Dollar Ends the Week on a Strong Note

– Official creditors (IMF, EC and ECB) are returning to Athens today for the first time in several months
– Ukraine’s debt negotiations are also back in the spotlight
– Aside from iron ore, most commodity prices remained under pressure this week
– Mexico reports monthly GDP proxy for May 

Price action:  The dollar is stronger on the day, especially against the Antipodean currencies. The Australian and the New Zealand dollars are down sharply to trade around $0.7300 and $0.6575, respectively.  The move was prompted by weaker data from China and a credit downgrade warning by S&P to Australia.  The euro failed to hold above $1.10 and is now just below $1.0950.  Sterling fell below $1.55 while the yen remains steady, trading on both sides of ¥124.  EM currencies remain under pressure with ZAR, TWD, and RUB losing the most today.  The Shanghai Composite was down 1.3%, its first loss in 7 sessions.  Other major Asian indices were also lower as MSCI Asia Pacific fell for the third straight day, with the Nikkei down 0.7%. Euro Stoxx 600 is up 0.3% near midday, while S&P futures are pointing to a flat open.

  • There are two events today in Europe to note.  The first is that the official creditors (IMF, EC, and ECB) are returning to Athens today for the first time in several months.  This is part of the assessment needed to begin negotiations for a third package.  In addition to the near total climb down by the Syriza-led government, the creditors are placing more demands on Greece.  The focus has shifted from the VAT and pensions to labor laws and restrictions products and professions.  These include the creditors’ demands to weaken collective bargaining and open up sectors, such as milk and bread sales, to greater competition.  Protection for some professions, including ferry transports, are to be relaxed.
  • The second involves the protracted negotiations for a debt relief in Ukraine.  It has a $120 mln interest payment due today.  There had been much speculation that it could default today.  However, reports indicate that the payment was made.  In order to secure IMF funding, Ukraine must reduce its debt levels.  Ukraine has proposed a 40% haircut to its private creditors, who have balked.  Instead, the private creditors want Ukraine to use its reserves to service the debt.  The IMF and the US have sided with Ukraine.  In fact, the IMF had seemed prepared to loan to Ukraine even if it defaulted to the private creditors under a program called “lending into arrears.”  The IMF will meet on July 31 to discuss its next step.
  • The Ukraine economy has imploded.  It has lost nearly a quarter of GDP, which is similar to Greece, but in a shorter period.  But unlike Greece, Ukraine also has high inflation.  With the denominator being crushed and new debt being taken on, the debt/GDP ratio is near 160%.  However, the geo-strategic importance is more widely recognized than Greece’s, and international officials are more sensitive to linkages between the economy and the support for a democratic pro-Western government.
  • It has been quite a week for commodity prices.  WTI broke below $50 per barrel for the first time since early April, down about 4.5% this week.  Copper reached its lowest level since 2009 while gold reached the lowest level since 2010, both down about 5% this week.  Iron ore seemed to have stabilized, up about 2% on net this week.  Many agricultural commodities have extended last week’s losses, with soybean futures down nearly 3% and corn futures down 4.5% this week.  As reflected in our recent EM sovereign rating model update, lower commodity prices continue to have a negative impact on the ratings of the commodity exporting countries, while benefiting the importing countries.
  • Eurozone flash manufacturing PMI came in at 52.2 vs. 52.5 expected.  Looking at the country breakdown, German manufacturing PMI came in at 51.5 vs. 51.9 consensus, while France’s fell back below 50 to 49.6 vs. 50.8 consensus.  In other data, New Zealand’s trade balance came in worse than expected at – NZD60 mln vs. NZD100 mln expected.  Sweden’s June trade balance came in at SEK8.4 bln, a sharp rise from last month’s SEK2.4 bln.
  • Caixin flash manufacturing PMI (formerly sponsored by HSBC) for China was reported at 48.2.  It had been expected to tick up from June’s 49.4 reading.  It remains below the 50 boom/bust level.  Official PMI reading (which remains above 50) comes out on August 1.  We expect further stimulus measures if the economic slowdown continues but recent indicators have been mixed.  For example, recall that Q2 GDP surprised on the upside at 7.0% y/y and recent lending data came in on the strong side.  Today’s softer data contributed to the first down session for the Shanghai Composite since last Wednesday.
  • S&P warned that fiscal deterioration could jeopardize Australia’s AAA rating.  We disagree with this, as our own sovereign rating model has Australia firmly in the AAA camp.  Still, the Aussie has been sold to new multi-year lows near $0.7270 after the attempt to rally faded yesterday after briefly popping above $0.7400.  The short-squeeze that lifted the New Zealand dollar was also sold into yesterday, and today’s losses basically complete the reversal of the post-RBNZ gains.
  • During the North American session, the US will report Markit PMI for July and new home sales for June, which tend not to be market-moving.  We note that the US initial jobless claims reading of 255k reported Thursday was the lowest since November 2013.  The stronger than expected reading is for the week containing the 12th, which is the survey week for the monthly BLS jobs data.  This should raise expectations for a strong jobs report on August 7, which would likely keep the Fed on track for lift-off in September.
  • Mexico reports monthly GDP proxy for May, expected at 1.15% y/y vs. 2.09% in April.  If so, Q2 growth will be tracking around 1.6%, down from 2.5% in Q1.  Mid-July CPI came in lower than expected at 2.76% y/y vs. 2.87% consensus.  This was the lowest since at least 1989, and moves further below the 3% target.  Under these conditions, we do not expect Banco de Mexico to make good on its intent to hike rates this year.  USD/MXN is making new all-time highs this week, yet there simply has been no inflation pass-through.  Expect further peso losses ahead.