Dollar Firm as Friday’s Optimism Gives Way to Greater Pessimism on Trade

  • Trade tensions are feeding the negative tone of global financial markets as the week begins
  • The yuan is the worst performing currencies in EM over the past week at -1.6% vs. USD
  • We retain our bullish dollar call for now with the expectations that the trade war will eventually end with a compromise and no recession
  • Australia reported weak March home loans; Norway reported weak Q1 GDP
  • A long and protracted trade war is another headwind for EM to contend with
  • Turkey April current account came in at -$589 mln; India April CPI is expected to rise 2.99% y/y

The dollar is mostly firmer against the majors as the week begins under the cloud of risk-off sentiment. Swissie and yen are outperforming, while the dollar bloc and Scandies are underperforming. EM currencies are broadly weaker. RON and BGN are outperforming, while TRY and KRW are underperforming. MSCI Asia Pacific was down 0.7%, with the Nikkei falling 0.7%. MSCI EM is down 0.8% so far today, with the Shanghai Composite falling 1.2%. Euro Stoxx 600 is down 0.5% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 5 bp at 2.42%, while the 3-month to 10-year spread has flattened 4 bp to stand at 1 bp. Commodity prices are mixed, with Brent oil up 1.7%, copper down 1.3%, and gold down 0.2%.

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.

Trade tensions are feeding the negative tone of global financial markets as the week begins. Talks ended Friday with no breakthrough, and no date has been set for the next round. Despite constructive spin from both sides, we remain pessimistic near term. Reports suggest the US is giving China one month to reach an agreement before the second phase of US tariffs kicks in on another $325 bln of Chinese imports.

Indeed, rhetoric from both sides over the weekend suggest things will get worse before they get better. This has weighed on global equity markets whilst boosting core bond markets. JPY, CHF, and JPY are bid to start the week as risk-off sentiment returns after a brief absence Friday.

The yuan is the worst performing currencies in EM over the past week at -1.6% vs. USD. Yet we do not see the yuan becoming weaponized as trade tensions intensify. Please see our recent MarketView piece on China for a deeper look at China (My Baby, Xi Wrote Me A Letter).

The Atlanta Fed’s GDPNow model is now tracking 1.6% SAAR for Q2, down from 1.7% previously. Elsewhere, the New York Fed’s Nowcast model is now tracking 2.2% SAAR for Q2 vs. 2.1% the previous week. The first revision for Q1 GDP (3.2% SAAR advance) will be May 30, but the clear takeaway is that the US economy remains firm, at least for now.

We retain our bullish dollar call for now with the expectations that the trade war will eventually end with a compromise and no recession. However, a deal will clearly take longer than previously expected. Yet a deeper and more protracted trade war is one of those exogenous shocks that could tip the US into recession. We feel that it is beyond the Fed’s purview to try and offset the impact of a trade war with monetary policy.

During the North American session, there is no US data to be reported. Rosengren, Clarida, and Kaplan speak today, and kick off a week that’s heavy on the Fed speeches. We would expect a lot of the focus to turn on the impact of higher tariffs on the US economy and Fed policy.

Australia reported weak March home loans. Instead of contracting the expected -0.5% m/m, loans instead contracted -2.8% m/m. The RBA has become increasingly concerned with the weak housing and the potentially negative spillover to the wider economy, and so this data will feed into those concerns.

WIRP shows 34% odds of a cut at the June 4 RBA meeting. We believe July 2 is more likely, but further weakness in the data would argue for a cut sooner rather than later. Meanwhile, AUD should remain heavy considering renewed trade tensions. Break below .6955 is needed to set up a test of the January low near .6740.

Norway reported weak Q1 GDP. Rather than growing the expected 0.2% q/q, total GDP contracted -0.1% instead. Looking at only mainland (excluding oil and shipping) GDP, growth was 0.3% q/q vs. 0.4% expected. Growth was dragged down by a -1.2% q/q decline in investment.

Norges Bank will likely view the slowdown as temporary and go ahead with plans to hike again June 20. However, if data remain soft, the bank may have to soften its expected rate path then. We believe both EUR/NOK and USD/NOK will continue to move higher.

A long and protracted trade war is another headwind for EM to contend with. This is particularly true for those nations that are part of the Greater China supply chain. As a result, virtually all EM central banks are on hold now, with most looking to ease as soon as possible. Those that have the leeway should also use fiscal stimulus.

Turkey April current account came in at -$589 mln vs. -$1.0 bln expected. The 12-month total collapsed to -$12.8 bln, the lowest since December 2009. Stealth measures to support the lira are unlikely to have much lasting impact. Reports that Turkey would no longer buy a Russian missile defense system were later denied by the government.

India April CPI is expected to rise 2.99% y/y vs. 2.86% in March. If so, inflation would be in the bottom half of the 2-6% target range. WPI will be reported Tuesday which is expected to rise 3.0% y/y vs. 3.18% in March. Limited price pressures should allow the RBI to ease again at its next policy meeting June 6.