Dollar Firm as Divergence Theme Returns

  • The dollar rally has resumed as the divergence theme remains alive and well
  • There is mounting political risk in the UK; sterling remains heavy
  • Japan reported weak April department store sales; dovish RBA minutes were released
  • Thailand Q1 GDP growth slowed as expected to 2.8% y/y; Korea reported weak trade data for the first 20 days of May
  • Turkish central bank effectively loosened policy after taking limited steps to stabilize the lira

The dollar is mostly firmer against as the divergence theme remains in play. Nokkie and Loonie are outperforming, while the Antipodeans and sterling are underperforming. EM currencies are mostly weaker. PHP and CNY are outperforming, while THB and TRY are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.1%. MSCI EM is up 0.1% so far today, with the Shanghai Composite rising 1.2%. Euro Stoxx 600 is up 0.6% near midday, while US futures are pointing to a higher open. 10-year UST yields are flat at 2.41%, while the 3-month to 10-year spread is steady at 5 bp. Commodity prices are mixed, with Brent oil up 0.4%, copper up 0.1%, and gold down 0.1%.

The dollar rally has resumed. DXY is making new highs for this move and trading at levels not seen since April 26, when it posted a cycle high near 98.33. The latest bullish drivers are not emanating from the US. Rather, developments elsewhere suggest the divergence theme is alive and well. Today, Brexit concerns are weighing on sterling while an extremely dovish RBA is pushing Aussie lower. Weak data from Thailand and Korea underscore that divergence includes EM.

During the North American session, the US reports April existing homes sales. A 2.7% m/m gain is expected. It’s a very light data week for the US. Indeed, there are no major US data releases until the week of June 3.   Until then, we will just have to listen to the Fed tell us how well the US economy is doing.

Evans and Rosengren speak today. Yesterday, Fed Vice Chair Clarida said the economy is operating close to the Fed’s dual mandate. That doesn’t sound like someone who’s in a hurry to cut rates. Neither did Powell, who spoke last night. The Fed Chair took a measured approach, noting that the impact of the trade tensions is still unknown. In other words, the Fed won’t be rushed into a rate cut, echoing most other Fed officials.

There is mounting political risk in the UK. May’s rivals are jockeying to replace her even as support for her Brexit bill is waning. The upcoming European Parliamentary elections could see Farage’s Brexit party win the most seats. While that has no direct bearing on the UK, it increases the odds that May’s replacement will be a Brexit hardliner like Boris Johnson, thereby raising the odds of a hard Brexit. Implied yields on the short sterling strip continue to fall.

Sterling remains heavy, to state the obvious. It’s down eight straight days against the dollar and eleven of the past twelve to trade at levels not seen since January. The January low near $1.2440 is within sight. Against the euro, sterling is down twelve straight days to trade at levels not seen since February. Here, a break of .8865 is needed to set up a test of the January high for EUR/GBP near .9108. First, the pair needs to break the 200-day moving average near .8793.

Japan reported weak April department store sales. Tokyo sales contracted -0.8% y/y while nationwide sales contracted -1.1% y/y. Data support the view that the unexpected GDP growth in Q1 is unlikely to be sustained in Q2. While the BOJ appears likely to add stimulus this year, we think it will be after the October consumption tax hike. USD/JPY continues to get a toehold above the 110 level, but it will be tough given likely bouts of risk-off sentiment ahead.

Dovish RBA minutes were released. It set forth two scenarios where a rate cut would be appropriate. First, if there was no further improvement in the labor market and second, if unemployment rose and inflation stayed low. That’s a low bar for a cut. Governor Lowe later doubled down, saying in a speech that a rate cut will be considered next month, and that unemployment needs to fall below 5% to help return inflation to target.

Aussie jobs data last week was on the soft side, with unemployment rising to 5.2% vs. 5.0% expected. The odds of a cut at the next RBA meeting have now risen to more than 70% from 35% at the start of last week. Given Lowe’s comments, we think the odds are even higher. With the currency outlook driven mostly by RBA expectations and China growth outlook, we remain negative on AUD and look for a test of the January low near .6740. After that, we are looking at levels from 2008 and 2009.

Thailand Q1 GDP growth slowed as expected to 2.8% y/y from a revised 3.6% (was 3.7%) in Q4. This is the slowest since Q4 2014. The BOT recently delivered a dovish hold and cut its growth forecast for this year by a couple of ticks to 3.8% due largely to weaker exports. Even this may be too optimistic. Consensus sees the next hike coming in 2020 but this may not happen. Either way, we will very likely see steady rates in 2019. Next policy meeting is June 26, no change is expected then.

Korea reported weak trade data for the first 20 days of May. Exports contracted -11.7% y/y vs. -8.7% in April, while imports contracted -0.1% y/y vs. -1.2% in April. The US-China trade war will continue to impact the economy. The weaker won will help at the margin, but not by enough to offset the headwinds emanating from China. Next policy meeting is May 31, no change is expected then.

Turkish central bank effectively loosened policy after taking limited steps to stabilize the lira. The central bank is now allowing commercial banks to access to funding at the 24% repo rate vs. the 25.5% overnight rate that’s been in effect for a couple of weeks. Right now, the case is for tighter policy, not looser. Recent moves suggest policymakers are simply trying to buy time until the Istanbul election next month. Like other efforts, this one seems doomed to failure and we see significant TRY losses ahead.