Dollar Broadly Weaker as Markets Focus on Stimulus from Europe and Japan

  • Market sentiment remains positive despite still-rising tensions between the US and China ; the dollar remains under pressure
  • Reports suggest the Trump administration is considering a range of sanctions on Chinese entities; regional Fed manufacturing surveys for May will continue to roll out;
  • The Fed releases its Beige Book report for the upcoming FOMC meeting June 10; Banco de Mexico releases its quarterly inflation report
  • Reports suggest the EC will propose a fiscal rescue package worth EUR750 bln; Bank of France Governor Villeroy de Galhau called for the removal of the so-called capital key
  • Japan announced another round of fiscal stimulus; USD/HKD continues to drift lower

The dollar is broadly weaker against the majors as markets remain in risk-on mode despite rising US-China tensions.  The Scandies are outperforming, while the yen and Swissie are underperforming.  EM currencies are mixed.  The CEE currencies are outperforming, while TRY and CNY are underperforming.  MSCI Asia Pacific was up 0.4% on the day, with the Nikkei rising 0.7%.  MSCI EM is up 0.1% so far today, with the Shanghai Composite falling 0.3%.  Euro Stoxx 600 is up 0.7% near midday, while US futures are pointing to a higher open.  10-year UST yield is flat at 0.70%, while the 3-month to 10-year spread is flat at +58 bp.  Commodity prices are mostly lower, with Brent oil down 1.7%, WTI oil down 1.3%, copper flat, and gold down 0.3%.

Market sentiment remains positive despite still-rising tensions between the US and China.  Equity markets have shrugged off reports of US sanctions on China (see below).  President Trump may feel emboldened by the still rising equity indices, which may give him the impression that he may be able to score electoral gains from being tough on China without hurting the economy or equity markets. We think this is misguided, and any action on top of the escalating rhetoric could quickly sour the risk-on mood.

The dollar remains under pressure.  DXY is trading at the lowest level since May 1 and is likely to test that day’s low near 98.645.  A break below that would set up a test of the March 27 low near 98.27, though some intermediate support may be provided by the 200-day moving average currently near 98.51.  The euro is trading at the highest level since April 1 on optimism regarding a fiscal rescue package.  Sterling is lagging and so the EUR/GBP cross is moving higher and setting up for a test of the .90n area.  Lastly, USD/JPY has edged higher though 108 still looks tough to crack.



Reports suggest the Trump administration is considering a range of sanctions on Chinese entities.  This would be in response to China’s efforts to exert direct influence on Hong Kong.  The Treasury Department could impose controls on transactions and freeze the assets of Chinese officials, businesses, and financial institutions, though reports suggest discussions are ongoing and no decision has been made yet.  Note that this would be separate from efforts by two US Senators, Van Hollen (D) and Toomey (R), to propose legislation that would sanction Chinese officials over the Hong Kong issue.  All these moves come just weeks after another bipartisan bill was introduced that could delist certain Chinese companies from US stock exchanges.

We believe this is the worst state of US-China relations since Tiananmen Square in 1989 and set to get worse.  We know President Trump’s strategy ahead of the election is to blame China for the pandemic and we just don’t think President Xi will be his punching bag for much longer.  Its Hong Kong move was a somewhat less direct way of asserting itself but China’s ability to strike back at the US more directly should not be underestimated.  CNY and CNH are trading at new lows for this cycle and should serve as a warning sign of trouble ahead.  Please see our recent piece “Hong Kong Turbulence Likely to Rise as US-China Relations Worsen.”

It looks as if the US corporate credit sector bomb is being slowly disarmed. Or at least, the worst-case scenario of widespread defaults that looked possible at the early stage of the pandemic look much more like a tail risk now. This is true even for the energy sector, where spreads have narrowed dramatically over the last several weeks from a high of around 2300 bp to near 1050 bp now.

The regional Fed manufacturing surveys for May will continue to roll out.   Richmond Fed reports today and is expected at -40 vs. -53 in April.  Yesterday, the Dallas Fed came in at -49.2 vs. -61.0 expected and -73.7 in April.  Previously, the Philly Fed survey came in at -43.1 vs. -40.0 expected and -56.6 in April, while the Empire survey came in at -48.5 vs. -60.0 expected -78.2 in April.  Yesterday, the Chicago Fed National Activity Index for April came in almost five times worse than expected at -16.74.  March was revised to -4.97 from -4.19 previously. The 3-month average is -7.22, and compares to the -0.7 threshold that typically signals recession.  These readings are truly off the charts.

