Dollar Bounce May Be Running Out of Steam

  • The dollar bounce continues but may be running out of steam; what started as a risk-off move has morphed into something more; the House passed e a stopgap bill by a 359-57 vote
  • There are several Fed speakers today; Chicago Fed President Evans raised eyebrows yesterday by saying the Fed could hike rates before average inflation of 2% is reached
  • US Markit flash PMI readings for September will be reported; Canada Parliament reopens today with the Trudeau government presenting its new fiscal agenda
  • Eurozone and UK PMI readings came in weak; Czech Republic is expected to keep policy steady
  • Japan and Australia data came in weak; RBNZ delivered a dovish hold; Malaysian markets are being hit by rising political instability; Thailand kept rates steady at 0.50%, as expected

The dollar bounce continues but may be running out of steam. It appears that what started as a risk-off move has morphed into something more, with the dollar gaining today even as equity markets are rallying nicely. Weak data out of Asia and Europe has made the US look relatively better, though this is likely to be temporary. DXY broke above the key 94 area but the move has not been sustained so far. Similarly, the euro broke support near $1.17 and cable broke below the 200-day moving average near $1.2725 today, but both have since recovered. While the market may take another stab at the upside, the broad-based weak dollar trend should eventually resume as we remain negative on the dollar due to the now-familiar combination of an ultra-dovish Fed and softening US economic data.

 

AMERICAS

The House passed e a stopgap bill by a 359-57 vote. The bill included $30 bln in farm aid that the White House and Republican lawmakers had sought but in turn, the Democrats got nearly $8 bln for a pandemic program to feed children vs. $2 bln that they were willing to accept. The bill now goes to the Senate for a vote, where it should pass easily given the bipartisan support seen in the House. Failure to pass a stopgap bill would lead to a government shutdown at the end of this month. With the current acrimonious climate in the legislative, it’s nice to have this risk event out of the way. Or at least kicked off to mid-December.

There are several Fed speakers today. Chair Powell appears before the House Panel on Covid-19, while Mester, Evans, Rosengren, Quarles, and Daly all speak. Powell delivered no surprises yesterday. Along with Treasury Secretary Mnuchin, he lauded the Cares Act for helping the economy cope with the pandemic but stressed that more fiscal stimulus is needed given the uncertain nature of the recovery.

Chicago Fed President Evans raised eyebrows yesterday by saying the Fed could hike rates before average inflation of 2% is reached. Evans also admitted that what the Fed means by average inflation has yet to be discussed. We do not view this as a hawkish dissent. Rather, what this really means is that the Fed’s new framework is very much a work in progress. However, the bottom line remains that the Fed has maximum flexibility to keep rates low for as long as it sees the need. Note Evans is not a voter this year but will be in 2021.

Markit flash PMI readings for September will be reported. Manufacturing is expected at 53.3 vs. 53.1 in August, while services is expected at 54.5 vs. 55.0 in August. Given weakness already seen today in the global PMIs, there are downside risks from the US readings. Yesterday, the Richmond Fed survey came in at 21 vs. 12 expected and 18 in August. Kansas City Fed reports Thursday and is expected to remain steady at 14. Last week, the Empire survey came in at 17.0 vs. 6.9 expected and 3.7 in August, while the Philly Fed came in as expected at 15.0 vs. 17.2 in August.  These are the first snapshots for September and will help set the tone for other manufacturing data.

Canada Parliament reopens today with the Trudeau government presenting its new fiscal agenda. Reports suggest a three pillar plan to support the economy will be unveiled. The first pillar will be increased healthcare spending for vaccines, testing, and control. The second will be financial support for struggling families and workers. The third pillar will focus on economic recovery and reconstruction. No budget targets have been established, with new Finance Minister Freeland set to detail later this year in a fiscal update. he need for more stimulus is clear, with real economic data last week showing a broad-based loss of momentum and headline inflation steady at 0.1% y/y. The Bank of Canada is on hold for now and waiting to see if the government will deliver a big slug of stimulus.

 

EUROPE/MIDDLE EAST/AFRICA

Spreads in Southern Europe continue to narrow, especially in Italy. Measured against German bunds, the Italian 10-year spread is at 135 bp, around pre-pandemic levels. Spain’s and Portugal’s spreads are both around 70 bp. Of note, Italy’s 30-year bond yield fell to a record low of 1.748%. Needless to say, the ECB has played a huge role in this narrowing process, as well as the EU’s recovery fund. But Italy has also benefited from the favorable results from the local elections this week which cemented the ruling coalition.

