Dollar Decouples From the Blue Wave (For Now)

  • Developments at the Capitol change nothing from a fundamental standpoint; yesterday’s ADP data bodes ill for Friday’s jobs report; weekly jobless claims will be important; FOMC minutes were dovish, as expected; Mexico reports December CPI
  • UK healthcare reports claim that the country could run out of ICU beds in less than two weeks; German factory orders posted a huge upside surprise the lockdown impact is showing up in the eurozone consumption data; eurozone reported December CPI
  • Japan reported very weak November real cash earnings; state of emergency for the Tokyo region was declared; top Japan policymakers met amidst growing concern over the strong yen; Australia reported strong trade data for November; EM inflows continue to rise at a fast pace, led by Emerging Asia

The Blue Wave trades remain in play but the dollar is not partaking, at least for today.  Equity markets are higher and UST prices are lower. Yet DXY is up after making a new cycle low yesterday near 89.209. We view this bounce as temporary and continue to target the February 2018 low near 88.25. The euro is trading back below $1.23 after setting a new cycle higher yesterday near $1.2350 but we feel it will eventually test the February 2018 high near $1.2555.  Sterling is trading back below $1.36 after failing to break above the recent high near $1.3705.  Lastly, USD/JPY has staged a big rally off of yesterday’s low near 102.60 after Japan officials expressed growing concern over yen strength (see below).

 

AMERICAS

Developments at the Capitol change nothing from a fundamental standpoint. After the Capitol was cleared of trespassers, both houses of Congress resumed and completed the certification process. Simply put, Joe Biden will be inaugurated President on January 20 and it looks likely that the Democrats will hold both houses of Congress. As such, we think the Blue Wave trades will continue and that today’s dollar decoupling is temporary.

What kind of stimulus can we expect if the Democrats do indeed take back the Senate? At a minimum, $1.5 bln as that along with $900 bln already passed would take the total up to $2.4 trln, which is the last real compromise the Democrats offered. Could it be larger? A $2.5 trln price tag would take the total up to $3.4 trln, which is what the Democrats passed back in May but died in the Senate. How about $2 trln as a solid compromise? This is of course all guesswork and we will have to wait and see how the new Congress and new administration frame the issue. We also expect a separate infrastructure spending bill of at least $1 trln this year that both parties can support.

Yesterday’s ADP data bodes ill for Friday’s jobs report. ADP reported -123k private sector jobs vs. +75k expected. Of course, the correlation with NFP is not that great. That said, the ADP reading underscores weakness in the labor market that’s been building in recent weeks and there is a definite risk of a negative number Friday. Consensus for NFP was +73k before ADP and has since fallen to +62k vs. +245k in November. We may see some further downward revisions but the whisper number is likely to move into negative territory now. ISM services PMI will be reported today and is expected at 54.5 vs. 55.9 in November. The employment component will be closely watched. December Challenger job cuts and November trade (-$67.0 bln expected) will also be reported today. Canada also reports November trade and December Ivey PMI.

Weekly jobless claims will be important.  Can last week’s improvement be sustained? Regular initial jobless claims are expected at 800k vs. 787k the previous week, while continuing claims are expected at 5.2 mln vs. 5.219 mln the previous week. Regular and PUA initial claims together fell to 1.1 mln last week, the lowest since late November. Elsewhere, total regular, PUA, and PEUC continuing claims fell to 18.7 mln the previous week, the lowest since mid-April. Perhaps we are seeing some signs of a stabilizing labor market after weakening earlier in December. Today’s reading may help determine this.

FOMC minutes were dovish, as expected. The Fed delivered a dovish hold in December and the minutes bear this out. All Fed officials felt that the current pace of asset purchases was appropriate, though “a couple” were open to lengthening the maturities. The Fed expected the economy to slow in the coming months, and most officials saw inflation risks weighted to the downside. “A number” of officials saw risks from the end of its loan facilities. The only surprise to us was that they felt that eventual tapering could be similar to what was seen in 20013-2014. Why was the Fed even mentioning tapering” It’s way too early for the Fed to be thinking about thinking about tapering. In that regard, however, the Fed did not discuss the timing, just the likely process.

Next FOMC meeting is January 26-27 and is likely to be a non-event. For now, the Fed should be content to take a wait and see approach. This is especially true now that the Blue Wave looks increasingly likely, as a big slug of stimulus is high on the agenda for the new Congress. That said, the Fed may start paying more attention to the rise in the long end of the US curve. Minutes show that it was already on their radar screen in December and now that the 10-year yield has broken above 1%, the yellow lights are likely flashing at the Fed. Further steepening of the curve will likely get the attention of more than “a couple” Fed officials at the upcoming FOMC meeting. Of note, Harker, Bullard, and Evans speak today.

