Dollar Consolidates as Markets Grapple With Rising Recession Risks

  • Reports suggest Mexico is preparing retaliatory tariffs; Senate Republicans have reportedly discussed taking legislative action to halt the US tariffs
  • Fed speakers today include Williams, Powell, and Brainard
  • Eurozone inflation for May eased to 1.2% y/y vs. 1.3% expected; UK PMIs for May continue to plunge
  • RBA cut rates 25 bp to 1.25%, as expected; the sub-50 manufacturing PMI club continues to grow in May
  • Korea May CPI rose 0.7% y/y vs. 0.8% expected; South Africa Q1 GDP was flat y/y vs. 0.6% expected

The dollar is mostly softer against the majors in very narrow ranges. Aussie and Nokkie are outperforming, while Swissie and Kiwi are underperforming. EM currencies are mixed. THB and MXN are outperforming, while ZAR and SGD are underperforming. MSCI Asia Pacific was down 0.1%, with the Nikkei flat. MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 1%. Euro Stoxx 600 is up 0.4% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 3 bp at 2.10%, while the 3-month to 10-year spread became less inverted to stand at -23 bp. Commodity prices are mostly lower, with Brent oil down 0.8%, copper down 0.1%, and gold up 0.1%.

We may see some further dollar consolidation and losses against the majors as the US rates market saga plays out. However, we doubt that EM can maintain any traction in this current environment. You might not like the dollar, but you should like EM FX even less. Even against the majors, one can make the argument that economic conditions elsewhere are deteriorating just as much. Today, eurozone inflation came in lower than expected, UK PMIs continue to slide below 50, and the RBA cut rates. For now, we are maintaining our bullish view on the dollar.

Reports suggest Mexico is preparing retaliatory tariffs in case talks with the US do not go well. Talks between the two nations began yesterday and will continue tomorrow. Our base case is that Mexico is forced to retaliate. USD/MXN made a new high for this move yesterday near 19.88, just shy of the key 19.9280 area. Break of that level would set up a test of the December high near 20.6570.

Senate Republicans have reportedly discussed taking legislative action to halt the tariffs on Mexico. These Senators may revive the resolution of disapproval over the national emergency declaration underpinning the tariffs. However, such a move would also stop the funding of the border wall via the same channel. Recall a resolution was passed earlier this year by Congress but did not have enough votes to override Trump’s veto. Then, 13 House Republicans and 12 Senate Republicans crossed party lines to support the resolution. Senator Grassley (R-Iowa) also hinted that Senate consideration of USMCA wouldn’t begin if the Mexican tariffs are enacted. To be continued.

During the North American session, the US reports April factory orders (-1.0% m/m expected). Yesterday’s ISM manufacturing PMI reading offered some faint hope, with employment, prices paid, and new orders components all rising from April. In addition, May auto sales came in stronger than expected at an annualized 17.3 mln pace, up from 16.4 bln in April.

Yet US rates markets are getting even more pessimistic. The 3-month to 10-year curve continues to invert. At -25 bp yesterday, it was the most inverted in this cycle and today is trading near -23 bp. Elsewhere, the Fed Funds futures strip continues to lean even more dovish. The implied yield on the January 2020 contract is 1.75%, which is fully pricing in two cuts this year and potentially a third one. The implied yield on the January 2021 contract is 1.34%, which is nearly pricing in two cuts next year. WIRP now sees an 18% chance for a cut at the June 19 FOMC meeting, up from around 5% last week.

Fed speakers today include Williams, Powell, and Brainard. They are all voters and so their views have taken on even greater importance considering recent market turmoil. Yesterday, Daly took a measured approach while Bullard continued his role as the resident dove. Bullard said a rate cut may warranted soon due to downside risks emanating from the trade war. Most other Fed officials are saying that rates are on hold for now, with the qualifier that the impact of tariffs is still unknown. He is a voting member of the FOMC and so his words carry a lot of weight. That said, he remains in the minority, at least for now.

Eurozone inflation for May eased to 1.2% y/y vs. 1.3% expected and 1.7% in April. We had warned of downside risks considering the lower than expected inflation reported by France and Germany last week. Core inflation fell to 0.8% y/y vs. 0.9% expected and 1.3% in April, which is even more worrisome. The data couldn’t have come at a worse time, ahead of the ECB meeting on Thursday. Markets are expecting generous terms for the TLTRO to be announced as well as a possible tweak to forward guidance based on weaker staff forecasts to be released.

UK PMIs for May continue to plunge. Construction PMI came in at 48.6 vs. 50.6 expected. Yesterday, manufacturing PMI came in at 49.4 vs. 52.2 expected. Services and composite (50.6 and 51.0 expected, respectively) PMIs will be reported tomorrow and it seems likely that we will get sub-50 readings here too. Bank of England next meets June 20 and it is not doing anything until after Brexit. Implied yields on short sterling contracts show the next hike priced in for mid-2023 and the one after that sometime beyond Q1 2025.

RBA cut rates 25 bp to 1.25%, as expected. Ahead of the decision, Australia reported Q1 current account data (-AUD2.9 bln) and April retail sales (-0.1% m/m). Governor Lowe stated the obvious when he said that it was “not unreasonable” to expect another cut, as its latest forecasts were based the rate path implied by market pricing. Downside risks to the economy have markets looking for at least two or perhaps even three cuts this year. Reports of potential US tariffs are just icing on the cake.

The sub-50 manufacturing PMI club continues to grow in May. In EM, we have Taiwan, Malaysia, Korea, Singapore, China, Russia, Poland, Turkey, Czech Republic, South Africa, and Mexico. Brazil is moving close at 50.2. And it’s not just EM. In DM, sub-50 manufacturing PMI readings were reported in Japan, the UK, Germany, Switzerland, and Italy. To be continued. However, the bottom line is that headwinds to global growth are growing and that’s very much negative for EM.

Korea May CPI rose 0.7% y/y vs. 0.8% expected and 0.6% in April. Inflation remains well below the 2% target. Bank of Korea just left rates steady last week at 1.75%. There was one dissent in favor of a cut, but Governor Lee said the current situation does not call for a rate cut. Next policy meeting is July 17, no change is expected then. May manufacturing PMI came in at 48.4, moving back below the key 50 level.

South Africa Q1 GDP was flat y/y vs. 0.6% expected and 1.1% in Q4. This was the second straight quarter of deceleration. GDP contracted -3.2% SAAR, the first such contraction since Q2 2018. Next policy meeting is July 18, no change is expected then. However, we think a rate cut is getting more and more likely in H2. Much will depend on the rand, however.