Dollar Consolidates as US-China Tensions Build

  • Market sentiment was dented in part by news that a new Covid-19 cluster was discovered in Wuhan; the dollar is consolidating recent gains
  • The US moved to block a government pension fund from investing in China
  • US Treasury continues its quarterly refunding; April budget statement today will be a harbinger of things to come
  • US inflation readings are largely irrelevant for the markets; Fed officials are pushing back against the notion of a negative policy rate in the US; COPOM minutes will be released
  • UK government may extend its wage program through September; Italian spreads continue to narrow
  • Reports suggest the state of emergency will be lifted in many regions of Japan; China-Australia tensions are rising

The dollar is broadly weaker against the majors despite as US-China tensions rise.  The Scandies are outperforming, while Loonie and sterling are underperforming.  EM currencies are mixed.  ZAR and TRY are outperforming, while MXN and KRW are underperforming.  MSCI Asia Pacific was down 0.6% on the day, with the Nikkei falling 0.1%.  MSCI EM is down 0.5% so far today, with the Shanghai Composite falling 0.1%.  Euro Stoxx 600 is up 0.5% near midday, while US futures are pointing to a higher open.  10-year UST yields is up 1 bp at 0.72%, while the 3-month to 10-year spread is up 1 bp to stand at +62 bp.  Commodity prices are mostly higher, with Brent oil up 2.9%, WTI oil up 5.3%, copper down 0.6%, and gold up 0.3%.

Market sentiment was dented in part by news that a new Covid-19 cluster was discovered in Wuhan. Similarly, a new group of infections emerged in South Korea. The number of infections were small, 5 in Wuhan and 85 in South Korea, but enough to ignite fears of a second wave of infections. Death rates continue to trend lower in Europe and the US. Yesterday, about 250 people died in France as a result of the virus, 180 in Italy, 120 in Spain, 90 in Germany, over 1,000 in the US and 500 in Brazil.

The dollar is consolidating recent gains.  DXY made new high for this move earlier near 100.44 but has fallen back but still holding above the 100 area.  The euro is trading just above $1.08 but remains heavy, while sterling has stabilized after its recent slide and is holding above the $1.23 area.  Given the still-high Brexit and EU risks, we suspect both currencies will break below these key levels.  US-China tensions (see below) should also give the greenback some safe haven demand.



The US moved to block a government pension fund from investing in China.  This has been long rumored and first came up during last year’s trade war.  Labor Secretary Scalia sent a letter to the board of the Federal Retirement Thrift Investment Board asking it to “halt all steps” in putting any retirement money in funds that have investments in Chinese companies.  The fund was scheduled to transfer around $50 bln to a fund meant to mirror MSCI’s All Country World Index, which includes China and other EM countries.  No response yet from China but this is a dangerous move.  As we noted last year, China holds over $1 trln of US Treasury bonds.  If the two countries were get into tit for tat limits on capital flows, we think that the potential harm is much greater for the US than it is for China.

The US Treasury continues its quarterly refunding.  It will sell $32 bln of 10-year notes today.  Yesterday, it sold $42 bln of 3-year notes at a record low yield of 0.23%.  Demand was strong, with a bid to cover ratio of 2.54 vs. 2.27 previously.  It ends with $22 bln of 30-year bonds to be sold Wednesday.  The total of $96 bln on offer compares to $84 bln last quarter.  Of note, the Treasury announced that it will likely start auctioning the re-booted 20-year bond on May 20 with an expected initial offering size of $20 bln.  So far, the markets have been able to absorb steadily growing issuance.  Can it digest the huge slug of issuance that’s yet to come?

April budget statement today will be a harbinger of things to come.  A deficit of -$737 bln is expected but with tax payments deferred and expenditures surging, we see upside risks to the gap.  Indeed, the increased bond issuance planned for Q2 simply reflects this new reality.  A consensus reading would take the 12-month total up to -$1.93 trln, the highest ever and easily eclipsing the previous high from early 2010 of -$1.5 trln.  The scary part is that this is just the beginning,  as we have $3 trln of spending (and counting) of fiscal stimulus coming down the pike.

