Dollar Comes Under Renewed Pressure

  • There will likely be more chatter about restrictive measures out of the UK and Europe; the dollar remains under pressure
  • It appears some blame is being pinned on the Fed for the equity sell-off; our take on the drop in stocks is a much more fundamental one
  • Despite some movement on fiscal stimulus, talks remain deadlocked; US data today are minor; Canada reports July wholesale trade and retail sales
  • BOE delivered a dovish hold yesterday; UK rates markets have reacted accordingly; UK reported August retail sales
  • Russia is expected to keep rates steady at 4.25%; Japan reported August national CPI

There will likely be more chatter about restrictive measures out of the UK and Europe. However, we very much doubt any larger scale lockdowns will be implemented at this juncture. The FT ran an article this morning saying the government’s scientific advisors are proposing a two-week national lockdown in October to contain the upswing in virus numbers. This is partially a reaction to the rising “R” (the virus’ reproduction rate), which is currently estimated at 1.7 in the UK. While the rising infection rates are indeed worrisome, the death rate may ultimately end up being the litmus test for whether any government will adopt more aggressive lockdown measures. We still have an extremely low number of Covid-related deaths this time around, due to a combination of better treatment protocols, more awareness, and different age distributions for the infected population.

The dollar remains under pressure.  Yesterday’s risk-off gains have worn off and DXY traded today at the lowest level since September 10. A break below the 92.478 area is needed to set up a test of the September 1 low near 91.746. Likewise, the euro needs to break above the $1.1910 area to set up a test of its recent high near $1.2010.  Sterling has recovered from the BOE-related selloff but is facing resistance near $1.30. The easiest route to express dollar weakness right now may be against the yen, as USD/JPY is trading at new lows for this move. Of note, the dollar is down against most foreign currencies for the week. This trend should continue next week, as we remain negative on the dollar due to the now-familiar combination of an ultra-dovish Fed and worsening US economic data.

 

AMERICAS

It appears some blame is being pinned on the Fed for the equity sell-off yesterday, led by big tech. It’s hard to see how Powell and the Fed could have been any more dovish this week. Simply put, rates are not going up anytime soon and certainly not until the recovery is well on its way. No more QE? Well, the Fed is already buying assets at a rate of $80 bln per month. The US Treasury curve is flatter than it was three months ago. Bond yields are low, as are credit spreads and mortgage rates. US financial conditions by any measure are extremely loose and so we are at a loss for what more Powell could have done to cement his ultra-dovish credentials. Add another “thinking about” to his forward guidance?

Our take on the drop in stocks is a much more fundamental one. That is, the US economy is clearly losing momentum in the absence of another stimulus package. Yesterday’s jobless claims data paint an overall picture of a labor market that is basically stalling. Things aren’t getting particularly worse, but they aren’t getting much better either. And with enhanced unemployment benefits running out, this is bad news for retail sales and the August weakness is just the beginning. US equity futures are pointing to a lower open today but the close will be key.

Despite some movement on fiscal stimulus, talks remain deadlocked. Reports suggest House Speaker Pelosi will not agree to anything less than $2.2 trln, while Senate Republicans were already going to struggle just to approve the $1.5 trln compromise from the so-called Problem Solvers Caucus of moderates from both parties that emerged this week. The deadlock may be another reason market sentiment has soured, as we think most had priced in a significant stimulus package before the election. That’s no longer a sure thing, but now more of a long shot.

The Trump administration continues to lead the conflict with China away from tariffs and towards a greater focus on tech. The latest shot from the Committee of Foreign Investment was against tech firms owned by tech giant Tencent, Riot, and Epic. Reports claim the Committee is looking in to the firms’ security protocols and data handling. Meanwhile, the discussion with TikTok continues, with Oracle still the frontrunner for a partial acquisition, along with a possible IPO in the US market.

