Dollar Falls, UST Yields Rise as Markets See Higher Odds of Stimulus Deal

  • The dollar remains under pressure as markets chase the reflation trade; stimulus talks continue; Senate Majority Leader McConnell holds the key
  • The 10-year UST yield traded today at the highest since June 9; the Fed releases its Beige Book report
  • UK inflation came in lower than expected September; Brexit negotiations seem to be moving towards a favorable outcome; there was very strong demand for the EU’s first-ever social bonds
  • Japan reported September supermarket sales; Australia reported September preliminary retail sales; Korea reported trade data for the first twenty days of October

The dollar remains under pressure as markets chase the reflation trade.  It’s noteworthy that the greenback is softening even as UST yields rise in anticipation of a stimulus deal (see below). DXY traded today at the lowest level since September 4 and has broken below the 93-94 range that has held for most of October. Next target is the low for the cycle near 91.746 from September 1.  The euro is trading at multi-week highs and a clean break of $1.1860 is needed to set up a test of its cycle high near $1.2010. Sterling is trading back above $1.30 on positive Brexit news (see below) while USD/JPY has broken below its narrow 105-106 trading range to trade at the lowest level since September 22 and appears to be on track to test its cycle low near 104 from September 21.

 

AMERICAS

Stimulus talks continue. House Speaker Pelosi that she was pleased with the White House’s latest position on virus testing and tracing. She added that the two sides are also “in range” on other health care provisions, but that differences remain in aid to state and local governments and income assistance to working families. However, she indicted that enough progress has been made that “We are starting to write a bill.”

Senate Majority Leader McConnell holds the key. He said that the Senate would bring it to the floor for debate “at some point” if a compromise were reached. However, he declined to say when a vote on a package would be held nor did he publicly say whether he would support the measure or not. And reports emerged that McConnell privately told his caucus that he advised the White House not to strike a deal with Pelosi ahead of the election, a deal he said that most Republican lawmakers cannot accept. Other Senators are following his lead, saying publicly that a large package is unlikely to make it through the Senate.

Markets appear to be pricing in higher odds of a stimulus package. We remain skeptical due to McConnell’s stance, though it’s evident that all the parties involved are dealing with a complicated pre-election political calculus that is shifting all the time. In the event talks fail, we should expect a quick unwind of the reflation trade and a considerable leg lower in risk assets. With control of the Senate very much at stake, there is still a large chance we get the most fiscally conservative outcome for this election: a Biden victory with a Republican Senate, meaning no large stimulus package will come after the election. Implied betting odds give Democrats about a 60% chance of Senate control, while forecasters such as FiveThirtyEight put the odds at over 70%. Note that a Biden victory is embedded here, because in the case of a 50-50 tie in the Senate, the vice president casts the tiebreaking vote.

The 10-year US Treasury yield traded today at the highest level since June 9. It has since fallen back from the intraday high near 0.83% but a clean break of the .80% area would set up a test of the June 5 high near 0.96%. The 200-day moving average near 0.87% currently will likely provide stiff resistance. And if the stimulus talks fail, then this would shape up to be a false breakout and yields would likely go sub-0.80% again. Stay tuned.

The Fed releases its Beige Book report. It is being prepared by for the upcoming FOMC meeting November 5. The last Beige Book report September 2 noted “Economic activity increased among most districts, but gains were generally modest and activity remained well below levels prior to the Covid-19 pandemic. Continued uncertainty and volatility related to the pandemic, and its negative effect on consumer and business activity, was a theme echoed across the country.” That report flagged uneven labor market conditions as “Some districts also reported slowing job growth and increased hiring volatility, particularly in service industries, with rising instances of furloughed workers being laid off permanently as demand remained soft.” Since the beginning of September, the labor market has stalled out and the economy has lost more momentum and so we expect a sober tone to be seen in this Beige Book.

Today is another light day for the US data. Only report is weekly mortgage applications. Mester, Kashkari, Kaplan, Barkin, Quarles, and Bullard all speak. The media embargo for the November 4-5 FOMC meeting goes into effect this Saturday. The last presidential debate takes place tonight.

Canada reports August retail sales and September CPI. Headline sales are expected to rise 1.1% m/m vs. 0.6% in July, while ex-autos are expected to rise 0.9% m/m vs. -0.4% in July. Headline inflation is expected to rise 0.5% y/y vs. 0.1% in August, while common core is expected to remain steady at 1.5% y/y. Next Bank of Canada meeting is October 28 and it is widely expected to remain on hold as it awaits more details from the government regarding fiscal stimulus.

