Dollar and Peso Firm as Trade Truce Reached

  • This could be a key week for the dollar
  • US tariffs on Mexico have been called off and removes some recession risks for both nations
  • The US reports April JOLTS job openings today
  • UK reported April GDP, IP, trade, and construction output
  • Japan reported April current account and final Q1 GDP; China reported May trade data
  • Late Friday, Chile shocked markets with a 50 bp cut to 2.5%

The dollar is broadly firmer against the majors as the new week begins amidst easing trade tensions. Euro and Loonie are outperforming, while the Antipodeans are underperforming. EM currencies are mostly softer. MXN and TRY are outperforming, while SGD and CNY are underperforming. MSCI Asia Pacific was up 10.9, with the Nikkei rising 1.2%. MSCI EM is up 1.2% so far today, with Chinese markets rising 0.9% after returning from holiday. Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 6 bp at 2.14%, while the 3-month to 10-year spread rose 7 bp and stands at -12 bp. Commodity prices are mixed, with Brent oil down 0.1%, copper up 0.3%, and gold down 0.9%.

This could be a key week for the dollar. The greenback suffered last week as Fed easing expectations gained strength and recession risks rose from rising trade tensions. Recent US data have been unhelpful, and further economic softness will likely lead to further dollar losses.

US tariffs on Mexico have been called off. The two countries have reached an agreement, though there is some confusion as to what was agreed upon. President Trump claims that Mexico agreed to large-scale purchases of US agricultural goods, but Mexico would not confirm. Press reports suggest that many aspects of the deal had already been agreed upon. Still, the truce is a welcome step back from the precipice.

Indeed, this easing of tensions removes some recession risks for both nations. The peso has rallied sharply, while the dollar has clawed back some lost ground. The US rates markets have also reacted accordingly, with the 3-month to 10-year curve being the least inverted since May 29 at -12 bp. WIRP shows 18% odds of a cut at the June 19 FOMC meeting, down from 25% last week. If the US data start to improve, we believe this trend will continue. We have long felt that markets had gotten too pessimistic on the US economy and by extension the dollar.

The US reports April JOLTS job openings today. A higher reading of 7496 is expected, which would signal further tightness in the labor market. May PPI, CPI, and retail sales will all be reported this week and have taken on greater significance after Friday’s weak jobs report. The Fed media embargo is in effect and so there are no more speakers until Powell’s post-decision press conference June 19.

The Atlanta Fed’s GDPNow model is now tracking 1.4% SAAR for Q2, down from 1.5% previously. Elsewhere, the New York Fed’s Nowcast model is tracking 1.0% SAAR for Q2 vs. 1.5% the previous week. More importantly, we got its initial estimate for Q3 growth of 1.3% SAAR. Q2 data have clearly been on the soft side, but we note that Q1 also started off on a soft note before rebounding to 3.2% SAAR growth in the advance report (3.1% SAAR in the first revision). While a slowdown from Q1 was to be expected, markets will be particularly sensitive for signs of a larger than expected drop-off.

UK reported April GDP, IP, trade, and construction output. GDP contracted -0.4% m/m, IP by -2.7% m/m, and construction output by -0.4% m/m, all much weaker than expected. The trade gap was narrower than expected at -GBP2.74 bln. Last week’s PMI readings for May confirmed our suspicions that the UK economy will continue to weaken into the October 1 Brexit deadline.

Despite ongoing hawkish comments from Governor Carney, the market does not believe the BOE will hike anytime soon. We remain negative on sterling and expect it to soon retest the May 31 low near $1.2560 on the way to the January low near $1.2440. EUR/GBP is leading this move, making new highs this month and on track to test the January high near .91085.

Japan reported April current account and final Q1 GDP. The current account surplus was larger than expected at JPY1.6 trln adjusted, while growth was revised up a tick from the preliminary reading to 2.2% SAAR. Bank of Japan meets June 20, and no change is expected then. However, we expect further stimulus after the October consumption tax hike.

China reported May trade data. Exports rose 1.1% y/y vs. -3.9% expected, while imports contracting -8.5% y/y vs. -3.5% y/y expected, which sends very mixed signals. This is a big data weak for China, with new money and loan data, retail sales, and IP all coming out. Markets will be very sensitive to signs of further weakness in the economy. USD/CNY made a new high for this move today near 6.9385, following USD/CNH’s lead from last week. Yet this yuan weakness largely reflects broader EM FX losses, not an intentional weakening.

Late Friday, Chile shocked markets with a 50 bp cut to 2.5%. This reverses the entire tightening cycle so far and takes the policy rate back to the recent lows. This week, Russia is expected to join the ranks of the rate cutters in EM. This largely reflects the global phenomenon of lower rates that’s being led by the major central banks. With EM also cutting when possible, the yield advantage for EM is likely to shrink. We remain negative on EM in this current environment.