Dollar Firm as Equities Pull Back Ahead of US Inflation Data

  • President Trump complained about the “devalued” euro
  • Past reports suggest the US is considering tariffs on nations with undervalued currencies
  • President Trump claimed that he is the one holding up a US-China deal
  • During the North American session, the US reports May CPI and budget statement
  • HKD firmed to its strongest level since December 18; Turkey central bank is expected to keep policy steady; India reports May CPI and April IP

The dollar is mostly firmer against the majors ahead of US CPI data. Sterling and yen are outperforming, while Aussie and Loonie are underperforming. EM currencies are mostly weaker. THB and HKD are outperforming, while TRY and ZAR are underperforming. MSCI Asia Pacific was down 0.4%, with the Nikkei falling 0.4%. MSCI EM is down 0.4% so far today, with the Shanghai Composite falling 0.6%. Euro Stoxx 600 is down 0.5% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 2 bp at 2.12%, while the 3-month to 10-year spread inverted 2 bp and stands at -12 bp. Commodity prices are mixed, with Brent oil down 2.4%, copper down 0.9%, and gold up 0.7%. 

President Trump complained about the “devalued” euro yesterday. He also said that the Fed is keeping interest rates too high. White House advisor Kudlow came out later for damage control, stressing that Trump was not calling for a weaker dollar. Yet this latest salvo gave markets an excuse to pull back after a good run. Equities are mostly lower today, while bonds and gold are rallying. USD and JPY are higher while the dollar bloc and EM FX are lower.

Previous reports suggest the Trump administration is considering tariffs on nations with undervalued currencies. This is yet another possible front in the mercantilist war that the US is fighting with its major trading partners. The comments about the euro support our view that it’s not just about China. Come November auto tariffs will come back into focus with the EU and Japan on the front lines.

We note that currency undervaluation is often in the eye of the beholder. According to the OECD, the euro is the most undervalued currency in the majors, to the tune of -22.4% vs. USD. The Economist’s Big Mac index is not as extreme, as it shows the euro -14.6% undervalued vs. USD and in the middle of the pack. Here, the yen is the most undervalued at -34.2% vs. USD.

President Trump claimed that he is the one holding up a US-China deal. He said the two already had a deal in place before China reneged and that “unless they go back to that deal I have no interest.” China officials have yet to respond to this or to his demands that Xi meet with him at G20 this month. Rather, policymakers have signaled they are in for the long haul by adding more stimulus measures.

During the North American session, the US reports May CPI. Headline inflation is expected to come in a tick lower at 1.9% y/y and core is seen steady at 2.1% y/y. Yesterday, PPI headline inflation came in lower than expected at 1.8% y/y while core was steady at 2.3% y/y. We do not think low inflation by itself will get the Fed to cut rates. Rather, we think it will take weakness in the real sector (employment, consumption, growth). That is why Friday’s retail sales data is key.

The May budget statement will also be reported, where a -$200 bln deficit is expected. If so, the 12-month total would rise to -$977.6 bln, a new cycle high. As we have warned many times, the deficit is the dollar’s Achilles Hell. When (not if) the next US recession hits, the deficit will blow out even as the Fed cuts rates, making it less desirable to hold USTs. To be continued.

Japan reported May PPI and April core machine orders. PPI rose 0.7% y/y, as expected, while machine orders rose 2.5% y/y vs. -5.3% expected. The orders data was a rare spot of good news for the economy. Bank of Japan meets June 20, and no change is expected then. However, we expect further stimulus after the October consumption tax hike.

The Hong Kong dollar firmed to its strongest level since December 18. This was directly the result of higher local rates, as one-month HIBOR jumped to around 2.4% the highest since 2008. This is how the peg is supposed to work and why we do not think it will be broken. Yet HKD strength comes even as local protests against a proposed extradition law intensified. Tear gas and rubber bullets were used on protestors in what police called a “riot situation.”

Turkey central bank is expected to keep policy steady. A handful of analysts look for a cut today, but we think this is too risky ahead of next week’s Istanbul election do-over. CPI rose 18.71% y/y in May, the lowest since August but still well above the 3-7% target range. If disinflation continues, the bank will be tempted to cut rates, but we think this month is too soon. Next policy meeting after today is July 25.

India reports May CPI and April IP. The former is expected to rise 3.05% y/y and the latter by 0.6% y/y. If so, inflation would remain in the bottom half of the 2-6% range. May WPI will be reported Friday, which is expected to rise 3.04% y/y vs. 3.07% in April. RBI just cut rates and signaled further easing is likely. Next policy meeting is August 7 and another 25 bp cut is likely then.