The eurozone September PMI figures were weak overall, showing a stronger performance of the industrial sector but and weaker in services. Headline manufacturing PMI jumped two full points to 53.7, but services dropped nearly three full points 47.6, dragging the composite down to 50.1 vs. 51.9 in August. We suspect that the divergence between these sectors will only widen in the months to come. Looking at the country breakdown, Germany’s manufacturing component posted a large upside surprise (56.6 vs. 52.5 expected), but services disappointed by dipping back below 50 (49.1 vs. 53.0 expected). The German composite fell to 53.7 from 54.4 the previous month. France’s numbers showed a similar pattern, though less extreme. The manufacturing PMI came in a bit higher than expected at 50.9, but the services disappointed substantially at 47.5 and led the composite PMI to drop more than three full points to 48.5.

UK Markit flash PMI readings for September were reported. Manufacturing fell to 54.3 vs. 54.0 expected and 55.2 in August, while services plunged to 55.1 vs. 55.9 expected and 58.8 in August. This led the composite PMI lower to 55.7 vs. 56.1 expected and 59.1 in August. These readings will only get worse as the renewed lockdowns persist. While recent data have been solid, it’s clear that the UK economy is facing headwinds as we move into Q4.

Czech National Bank is expected to keep policy steady.  The bank has been on hold since its 75 bp cut back in May.  At its last meeting August 6, the bank signaled steady market rates until mid-2021 followed by a gradual increase, which we assume would be due to monetary policy tightening.  Since that meeting, the real sector data have come in largely weaker than expected, while inflation appears to have peaked.  As such, the bank may push out its forward guidance into H2 2021.

 

ASIA

Japan flash PMI readings for September were reported. Manufacturing came in at 47.3 vs. 47.2 in August, services came in at 45.6 vs. 45.0 in August, and the composite came in at 45.5 vs. 45.2 in August. August convenience store sales were also reported and came in at -5.5% y/y vs. -7.4%^ in July. Japan remains the clear laggard and this is disappointing for policymakers. We think it also increases the odds of another dose of fiscal stimulus from new Prime Minister Suga. While we think the BOJ is on hold for now, Governor Kuroda pledged close coordination with the government after meeting with Suga for the first time today.

Australia flash PMI readings for September were reported. Manufacturing came in at 55.5 vs. 53.6 in August, services came in at 50.0 vs. 49.0 in August, and the composite came in at 50.5 vs. 49.4 in August. However, preliminary August retail sales came in weak, falling -4.2% m/m. While much of the weakness was concentrated in Victoria (-12.6% m/m) due to the lockdown, sales ex-Victoria still fell -1.5% m/m. August jobs data were stronger than expected and should have supported consumption. Unfortunately, the sales data suggests there are still downside risks to the economy. Indeed, a major Aussie bank moved up its call for an RBA cut to the next meeting October 6 while WIRP suggests nearly 75% odds of a cut then.

Reserve Bank of New Zealand delivered a dovish hold. It kept rates steady at 0.25%, as expected. However, the bank said it may introduced the so-called Funding for Lending Program (FLP) later this year. It noted that “Providing term funding at rates near the OCR via an FLP would lower the financial system’s funding costs, and therefore borrowing costs for firms and households.”   The RBNZ has said it is actively considering taking rates negative in combination with term funding for banks and so speculation is growing that the RBNZ will eventually take rates negative. WIRP is pricing in chances of a negative policy rate by April, and this has helped push down the Kiwi curve so that the 2- to 5-year portion is currently negative. Next and last policy meeting for the year is November 11.

Malaysian markets are being hit by rising political instability. The government is under threat of snap elections. Prime Minister Muhyiddin Yassing took power earlier this year with a very narrow margin, after a messy transition of power that had roots partially in the 1MDB scandal. Now the opposition led by Anwar Ibrahim claims to have enough support to make the move against Muhyiddin. The ringgit has depreciated for the third consecutive session against the dollar, down around 1% since the start of the week, though equity markets are moving roughly in line with the region.

Bank of Thailand kept rates steady at 0.50%, as expected.  The bank has been on hold since its last 25 bp cut back in May.  Assistant Governor Titanun said policy would remain accommodative but noted that fiscal stimulus would bear the load for now. Its 2020 GDP forecast was tweaked to -7.8% from -8.1% previously, while its 2021 forecast was cut to 3.6% from 5.0% previously. Governor Veerathai steps down at the end of this month, and speculation is growing that his successor will deliver a cut upon taking the post. Deflation has persisted for the six straight months and is still well below the 1-4% target range.