US data today are minor. Q2 current account data (-$160 bln expected), August leading index (1.3% m/m expected), and preliminary September University of Michigan consumer sentiment (75.0 expected) will all be reported. None are market-moving, though inflation expectations in the Michigan survey may be of some limited interest.

Canada reports July wholesale trade and retail sales. They are expected to rise 3.5% m/m and 1.0% m/m, respectively.  Other data have come in softer than expected this week, including manufacturing and existing home sales and headline inflation. Last week, the Bank of Canada delivered a somewhat hawkish hold.  No, it wasn’t threatening to hike rates anytime, but instead removed language about adding more stimulus if needed.

 

EUROPE/MIDDLE EAST/AFRICA

The Bank of England delivered a dovish hold yesterday, as expected. While leaving all policy settings unchanged, the bank appears to be setting the table for negative interest rates. It said it discussed the effectiveness of negative rates and will begin a “structured engagement” with UK bank regulators on operational considerations on how it might implement them. It added that can increase the pace of QE if conditions worsen, noting that it sees risk of a longer period of elevated unemployment as the growth outlook remains uncertain. Our call remains that the BOE increases QE in November and cuts rates to zero in late 2020 or early 2021. We still don’t think it’s a done deal, but they are certainly inching closer to the possibility of negative rates.

UK rates markets have reacted accordingly. The entire UK gilt curve out to 7 years is currently negative.  Implied rates on short-sterling futures were down as much as 9 bp across the curve yesterday and are marginally lower today, further pricing in cuts and the risk of negative rates by March. We agree with pricing in higher probability of this risk (and of more QE) given the headwinds building from getting parts of the economy off the fiscal life support. But we are not yet ready to believe negative rates are in the cards, beyond a measure of absolute last resort. The experience of other central banks is inconclusive at best in terms of its benefits, and costs to the banking sector and savers are likely to be significant. Of course, much will depend on Brexit negotiations. Elsewhere, Bloomberg’s WIRP model based on OIS suggests a good chance of negative rates by February. Sterling took a big hit after the decision but recovered to end the day basically flat. It is marginally higher today but is facing resistance near $1.30. Break of the $1.3125 area is needed to signal potential for a deeper recovery in cable.

UK reported August retail sales. Headline sales came in right at consensus, rising 0.8% m/m vs. a revised 3.7% (was 3.6%) in July, while sales ex-auto fuel came in a couple of ticks better than expected at 0.6% m/m vs. a revised 2.1% (was 2.0%) in July. The government-subsidized meals under the “Eat Out to Help Out” program last month undoubtedly helped boost sales. That program has ended, while other government support measures are also likely to end or curtailed this fall, including the jobs furlough program. Renewed lockdowns, even targeted ones, will also have a chilling effect on activity.

Russia central bank is expected to keep rates steady at 4.25%.  A small handful of analysts look for a 25 bp cut to 4.0%.  Lower oil prices are a reason to cut, but the weak ruble is a reason not to cut.  Inflation is also picking up and so the bank is likely to remain cautious today.  August retail sales will also be reported and are expected to fall -1.7% y/y vs. -2.6% in July.

 

ASIA

Japan reported August national CPI. Headline came in as expected, falling a tick to 0.2% y/y, and so did ex-fresh food, falling -0.4% y/y as expected from a flat y/y reading in July.  The core reading would be the lowest since November 2016 and further below the 2% target. Discounted travel costs from a government campaign to boost tourism was the major factor, but overall price pressures remain low. The BOJ just left its policy settings unchanged yesterday and it’s pretty clear that it will stay on the current policy track as the 2% target remains far away.  According to the BOJ’s July forecasts, that target won’t be reached until well after FY2022 (where it sees inflation of 0.7%).  The bank will release updated macro forecasts at the next meeting October 29.

The strong yen is doing Japan no favors. USD/JPY is making new lows for this move and is within sight of the July 31 low near 104.20. More importantly, charts point to a test of the March low near 101.20.