Dollar Consolidates as Equity Markets Stabilize

  • The dollar is consolidating its recent gains as global equity markets try to stabilize
  • Italy must respond to the EU’s request to revise its draft budget proposal by today
  • UK reported labor market data
  • During the North American session, the US reports October budget data
  • China reported slower than expected money and loan growth in October
  • We would downplay reports of talks between Mnuchin and Liu; EM should remain under pressure
  • Poland reports September trade and current account data; Brazil September retail sales are expected to rise 1.6% y/y

The dollar is weaker against the majors as global markets try to stabilize.  Kiwi and Stockie are outperforming, while the yen and Swissie are underperforming.  EM currencies are mixed.  INR and PHP are outperforming, while TRY and MXN are underperforming.  MSCI Asia Pacific was down 1%, with the Nikkei falling 2.1%.  MSCI EM is flat so far today, with the Shanghai Composite rising 0.9%.  Euro Stoxx 600 is up 0.3% near midday, while US futures are pointing to a higher open.  The US 10-year yield is down 2 bp at 3.16%.  Commodity prices are mostly lower, with Brent oil down 2.4%, copper up 0.5%, and gold down 0.2%.

The dollar is consolidating its recent gains as global equity markets try to stabilize.  Asian equities sank after the US rout yesterday, but sentiment has improved as European stocks are up slightly and US futures are pointing to a higher open.  Risk off sentiment is coming in waves now, and we fully expect another wave ahead.  That’s bad news for equities and EM whilst good for USD and US Treasury bonds.  Those drivers remain intact.

Italy must respond to the EU’s request to revise its draft budget proposal by today.  Prime Minister Conte is scheduled to meet with key ministers today.  Reports suggest that Italy will revise its growth forecasts down slightly but will keep its deficit targets unchanged.  Of course, this makes no sense and the EU will not be happy.  It still looks like tensions are likely to get worse and the possibility of sanctions on Italy is rising.  Italy’s 10-year spread to Germany is moving higher to 312 bp, the highest since October 24.

The euro’s modest bounce today quickly ran out of steam.  It is back to trading at yesterday’s low near $1.1215.  The $1.1185 level is the 62% retracement objective of the big January 2017-February 2018 rally.  Break below that would set up a test of that January 2017 low near $1.0340.

UK reported labor market data.  Employment rose 23k vs. 25k expected in September, whilst the unemployment rate rose a tick to 4.1%.  Average weekly earnings accelerated to 3.0% y/y (3.2% y/y ex-bonuses), supporting the BOE’s view that the labor market continues to tighten.  The UK reports October CPI tomorrow.

It’s worth noting that markets have pushed back expectations of BOE tightening this week.  Short sterling implied yields are now pricing in the next hike by June 2019 and the one after that in June 2020.  Last week, they were seen coming in March 2019 and March 2020.  Despite today’s small bounce, sterling remains heavy and is on track to test the October low near $1.27 and then the August low near $1.2660.

During the North American session, the US reports October budget data.  Whilst typically not a market-moving release, we think the deficit will become more and more important in the coming months.  Note September saw the end of FY2018, where the deficit rose to -$779 bln (-3.8% of GDP) from -$666 bln (-3.4%) in FY2017.  The CBO forecasts the deficit to widen to -4.6% in FY2019 and FY2020 based on growth forecasts of 2.9% this year and 2.0% next year.

The Fed’s Kashkari, Brainard, and Harker speak today.  With no press conference after last week’s FOMC decision, Fed officials are likely to be peppered with questions regarding future policy moves.  They should present a united front in noting a robust economy, tight labor market, and rising price pressures.  Of course, this should be taken to mean that a December hike is pretty much a done deal and that more hikes are planned in 2019.

China reported slower than expected money and loan growth in October.  Of note, new loans were CNY697 bln vs. CNY905 bln expected, while aggregate finance was CNY728.8 bln vs. CNY1.3 trln expected.  With policymaker firmly focused in growth rather than deleveraging, we expect further stimulus measures.  In light of this data, press reports of increased directed lending make sense.

We would downplay reports of resumed talks between Treasury Secretary Mnuchin and Vice Premier Liu.  After speaking on the phone last week, the two are reportedly discussing a visit to Washington DC by Liu before Trump and Xi meet on the sidelines of G20.  Recall that trade policy is really being run by hardliners Navarro and Lighthizer, not Mnuchin, and so that is why we downplay the significance.

EM should remain under pressure.  MSCI EM is on track to test the October 30 low near 930.  Likewise, MSCI EM FX is on track to test its October 31 low near 1595.  Today, the usual suspects TRY, MXN, and ZAR are leading the way down.

Poland reports September trade and current account data.  It then reports Q3 GDP Wednesday, which is expected to grow 4.6% y/y vs. 5.1% in Q2.  The economy remains very robust, but price pressures have eased in recent months.  For now, the bank is sticking with its forward guidance of steady rates through 2019.

Brazil September retail sales are expected to rise 1.6% y/y vs. 4.1% in August.  The economy remains sluggish, and markets have pushed out the timing of the first rate hike into 2019.  Next COPOM meeting is December 12, no change is expected then.