 

EUROPE/MIDDLE EAST/AFRICA

UK inflation came in lower than expected September. While perking up bit from August, it’s unlikely to derail the BOE’s easing plans. Headline inflation came in at 0.5% y/y vs. 0.6% expected and 0.2% in August, while CPIH came in at 0.7% y/y vs. 0.8% expected and 0.5% in August. Aside from specific items, the overall economic outlook remains weak and largely held up by government policies. UK breakeven rates remain elevated, in part reflecting concerns about the post-Brexit trade relationship with the EU, but this is unlikely to deter the BOE. Breakeven rates in the UK have historically been higher than its peers, and the gap has widened further since the referendum. The next few months will probably mean even further downward pressure on inflation given the new restrictions (in the UK and Europe), the rolling off of some government programs, and the appreciation of the pound.

The BOE is likely to increase its asset purchases at the next meeting November 5, probably by around £100 bln. Simply put, the resurgence of the virus will be a strong headwind in Q4 and possible even Q1. In related news, public sector net borrowing ex-banks for September came in at £36.1 bln vs. £33.6 bln expected and a revised £30.1 bln (was £35.9 bln) in August. With government support to be extended and the economy to remain under pressure, budget deficits and borrowing needs will remain elevated well into 2021, necessitating further BOE purchases to help maintain lower yields. We feel that next month’s expected top up of asset purchases is unlikely to be the last.

 

The Brexit negotiations seem to be moving towards a favorable outcome, as we expected, giving sterling a boost. There are still plenty of opportunities for talks to fail, but today’s comments by top EU negotiator Barnier are striking the right tone. He said that a deal is within reach and that their position is “fully compatible with the respect of British sovereignty, a legitimate concern of Boris Johnson’s government.” This is exactly what Johnson needs in order to be able to claim victory – even if it’s just a skinny-face-saving deal. Sterling is up 0.7%, outperforming other major currencies in a session of broad dollar weakness. Options markets are seeing implied vol rising in line with that of EUR/USD, while risk reversals seem to have stabilized at levels well off the lows for the year.

There was very strong demand for the EU’s first-ever social bonds. The order book was EUR233 bln for only EUR17 bln of 10- and 20-year paper on offer. Nearly two thirds of the buyers were so-called ESG investors. Official demand provided a backstop, with 37% of the 10-year paper going to central banks and official institutions. While the ESG angle adds a different layer of complexity, the strong demand for the first EU debt issuance since the recovery fund was announced bodes well for the EU’s planned bond sales going forward. Next year, the bulk of its recovery fund will be financed by such EU debt issuance.

 

ASIA

Japan reported September supermarket sales. Sales fell -4.6% y/y vs. +3.3% in August. This was due int large part to high base effects. Consumers were front-running the planned consumption tax hike last October and brought forward a lot of purchases into September. Department store sales will be reported tomorrow and will likely show a similar impact. That said, Japan’s recovery remains weak and uneven compared to its DM peers and policymakers know this.

Indeed, BOJ is sounding dovish ahead of next week’s policy meeting. Board member Sakurai said there has been no big change in the economic outlook from July, suggesting little change to the forecasts in its Outlook Report prepared for the meeting. He said it’s hard to see rapid acceleration of inflation. In turn, his comments suggest no change in policy stance anytime soon, though Sakurai said the bank must “carefully mull” potential extension of its virus-related programs. He warned that a delayed recovery may raise risks to the financial system and that the bank needs to consider what measures may be needed to help.

Australia reported September preliminary retail sales. Headline sales came in at -1.5% m/m vs. -4.0% in August. These are the first back t- back declines since July and August 2017. The state of Victoria posted a small monthly decline following a larger one in August due to the lockdown. The Australian Bureau of Statistics noted that “Food retailing, household goods retailing, and other retailing, which includes online only retailers, recorded falls this month.”  No wonder the RBA is sounding so dovish of late. Markets have taken note and WIRP suggests nearly 85% odds of a rate cut at its next meeting November 3.

The yuan continues to power ahead, now nearly 5% stronger against the dollar on the year. As we always point out, the move is following the broad down trend in the dollar. Still, the yuan is now at the strongest level in two years. Last month’s administrative measure by the PBOC to reduce the cost of shorting the currency had little lasting impact, though it was never clear that the objective was to slow down the pace of yuan appreciation. The currency’s path remains a political decision, and we have no doubt that policymakers would succeed in changing its course should they really want to. But regardless of their intentions (which we won’t pretend to know), the PBOC has a history of pushing back against speculative forces once markets start looking like a one-way bet – and it’s starting to look that way. We would be prepared for some volatility ahead.

Korea reported trade data for the first twenty days of October.  Exports fell -5.8% y/y and imports fell -2.8% y/y. However, the weakness was largely due to fewer working days this year.  Adjusting for that, average daily exports rose 5.9% y/y.  Exports to the US fell -2.3%, while exports to the EU rose 14%. Korea is one of the regional economies that is benefiting from strong mainland growth.  Yesterday, Taiwan reported strong export orders for September and point to robust exports through early 2021.