Mexico reports December CPI.  Headline inflation is expected at 3.10% y/y vs. 3.33% in November.  If so, it would be the lowest since May and would move closer to the center of the 2-4% target range.  Central bank minutes will also be released that day.  Next policy meeting is February 11.  The bank has been on hold since the last 25 bp cut to 4.25% in September.  However, the decision to hold at the last meeting December 17 was split 3-2 and the bank said future decisions will depend on inflation factors.  With inflation falling and the peso firming, we think easing could resume at the next meeting.

 

EUROPE/MIDDLE EAST/AFRICA

UK healthcare reports claim that the country could run out of ICU beds in less than two weeks. Officials are considering new measures to reduce chances of the health system being overwhelmed, including canceling elective or non-Covid related activities. By some measures, 1 in 30 people in London were infected by the virus between December 27 and January 2. The UK economy is already expected to contract in Q1 from the national lockdown.

German factory orders posted a huge upside surprise. The November figure came in at 2.3% m/m vs. -0.5% expected and a revised 3.3% (was 2.9%) in October. The y/y WDA rate rose to 6.3% y/y, triple the expected 2.1% and the revised October gain of 2.3% (was 1.8%). However positive, there are still far more headwinds in store, as the new restrictive measures against the virus in Germany and around the world are still to be reflected in the industrial data.

Unfortunately, the lockdown impact is showing up in the consumption data. The eurozone reported a huge -6.1% m/m drop in retail sales for November, nearly double the -3.4% expected and down from a revised 1.4% m/m gain (was 1.5%) in October. The y/y rate plunged to -2.9% vs. +0.9% expected and a revised 4.2% (was 4.3%) in October, and is the first negative reading since May.

Eurozone reported December CPI data. Both headline and core inflation remained steady as expected at -0.3% y/y and +0.2% y/y, respectively.. It’s clear that the ECB will continue to struggle in meeting its 2% inflation target this year, though it should be satisfied with the overall resilience of the eurozone economy as we move into 2021. With virus numbers spiking again in many countries, we are probably entering a period in which economic data will probably mean less than usual.

 

ASIA

Japan reported very weak November real cash earnings. They were expected to rise 0.2% y/y but instead fall -1.1% y/y vs. a revised -0.1% (was -0.2%) in October. This continues a string of negative y/y comparisons that began in March. November household spending will be reported Friday and is expected at -1.0% y/y vs. +1.9% in October. In light of the earnings data, we see downside risks. Of note, the October gain was flattered by low base effects stemming from last year’s consumption tax hike, but the overall trend has been one of improvement. That trend is clearly in danger of reversing.

As expected, Prime Minister Suga declared a state of emergency for the Tokyo region. It is expected to last one month but that is clearly open to question. Indeed, the head of the government’s advisory panel admitted “Stronger measures might be needed.” This simply adds to the headwinds facing the economy. With fiscal stimulus in the pipeline, however, the Bank of Japan is likely to remain on hold for now. Next policy meeting is January 21 and no change is expected then.

Top Japan policymakers met amidst growing concern over the strong yen.

Senior officials from the Finance Ministry, BOJ, and the financial regulator met today and is the next step in the escalation ladder. The Finance Ministry’s top official on currency matters said afterwards that “The stability of financial markets is extremely important. The government and Bank of Japan will work together as needed while carefully watching markets and the economy.” Of course, we all know that financial stability is code for a strong yen. That said, Japan policymakers are in a similar predicament as the ECB and nothing beyond jawboning is likely. We are in a weak dollar environment and so FX intervention would do nothing beyond an initial knee-jerk reaction.

Australia reported strong trade data for November. Exports rose 3% m/m vs.. -2% expected and a revised 4% (was 5%) in October, while imports rose 10% m/m vs.. 3% expected and a revised 2% (was 1%) in October. The nation continues to benefit from surging commodity prices and the recovery in mainland China. For now, the RBA is in wait and see mode and so far, what it sees is solid growth. Next policy meeting is February 2 and no change is expected then. It will issue its Statement on Monetary Policy after that meeting and is likely to upgrade it macro forecasts then.

Emerging Market inflows continue to rise at a fast pace, led by Emerging Asia. Bloomberg’s capital flow proxy to EM markets is now back to early 2018 levels, even though implied volatility in the FX space remains far higher than pre-pandemic levels. According to data from the IFF, Emerging Asia has led inflows by a wide margin, clearing over $20 bln just in December compared to $12 bln for LatAm and $7 bln for EMEA.  Conditions for EM are likely to remain positive in 2021 and so the inflows should continue.