US inflation readings are largely irrelevant for the markets.  CPI will be reported today, with headline inflation expected to plunge to 0.4% y/y from 1.5% in March and core expected to fall to 1.7% y/y from 2.1% in March.  PPI will then be reported Wednesday, with headline inflation expected to fall -0.3% y/y vs. +0.7% in March and core expected to fall to 0.9% y/y from 1.4% in March.

Fed officials are pushing back against the notion of a negative policy rate in the US.  Yesterday, Chicago Fed President Evans said that he doesn’t “anticipate that being a tool we would be using in the U.S.,” a view echoed by Atlanta Fed President Bostic. Again, we know better than to say it would never happen, but the experience of negative rates in other counties suggests it is highly unlikely to be a worthwhile tool for the US.  Bullard, Kashkari, Harker, Quarles, and Mester all speak today.  We suspect the negative rates issue will come up again and we expect the Fed to push back further.  Note Fed Funds futures are still implying negative rates by mid-2021.

Brazil COPOM minutes will be released.  At that meeting, it surprised markets with a 75 bp cut to 3.0% and signaled a cut at the June 17 meeting.  The minutes may provide more clues, but the CDI market is now pricing in a 50 bp cut to 2.5% next month with potential for another cut August 5.  IPCA inflation eased to 2.4% y/yin April, below the 2.5-5.5% target range.  There has been little inflation pass-through from the weak real and so further easing is likely despite the damage to the currency.



UK government may extend its wage program through September.  Currently, the program pays 80% of furloughed workers’ wages but will gradually taper off until the program ends in June.  Over a scheme being discussed, the program would be extended three months, with workers allowed to work part-time with the wage bill being split between the government and employers.  If nothing else, this means that the government does not see a quick recovery and that it is looking ahead to a long, slow slog.

Italian spreads continue to narrow gradually after last week’s scare from the German court ruling. We expect this trend to continue at a gradual pace. We are pretty confident that this issue will be resolved, and it will be not be the fatal blow to the union. That said, it is yet another sign of discord, a risk event, and adds to the perception of a relatively weaker and less unified response by the euro area. The 10-year spread gap to narrowed is off some 10 bp over the last few sessions.

Oil prices are up 3-5% on the day due to a combination of potential re-opening inspired pickup in demand and production cuts by Saudi Arabi. The Kingdom surprised markets (and us) by announcing a unilateral supply cut of 1 mln barrels per day yesterday beyond what it had already agreed with OPEC+. However, some reports claim that a few US shale oil fields are starting to reopen in response to the recent pickup in prices and lower inventory build.


Reports suggest the state of emergency will be lifted in many regions of Japan.  The government will reportedly finalize a plan to end the state of emergencies in 34 of Japan’s 47 prefectures after receiving opinions from a panel of experts May 14.  Economy Minister Nishimura earlier said some limits might be lifted ahead of May 31, when the declaration of emergency is set to expire.  He added that the remaining 13 prefectures, which include hardest-hit Tokyo and Osaka, could be opened if the virus can be contained by month-end.

China reported April CPI and PPI.  The former eased to 3.3% y/y vs. 3.7% expected and 4.3% in March, while the latter fell -3.1% y/y vs. -2.5% expected and -1.5% in March.  Clearly, price pressures are falling, with PPI pointing to potential outright deflation ahead.  No wonder the PBOC just promised “powerful” easing measures.

Tensions between Australia and China are rising.  The tiff started when the Australian government called for an investigation into the origins and handling of the coronavirus, which China saw as thinly veiled criticism.  China just suspended its beef imports from four Australian abattoirs.  Elsewhere, sentiment continues to deteriorate as illustrated by April NAB business conditions index fell to -34 from a revised -22 (was -21) in March.  However, the business confidence component improved to -46 from a revised -65 (was -66) in March.  Westpac consumer confidence will be reported tomorrow.