Dollar Bounces on Turnaround Tuesday

  • The dollar is staging a modest recovery today 
  • Yesterday, the Fed’s Bostic continued a string of supportive comments
  • Fed Governor candidate Nellie Liang has withdrawn herself from consideration
  • During the North American session, both the US and Canada report November trade data
  • Germany reported very weak November IP
  • Brexit news has been limited ahead of the UK parliamentary debate that starts tomorrow
  • EM continues to be pulled in two different directions

The dollar is mostly firmer against the majors on a potential Turnaround Tuesday.  Stockie and Loonie are outperforming, while the Antipodeans are underperforming.  EM currencies are mostly weaker.  RUB and BRL are outperforming, while TRY and ZAR are underperforming.  MSCI Asia Pacific was down 0.1%, with the Nikkei rising 0.8%.  MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 0.3%.  Euro Stoxx 600 is up 1% near midday, while US equity futures are pointing to a higher open.  The US 10-year yield is flat at 2.70%.  Commodity prices are mostly higher, with Brent oil up 1.7%, copper up 0.4%, and gold down 0.5%.

The dollar is staging a modest recovery today after being on its back foot since Powell’s comments last week.  Our base case remains that the US economy is in better shape than markets believe right now, and that US rates will back up in the coming weeks.  That would be dollar-positive.  Also helping the dollar are signs that the rest of the world is weakening.  For now, we stand by our bullish dollar call for 2019 but fully acknowledge that the greenback remains vulnerable near-term.

Yesterday, the Fed’s Bostic spoke and continued a string of supportive comments first led by Powell last week.  While Bostic said that the US economy is in a “pretty good position,” he nevertheless trimmed his rate outlook to one hike this year from two previously.  Bostic said that so far, the impact of the shutdown has been “relatively small” but warned that it can become “more material” as it drags on.  We expect Fed speakers this week to all follow Powell’s lead and stay on message that the Fed really cares what markets think.

The implied yield on the January 2020 Fed Funds futures contract has recovered from the low near 2.22% last week.  This basically takes back the rate cut that was priced in for this year.  However, at 2.39%, we think the markets continue to underestimate the Fed’s capacity to tighten this year.  Until the market shifts back towards a more hawkish stance, the dollar is likely to have trouble getting traction.

Fed Governor candidate Nellie Liang has withdrawn herself from consideration.  She was awaiting Senate confirmation and sources say she was not pressured by the White House to withdraw.  The other Governor candidate Marvin Goodfriend did not get full Senate confirmation despite being approved by the Senate Banking Committee.  As such, he will have to be renominated if he is to be remain in the running.

To date, Trump’s nominees have been orthodox choices.  However, with friction still high between the White House and the Fed, there is certainly a risk that a more unorthodox (read dovish) candidate will be chosen to replace Liang.  We are not sure how markets would react.  Investors have been spooked by perceived Fed hawkishness, yet the nomination of a pliant candidate would not be taken well either.  Stay tuned.

During the North American session, both the US and Canada report November trade data.  The US also reports JOLTS job openings and consumer credit.  Other data releases have been delayed by the partial government shutdown, which is entering its third week.  Bostic warned that the shutdown may affect access to US economic data, which in turn would affect the ability of the Fed to do its job.

Germany reported very weak November IP.  Instead of rising the expected 0.3% m/m, IP contracted -1.9% m/m and dragged the y/y rate down to -4.7% WDA.  This is the worst reading since the financial crisis and comes after stronger than expected retail sales (1.4% m/m) and weaker than expected factory orders (-1.0% m/m) were reported yesterday.

The ECB next meets January 24.  At the December meeting, staff forecasts were trimmed marginally, and Draghi stuck to his forward guidance of a rate hike after the summer.  This thesis is being put to the test with recent weakness in the eurozone data.  In turn, this is limiting euro gains in the face of broad-based dollar weakness.  A break of the $1.15 area is needed to signal further gains.

Brexit news has been limited ahead of the UK parliamentary debate that starts tomorrow.  Press reports suggest May is still trying to get more concessions from the EU, including a “political and legal” promise that the Irish backstop will be short-lived.  This would reportedly involve a target date of late 2021 for the new trading arrangement to go into effect.   However, EU officials say that there will be no more sweeteners offered.  Sterling is taking advantage of recent dollar weakness to mount another challenge of the $1.28 area.  However, it has so far been able to break above it as Brexit uncertainty remains high.

Australia reported November trade data overnight.  The AUD1.9 bln surplus was slightly lower than expected.  Building approvals and job vacancies will be reported tomorrow and retail sales will be reported Friday.  Next RBA meeting is February 4.  With growing headwinds, market expectations for RBA tightening have been pushed out to early 2020 from late 2019 previously.  AUD has rebounded after taking it on the chin and trading below .68 last week for the first time since 2009.  A clean break above .7145 would set up a test of the December high near .7395.

EM continues to be pulled in two different directions.  The more benign Fed outlook is helping risk sentiment and EM, but this is being offset by signs of significantly slower global growth in 2019.  We expect markets to remain volatile as these two factors move back and forth in a fight to be the major driver.  Longer-term, we think the negative global backdrop for EM will be the eventual winner of this battle.