Dollar Firm as Market Calm Shattered by Risk-off Triggers

  • The week is starting off with a bout of risk-off sentiment from several triggers
  • North Korea ran live-fire military exercises Saturday; President Trump shocked markets with renewed tariff threats
  • Caixin reported April China services and composite PMIs; we do not think China will use the weak yuan as a weapon
  • Obviously, renewed threats to global trade are negative for EM
  • During the North American session, there are no US data reports
  • Final eurozone services and composite PMI readings were reported
  • Indonesia Q1 GDP came in weaker than expected

The dollar is broadly firmer against the majors as the week begins under a cloud of risk-off sentiment. Yen and euro are outperforming, while Nokkie and sterling are underperforming. EM currencies are broadly weaker. BGN and RUB are outperforming, while ZAR and MXN are underperforming. MSCI Asia Pacific ex-Japan was down 1.8%, with Japan closed until tomorrow for Super Golden Week. MSCI EM is down 1.6% so far today, with the Shanghai Composite down 5.6% after China reopened from holiday. Euro Stoxx 600 is down 1.5% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 2 bp at 2.53%, while the 3-month to 10-year spread has flattened 2 bp to 11 bp. Commodity prices are mostly lower, with Brent oil down 0.9%, copper down 0.9%, and gold up 0.2%.

North Korea ran live-fire military exercises Saturday that likely included the launch of a short-range ballistic missile. Rather than threaten Kim, President Trump took a surprisingly conciliatory tone. Elsewhere, press reports that Pyongyang-watchers are detecting subtle changes in North Korea’s top diplomats that may signal a shift in diplomatic tactics. Stay tuned. Korea is closed today on holiday. USD/KRW is trading at its highest level since January 217 and is on track to test the December 2016 high near 1212.

With a trade deal seemingly within reach, President Trump shocked markets with renewed tariff threats. Unless China gives in to US demands quickly, he said the US will increase tariffs on $200 bln of imports from China from 10% to 25% this Friday. He will also extend that 25% duty on another $325 bln of Chinese goods “shortly.” These threats will likely derail any trade deal between the two nations, as we simply cannot see China giving into this sort of threat.

China officials said its trade delegation would still travel to Washington for the next round of talks. However, China was unable to confirm when, suggesting there will be some delay. China officials were scheduled to arrive this Wednesday, led by Vice Premier Liu. Markets had been led to believe that this could have been the final round of talks before a final deal was announced.

Lastly, the mood is likely to remain sour after US warships sailed near disputed islands in the South China Sea today. US Navy official said that the move was meant to assert international sailing rights and to “challenge excessive maritime claims.” China has controversially occupied several islands in the Spratly chain that are also claimed by the Philippines, Taiwan, and Vietnam.

Caixin reported April China services and composite PMIs. Services came in higher than expected at 54.5, but this was not enough to prevent a drop in the composite PMI to 52.7 from 52.9 in March. Last week, Caixin reported its manufacturing PMI dropping sharply to 50.2 from 50.8 in March. Official PMI saw all three of its measures fall in April.

Even with Trump’s threats, we do not think China will use the weak yuan as a weapon. Instead, we expect yuan weakness that fully reflects broad-based EM FX weakness. USD/CNY gapped higher to near 6.80, the highest level since January 24. The correlation between CNY and MSCI EM FX remains high at nearly 0.75 currently.

Obviously, renewed threats to global trade are negative for EM. We expect further EM weakness in this current environment, where things are likely to get worse before they get better. Can China officials remain silent in the face of renewed US threats? We doubt it.

During the North American session, there are no US data reports. Fed officials are out in full force this week, with Harker speaking today. Markets continue to price in one hike this year followed by another hike next year. We think this is what Powell was pushing back against, though to little effect so far. WIRP suggests 10% odds of a cut at the June 19 FOMC meeting, which seems absurd to us.

Final eurozone services and composite PMI readings were reported. Headline services rose to 52.8, dragging the composite higher to 51.5. Spain and Italy composite readings fell much more than expected from March to 52.9 and 49.5, respectively. Deterioration in their services PMIs more than offset the improved manufacturing PMIs for these two. Elsewhere, French and German composite readings both rose a tick from the flash readings at 50.1 and 52.2, respectively.

The euro has gotten little support from recent strength in the eurozone data. It is struggling to break back above $1.12 and so we favor a resumption of the downtrend soon. Any break above $1.12 would present a good opportunity for euro bears to reload.

Indonesia Q1 GDP came in weaker than expected. Growth slowed to 5.07% y/y vs. 5.2% expected and was the lowest since Q1 2018. Bank Indonesia delivered a dovish hold in April, and we believe an easing cycle will begin in H2. Next policy meeting is May 16, but we think that may be too soon for a cut. For USD/IDR, a break above 14365 is needed to set up a test of the December high near 14655.