The Fed releases its Beige Book report for the upcoming FOMC meeting June 10.  We don’t expect many surprises here, as the Fed is definitely in wait and see mode.  Bullard and Bostic speak today.  Fed Funds futures are no longer pricing in small odds that rates go negative next year.  We think this is more a function of market optimism (as evidenced by rising US equities) more than the strong and concerted pushback by Fed officials in recent weeks.

Banco de Mexico releases its quarterly inflation report.  Minutes will be released tomorrow.  Last week, mid-May inflation accelerated to 2.83% y/y, the highest since March and moving closer to the 3% target.  There seems to be some pass-through from the weak peso and while this complicates matters, we think the central bank will remain focused on boosting growth.  Next policy meeting is June 25 and another 50 bp cut to 5.0% is expected then, if not sooner.



Reports suggest the European Commission will propose a fiscal rescue package worth EUR750 bln.  According to an official involved in the plan, it would be partly funded by joint debt issuance, with EUR500 bln distributed in the form of grants and EUR250 bln in loans.  Last week, France and Germany first came out with their joint proposal for a EUR500 bln plan that largely took the form of grants.  Skeptic nations (Austria, the Netherlands, Sweden, Denmark) then released their own plan last weekend for a 2-year package that largely took the form of loans.

After the EC officially releases its version, the horse-trading begins.  If these early reports are correct, then the EC plan draws from both of the other plans.  The so-called “Frugal Four” signaled a willingness to accept some aid in the form of grants, but were reluctant to engage in open-ended aid programs that would eventually lead to a debt union.  Negotiations will likely be slow and at times tortuous.  However, the fact that the Frugal Four may accept some of the aid taking the form of grants is a very positive sign.  This has taken the euro to its strongest level since April 1 near $1.1030.  A clean break of the $1.10 area sets up a test of the March 3 high near $1.1165.

Meanwhile, Bank of France Governor Villeroy de Galhau called for the removal of the so-called capital key.  Under the capital key, the ECB must buy bonds of all eurozone nations in proportion to the relative size of their economies, which Villeroy said is an “uncalled-for constraint.”  This is noteworthy as it comes on the heels of the German court challenge to the ECB’s asset purchases.  We doubt the ECB would take such a contentious step whilst still fending off court challenges to its existing programs. However, the fact that Villeroy proposed it suggests that the ECB may more flexible and aggressive than markets are pricing in.

All this news comes ahead of the ECB meeting next week.  The account of the ECB’s April 30 meeting supports our view that it will add stimulus June 4.  Last month, ECB officials basically ruled out a V-shaped recovery and admitted the bank’s “mild” economic scenario was probably too optimistic.  ECB Chief Economist Lane said last week that tail risks had deteriorated substantially and the ECB must be ready to adjust tools in June if needed.

Credit spreads in Europe continue to narrow, but there is still a way to go before returning to 2019 levels.  We expect this improving trend to continue. There hasn’t been any set-backs in the economic reopening processes. The ECB should remain dovish and, if anything, is more likely to provide more rather than less monetary support than is currently priced in. The governments are acting vigorously to support local businesses and employment, and there is even the upside risk of that the pandemic recovery fund will materialize without major friction between countries.

Options markets have followed the recent trend of a stronger pound but remain well into negative territory. The 3- and 6-month risk reversals have recovered from around -3.3 to nearly -2.0 now, though still suggesting far more demand for GBP downside protection than upside in the options markets. This seems justifiable to us given: (1) the far worse outcome of the pandemic in the UK, at least in terms of human lives; (2) the recent political fallout with government advisor Dominic Cummings, which should dent Boris Johnson’s otherwise resilient popularity; and (3) the still very much live hard Brexit risks. Until last week, non-commercial positioning in the CFTC futures was still showing a build in short sterling contracts and a net short position, which could help explain some of yesterday’s sharp bounce in GBP/USD.


Japan announced another round of fiscal stimulus.  A package totaling JPY117 trln ($1.1 trln) was quickly put together after another round of dismal economic data and polls showing ebbing support for Prime Minister Abe’s government.  Funds will be targeted for helping struggling companies, rent subsidies, and healthcare assistance.  It will be funded by a second supplementary budget worth JPY31.9 trln, which of course suggests that the actual stimulus contained in the package is worth much less than the headline JPY1.1 trln number.  Still, the move is welcome in light of the fact that the BOJ is currently on hold and waiting for more help from the fiscal side.

USD/HKD continues to drift lower.  After last week’s move to trade at the highest level since March 23, expected further upside movement as tensions remain high.  That may eventually happen.  In the meantime, there have been some sizable moves in HKD forwards (implying the risk of HKD depreciation), especially the 12-month tenor, but nothing yet outside historical ranges. Protests are picking up again with people back on the streets and roads blocked.