Dollar Bid as US Returns from Holiday Facing Many Questions

  • US-China tensions are coming back to the forefront; the dollar is getting some traction
  • The Senate returns to Washington today and a stimulus package seems more and more unlikely; the Fed media embargo went into effect Saturday
  • The next round of Brexit talks began yesterday in London; sterling has taken it on the chin; UK manufacturers called for an extension of the job furlough program
  • German’s external sector data disappointed somewhat; oil prices continue to trend lower with Brent falling for the fifth consecutive session
  • Japan reported a lot of data overnight; China-Australia relations have worsened

US-China tensions are coming back to the forefront after confrontational comments by President Trump. In full campaign mode, Trump ramped up his vow to further sever ties with China, this time by threatening to “prohibit federal contracts from companies that outsource to China.” Of course, we are a long way from anything tangible materializing in this area. But the risk, in our view, is that it forces Biden to reaffirm his China hawk credentials, further fueling broad-based anti-China sentiment in the US. This will ultimately force whoever wins the election to take policy action down the road. Recent polls from battleground states have been marginally favorable towards Biden, as reflected in his improved odds in betting markets.

The dollar is getting some traction. DXY is trading at the highest level since August 26. However, for us to get more constructive on the greenback, DXY would have to break above the 94.00 area, which represents some highs from August as well as the 38% retracement objective of its fall from the June 30 peak. This corresponds with the $1.17 area for the euro and the $1.30 area for sterling. Until that happens, we believe markets will stick with the momentum trade that favors a weaker dollar. Much will depend on whether US equity markets can regain some traction this week. If not, continued stock market losses could morph into a more broad-based risk-off trading environment that gives the dollar another boost.

 

AMERICAS

The Senate returns to Washington today and a stimulus package seems more and more unlikely. After House Democrats recently signaled a willingness to cut another $500 bln from its plan, Senate Republicans did not make any counter-offer. Indeed, it appears that Senate Leader McConnell will try to pass a “skinny” $500 bln plan, half of its previous $1 trln plan and highly unlikely to pass in the House. Data support our view that the US economy is losing momentum even as virus numbers remain elevated, making further stimulus even more crucial. The only piece of good news to emerge is that Treasury Secretary Mnuchin said that he and House Speaker Pelosi have agreed to a clean Continuing Resolution bill that would keep the government running until December.

The Fed media embargo went into effect Saturday and so there will be no more Fed speakers until Powell’s post-decision press conference September 16.  At that meeting, the Fed will release its updated Summary of Economic Projections. The Beige Book report was relatively uninspiring, noting increased economic activity across most Fed districts but generally modest and below levels prior to the pandemic. Indeed, many districts noted a slowing pace of growth in tourism and retail after some recovery was seen. Lastly, some districts reported slowing job growth and increased hiring volatility.   Only US data report today is July consumer credit, which is expected to rise $12.9 bln.

 

EUROPE/MIDDLE EAST/AFRICA

The next round of Brexit talks began yesterday in London. Expectations were already low, as both sides are dug in with regards to the two most contentious areas, fisheries and level playing field. However, UK Prime Minister Johnson muddied the waters completely by threatening to dilute parts of the Brexit withdrawal agreement. The EU warned that there cannot be a new trade deal if Johnson breaks his promises on the earlier accord. We expect continued brinkmanship and doubt that any positive headlines will come out of today’s meeting between negotiators David Frost and Michel Barnier.

Sterling has taken it on the chin and is the second worst performing major currency today and for the past week. Only NOK has fared worse, and that‘s due to plunging oil prices (see below). $1.30 is a key level for cable and a break below could open up a relatively quick move down to the July 22 low near $1.2645. For what it’s worth, IMM data and anecdotal reports suggest to us that positioning in sterling is relatively balanced after the broad dollar rally in the last few months, meaning the technical outlook seems clear for short-term downward correction for sterling. That said, we don’t think Brexit headlines at this stage of the negotiation mean are enough to offset broad dollar weakness and so we would be inclined to fade any move on the back of such headlines.

Elsewhere, UK manufacturers called for an extension of the job furlough program. It’s set to expire next month and firms warn that nearly a third will have to let workers go without government aid to pay wages. Yesterday, a Parliamentary committee called on Chancellor Sunak to extend the furlough program for the arts and leisure sectors, saying they both face “mass redundancies” if government support is discontinued. Of note, , BOE Chief Economist Haldane pushed back against extending the scheme, arguing that keeping this form of “life support” beyond October would prevent a “necessary process of adjustment.”

German’s external sector data disappointed somewhat this morning. This follows yesterday’s downbeat IP figures but still indicate a continued recovery. Exports increased 4.7% m/m in July while imports rose 1.1% m/m, both below expectations. This translated to a current account balance of EUR20 bln, which is right around the 5-year average for Germany. Yesterday, July IP rose only 1.2% m/m vs. 4.5% expected. Final eurozone Q2 GDP data was revised slightly to -11.8% q/q from -12.1% preliminary. It’s not clear where the improvement came from, as household consumption fell -12.4% vs. -12.2% expected, investment plunged -17.0% q/q vs. -12.5% expected, and government expenditure fell -2.6% q/q vs. -2.5% expected. Exports collapsed -18.8% q/q and imports by -18.0% q./q, which may have been enough for net exports to soften the blow to GDP.

Oil prices continue to trend lower with Brent falling for the fifth consecutive session. Brent’s front month contract is trading around $41.35 per barrel, down nearly 11% from the recent highs at the start of the month. WTI has fared worse, down nearly 4% today and 13% since the late August peak. Of note, the curve has become further inverted (backwardation). The move has been driven by downward revisions to global demand and Saudi Arabia’s recent move to cut prices.

 

ASIA

Japan reported a lot of data overnight. July real cash earnings fell -1.6% y/y vs. -1.9% expected, household spending collapsed -7.6% y/y vs. -3.7% expected, current account surplus was JPY964 bln adjusted vs. JPY1.44 trln expected, and final Q2 GDP was revised slightly to -28.1% SAAR vs. -28.5% expected. Bank of Japan next meets September 17 and no change in policy is expected. The bank will release its updated macro forecasts in its Outlook Report at the October 29 meeting. Reports suggest the bank may upgrade its monthly economic assessment, though it would likely signal that the economy was no longer in the “extremely severe situation” flagged in its last assessment from July rather than suggesting a robust recovery. Reports suggest that any change will be finalized at the BOJ meeting.

China-Australia relations have worsened. Two Australian journalists were detained by Chinese authorities before being allowed to leave the country. It appears to be a tit-for-tat move after a Chinese-born journalist was detained by Australia, but this could clearly escalate into something far worse that could harm the economic outlook. The RBA left rates steady last week but expanded its Term Funding Facility for banks. Banks can access additional funding equivalent to 2% of their outstanding credit for three years at a fixed rate of 25 bp. The RBA also signaled willingness to ease further, noting that it “continues to consider how further monetary measures could support the recovery.”