Dollar Begins the Week Under Pressure

  • Concerns of a second wave of infections weighed on markets during the Asian sessions but seem to have faded as Europe opened
  • In the US, the virus news stream remains mixed; there are only minor US data out today
  • BOE Governor Andrew Bailey is apparently thinking about thinking about hiking rates; the UK government is reportedly discussion another round of counter-cyclical stimulus
  • RBA Governor Lowe said he was not concerned with recent AUD strength; Korea reported trade data for the first 20 days of June

Concerns of a second wave of infections weighed on markets during the Asian sessions but seem to have faded as Europe opened. Germany continues to register higher infection counts due to contamination in meat-processing plants and refugee shelters. In the EM world, China seems to have contained the outbreak in Beijing. However, Brazil and India remain in focus, with the latter reporting increased infections in rural communities. Despite these worrying headlines, we don’t think the numbers look too bad. Much of the higher rates of confirmed infections is likely due to increased testing, and we haven’t (yet) seen a commensurate spike in hospitalization rates. Moreover, health systems around the world are far better prepared to cope with this virus, and no longer at risk of collapsing. As such, we don’t see any meaningful reversal of the re-opening trends at this point.

The dollar remains subject to swings in risk sentiment. DXY traded earlier today at the highest level since June 2 but has turned lower as market sentiment improved. The euro remains heavy but found some support just below the $1.12 area. Same goes for sterling, which found some support just below Friday’s low near $1.2345. USD/JPY continues to trade in narrow ranges around the 107 area.

AMERICAS

In the US, the virus news stream remains mixed. The biggest negative headlines came from Florida with the biggest daily infection increase, but the numbers in Arizona and California are also worsening. On the other hand, New York City takes another step forward today by moving to Phase II of reopening. This is welcome news but also serves as a reminder that we are nowhere back to normal. Restaurants can only offer outdoor seating with appropriate distancing, but no one can wait for a table. Shoppers must maintain social distancing rules. Movie theaters will remain closed, as will sports stadiums and concert venues.

There are only minor US data out today. May Chicago Fed National Activity Index and existing home sale (-5.6% m/m expected) will be reported. There are no Fed speakers today. Late Friday, Moody’s affirmed its Aaa rating for the US with stable outlook. The agency noted that the US credit profile remains resilient amid the pandemic. We are surprised so far that the ratings agencies are overlooking the significant fiscal slippage under way in the US.

EUROPE/MIDDLE EAST/AFRICA

BOE Governor Andrew Bailey is apparently thinking about thinking about hiking rates. Bailey said that when the time comes, he would probably reverse his predecessor’s order of normalization by reducing the balance sheet first before hiking rates later. Recall that former BOE Governor Carney’s view was that the balance sheet would only be reduced when rates reached 1.5%. But Bailey thinks that “Elevated balance sheets could limit the room for maneuver in future emergencies.” He also stressed that QE “mustn’t become a permanent feature.”

While the Fed has been the trailblazer in terms of exiting unconventional policies, there is no thing set in stone as to how it should be done. After the financial crisis, the Fed first hiked rates first, then passively shrank the balance sheet by allowing maturing securities to roll off its balance sheets, then actively shrank the balance sheet by selling securities. This seemed to work but that said, the BOE may try a different sequence. However, we think it is way too early to be discussing any form of tightening. Instead, Bailey should be stressing that the BOE “isn’t even thinking about thinking about hiking rates.”

The UK government is reportedly discussion another round of counter-cyclical stimulus. A temporary cut to VAT (20% currently) seems to be one of the main measures being considered amongst other tax cut measures. Another possibility would be to accelerate planned spending as part of a renewed infrastructure push. To us, it’s strange the Governor Bailey is thinking about exiting its current emergency settings even as Chancellor Sunak is thinking about adding more fiscal stimulus. Separately, the government plans to reduce the 2-meter social distancing rule, an important step towards normalization of the service sector.

ASIA

RBA Governor Lowe said he was not concerned with recent AUD strength. He acknowledged that “at some point, it’s true that could become a problem. But, I don’t think we’ve reached that point yet.” Yet he professed a desire for a weaker currency, noting that “I’d like a lower [AUD] because I’d like lower unemployment and slightly higher inflation.” Despite the mixed messages, AUD is up on the day after finding support near the .68 area. If risk-on sentiment is sustained, the currency is likely to test the June cycle high near .7065.

Korea reported trade data for the first 20 days of June. Exports contracted -7.5% y/y vs. -23.7% in May, while imports contracted -12.0% y/y vs. -21.1% y/y in May. So far, the recovery in regional activity has been much weaker than hoped for given China’s reopening. Bank of Korea last cut rates 25 bp to 0.5% in late May but signaled that this was close to the effective lower bound. Governor Lee said the bank is considering unconventional policies to support growth but gave no further details. We do not think any new measures will be announced this week, but official could give some hints about what might be done at future meetings.