Dollar Builds on Gains as Trade Optimism Grows

  • Reports suggest that existing tariffs may be removed as part of a Phase One trade deal
  • During the North American session, we get several US data points; Brazil COPOM released its minutes
  • The last of the October UK PMIs were reported; UK politics remain in flux and the signs aren’t good
  • PBOC cut its 1-year lending rate for the first time since 2016; RBA kept rates unchanged at 0.75%, as expected

The dollar is mixed against the majors as it tries to build on yesterday’s gains.  The Antipodeans are outperforming, while Swissie and yen are underperforming.  EM currencies are mostly firmer.  ZAR and CNY are outperforming, while CLP and TRY are underperforming.  MSCI Asia Pacific was up 0.9% on the day, with the Nikkei rising 1.8% after reopening from holiday.  MSCI EM is up 0.6% so far today, with the Shanghai Composite rising 0.5%.  Euro Stoxx 600 is flat near midday, while US futures are pointing to a higher open.  10-year UST yields are up 4 bp at 1.81%, while the 3-month to 10-year spread has steepened 6 bp to +31 bp.  Commodity prices are mostly higher, with Brent oil up 1%, copper up 0.5%, and gold down 0.4%.

The greenback is firmer for the second straight day, with DXY trading back above the 200-day moving average.  Overall, we believe that the US economy remains in solid shape and this should ultimately support the dollar.  Doubts about Brexit (see below) have crept in again and that is weighing on the euro and sterling.  On the other hand, EM FX continues to gain from an improved trade outlook.  Trade optimism also continues to drive global equity markets higher.  The S&P 500 closed at an all-time high yesterday and futures are up this morning. Most equity markets in Asia were up, with the Japanese Nikkei outperforming (+1.8%).

Reports suggest that existing tariffs may be removed as part of a Phase One trade deal.  China is pushing the US to take December tariffs off the table and also to remove the ones from September, while reports suggest the US is considering doing this.  China is playing hardball here.  If our thesis is correct and China has the upper hand, Trump should give in to these demands so that he can claim a win.  This would be another positive for EM and equities.  The Of note, President Xi Jinping reaffirmed his commitment to strengthening IP protections and improving trade relations.  The yuan is trading with a 6 handle again against the dollar for the first time since early August, which could be interpreted as a sign of good will from Chinese officials.

 

AMERICAS

During the North American session, we get several US data points.  September trade (-$52.4 bln expected), JOLTS job openings (7063 expected), and October ISM non-manufacturing PMI (53.5 expected) will all be reported.  The Fed’s Barkin, Kaplan and Kashkari speak.  Market is finally acknowledging the stronger US data from last week.  WIRP suggests odds of a cut December 11 have fallen to 11%, while the US 3-month to 10-year curve has steepened to 31 bp, the highest since March 1.  These rate movements should ultimately support the dollar.  Also, Canada reports September trade (-CAD600 mln expected).

Brazil COPOM released its minutes.  At that meeting, it cut rates 50 bp to 5.0% and signaled another 50 bp cut to 4.5% at the December 11 meeting.  The minutes reaffirmed that but stopped short of further forward guidance, as “The members of the Copom decided to stress that the current stage of the business cycle recommends caution when considering possible new changes in the degree of stimulus.”  CDI market is still pricing in a last 25 bp cut at the February 5 meeting, however.

 

EUROPE/MIDDLE EAST/AFRICA

The last of the October UK PMIs were reported.  Services and composite readings both came in at 50.0 vs. 49.7 and 49.5 expected, respectively.  With Brexit uncertainty likely to be extended into next year, this small improvement is nothing to get excited about.  BOE meets Thursday and is widely expected to remain on hold until the Brexit uncertainty has been entirely lifted.

UK politics remain in flux and the signs aren’t good.  First, Brexit Party leader Farage said his party will field 600 candidates in the upcoming elections if Johnson does not withdraw his Brexit deal.  This is a risky move, as it risks splitting the pro-Brexit vote and possibly handing Labour a victory.  Elsewhere, Scottish National Party leader Sturgeon has hinted that she might support Labour, pledging never to help the Tories stay in power.  Election uncertainty (and by extension Brexit uncertainty) is keeping sterling below $1.30.  A Labour victory would be taken badly by the markets, to state the obvious.

 

ASIA

BOJ Governor Kuroda joined the chorus of policymakers asking for more action by governments.  His angle was to note how “fiscal policy will be more effective” in the current context of what the BOJ has already done. Implicitly, we think he is confirming our view that most central banks have reached (or are very close) to the limit of what monetary policy can do.  Still, this doesn’t mean that the BOJ will refrain from taking further action.

The PBOC cut its 1-year lending rate to banks for the first time since 2016.  Officials reduced the rate on the medium-term lending facility (MLF) by 5 bp to 3.25%. The move will help ease liquidity constraints for commercial banks and hopefully boost lending to small-to-medium-sized companies.  This continues the strategy of cautious easing measures, as the one-year benchmark prime rate was left unchanged.

The Reserve Bank of Australia kept rates unchanged at 0.75%, as expected. The statement noted that “it is reasonable to expect that an extended period of low interest rates will be required” but the board is prepared to ease further if necessary. Still, the probability of a cut this year has been steadily declining over the last several weeks. The implied probability of a cut at the December meeting is now under 20%, compared with around 70% in early October.  The Australian dollar has been steadily appreciating since then, now up nearly 2.5% against the dollar over the last month, which acts like monetary tightening.  AUD is having trouble breaking above the key retracement level near .6925.  After that is the 200-day moving average near .6955.