huge Democratic advantage in early voting. Neither Republican has conceded yet and there is always the risk of legal challenges after the final results are announced. Biden won Georgia by only 12k votes and so we always knew it would be closer either way. If both Democrats win, the 50-50 tie in the Senate would be broken by incoming Vice President Harris.

The Blue Wave trades are picking up steam. The tentative results suggest the odds are rising of another big slug of stimulus in 2021. This in turn has led to the breaching of some important thresholds in the US fixed income market. The 10-year yield broke above 1% for the first time since March last year, while TIPS inflation breakeven rates are now above 2% for the first time since late 2018. This has negative implications for the dollar, as real yields continue to fall. Furthermore, we think the Fed will have to increase its QE in order to help absorb increased UST issuance so that long rates don’t rise too much. This is typically dollar-negative.

In the equity markets, Nasdaq futures are taking a hit on the greater risk of greater regulatory action on tech as well as potential for higher corporate taxes. DJIA futures are higher, while S&P futures are lower. Small cap and renewable energy sectors are likely to benefit from the Blue Wave outcome, as well as sectors that are likely to be supercharged by further stimulus. The debate will continue but we believe the Blue Wave favors equities overall due to a more favorable growth outlook. And if investors flee US fixed income, we suspect US equities would be the natural destination.

FOMC minutes will be released. The Fed delivered a dovish hold then as it changed its forward guidance  slightly to say that the current pace of asset purchases would continue until “substantial” progress seen on meeting its dual mandate.  Previously, it said the pace would be maintain for “the coming months.”  Chair Powell drove that point home in the press conference.  He declined to specify what was meant by “substantial” progress while warning that it won’t be easy to have inflation move higher, especially given significant global deflationary pressures.  For good measure, he said the Fed will need to help the economy “for quite a period of time.”  Next FOMC decision is January 27 and no change is expected. However, markets should be prepared for some pushback on rising long rates if the 10-year approached 1.25%.

ADP private sector jobs estimate will be today’s data highlight. It is expected at +75k vs. +307k in November. For Friday jobs data, consensus sees +73k vs. +245k in November, with unemployment seen rising a tick to 6.8%. December ISM manufacturing PMI came in at 60.7 vs. 56.8 expected and 57.5 in November, with the employment component rising to 51.5 from 48.4 in November. ISM services PMI will be reported Thursday and the employment components in that sector will be the final clue ahead of Friday. November factory orders (0.7% m/m expected) will also be reported.

 

EUROPE/MIDDLE EAST/AFRICA

Eurozone final services and composite PMI readings fell modestly. The headline composite PMI fell to 49.1 from 49.8 preliminary, driven largely by a drop in the services PMI to 46.4 from 47.3 preliminary. Germany’s composite PMI fell half a point from the preliminary to 52.0, while France’s fell a tick to 49.5. Spain’s composite improved seven full points from November to 48.7, while Italy’s improved three ticks to 43.0. The overall drop reflects the impact of the virus lockdowns, but the PMI readings held up well and suggest resilience in December. Elsewhere, the UK reported final services and composite PMIs of 49.4 and 50.4, respectively. Both were lower than the preliminary readings and are likely to worsen this month and next due to the national lockdown.

Germany December CPI will be reported. Headline is expected to rise a tick to -0.6% y/y (EU Harmonized). The German state data reported so far today have been mixed and give little insight to the national reading. Of note, France today reported lower than expected December CPI of 0.0% y/y vs. 0.2% in November (EU Harmonized). The eurozone reading comes out tomorrow, where consensus sees the y/y rate improving a tick to -0.2% y/y. It’s clear that the ECB will continue to struggle in meeting its 2% inflation target this year, though it should be satisfied with the overall resilience of the eurozone economy as we move into 2021.

While the US election results are mostly positive for EM, we think the balance of risks could shift against Russia. The political risk around Russian assets has increased, in our view. Democrats are likely to want some payback from perceived Russian interference in the US elections, the recent hacks, as well as many other actions taken by Putin on the geopolitical stage. Tensions between Germany and Russia following the poisoning of Alexey Navalny, as well as the 2019 murder in Tiergarten, can serve as a bridge for cooperation between US and Europe on reprehending Russia. Of course, the broad commodity rally and dollar weakness trend will provide huge support for Russia assets. But with no scarcity of commodity plays, we would prefer to express the reflation views elsewhere, such as Latin American assets, where we see a better near-term outlook for risk-reward.

 

ASIA

Final services and composite PMIs across Asia were mixed. First, Australia reported its readings at 57.0 and 56.6, respectively. Both were down four ticks from the preliminary readings. Then Japan reported its final readings at 47.7 and 48.5, respectively. Both were up five ticks from the preliminary readings, but these readings will fall this month if a state of emergency in Tokyo is declared. Caixin’s China services PMI came in at 56.3 vs.57.9 expected and 57.8 in November, pulling the composite down to 55.8 from 57.5 in November. Elsewhere, PMIs in India also disappointed, with the services and composite readings both down 1.4 points to 52.3 and 54.9, respectively. Lastly, Singapore’s Whole Economy PMI rose to 50.5, the first expansionary reading since early last year.

The takeaway here is that while Asia has led the global recovery so far, momentum appears to be slowing a bit as we move into the new year. This means that policymakers in Asia are unlikely to take their feet of the gas anytime soon.

 

COMMODITIES AND ALTERNATIVE ASSETS

In oil markets, the OPEC+ impasse was broken by Saudi Arabia. It agreed to shoulder the burden of output cuts with a surprise unilateral 1 mln bbl/day reduction in February and March. This will allow token increases by Russia and Kazakhstan for a combined 75k bbl/day increase in each month. The Saudis have once again taken control of OPEC+ and instilled some discipline. This outcome should provide some near-term support for energy markets, which along with the expected stimulus out of the US, should keep crude above $50. Of note, the curve continues to move into backwardation, meaning a lower price at the back of the curve than the front.