Dollar Firm as Markets Await Fresh Drivers

  • President Trump confirmed that he is exploring tax cuts; our base case scenario for no US recession remains
  • FOMC minutes will be released; despite all the uncertainty in the US, we remain dollar bulls
  • Markets shrugged to news that Italian Prime Minister Conte resigned; Canada reports July CPI
  • Japan reported weak July supermarket and department store sales; Korea reported weak trade data for the first 20 days of August
  • South Africa July CPI is expected to rise 4.3% y/y

The dollar is mostly firmer against the majors as markets await fresh drivers.  The Scandies are outperforming, while sterling and yen are underperforming.  EM currencies are mostly firmer.  ZAR and RUB are outperforming, while CNY and CZK are underperforming.  MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.3%.  MSCI EM is up 0.2% so far today, with the Shanghai Composite flat.  Euro Stoxx 600 is up 1% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 3 bp to 1.58%, while the 3-month to 10-year spread has steepened 1 bp to stand at -33 bp.  Commodity prices are mixed, with Brent oil up 1.6%, copper up 0.2%, and gold down 0.4%.

President Trump confirmed that his administration is exploring tax cuts.  After denying a payroll tax cut was being considered, Trump now says he is open to the idea.  He also said that a cut in the capital gains tax via indexing is also being considered, adding that he can do it without congressional approval.  This would very likely run into legal challenges, in our view.

It seems clear that the White House is becoming increasingly concerned about the economy ahead of 2020 elections.  Unfortunately, budget deficits continue to widen and so there is very little room for fiscal stimulus.  Some estimate that the 2011-2012 payroll tax cut led to $100 bln of lost revenue.  Limited fiscal stimulus is one major reason why Trump and his economic team continue to jawbone the Fed for lower rates.

Our base case scenario for no US recession remains in place.  However, we acknowledge that headwinds are building.  The next round of US tariffs on China go into effect September 1, with the second half coming December 15.  The trade war has had negative knock-on effects on the rest of the world, depressing global activity.  We will say it once again: the best policies to deal with a trade war are neither fiscal nor monetary.  These can only soften the blow.  The best way to deal with the negative impact of a trade war is to eliminate the tariffs.

FOMC minutes will be released.  The July 31 meeting saw the Fed embark on what Chair Powell termed a mid-cycle adjustment.  Given the lack of Fed speakers since the decision, these minutes take on greater importance in divining the Fed’s future rate path.  US data this week is minor, with July existing home sales (2.3% m/m expected) to be reported today.

Minneapolis Fed President Kashkari is scheduled to speak today and tomorrow.  After that, there is nothing on the schedule until Powell’s Jackson Hole speech Friday morning.  For our latest thoughts on the Fed, please read our recent piece “Thoughts on the Fed Ahead of Its Jackson Hole Symposium.”  WIRP suggests 100% odds of a cut September 18, with 13% odds of a 50 bp move.

Despite all the uncertainty in the US, we remain dollar bulls.  If nothing else, the rest of the world looks even shakier.  DXY rally ran out of steam yesterday just below 98.50 but today’s follow-through selling has so far had limited success.  We believe the Fed will not be as dovish as markets expect this week.  This disappointment would likely be dollar-positive.

Sterling and euro went bid yesterday on possible signs of a UK-EU thaw.  They’ve gone nowhere today.  German Chancellor Merkel said that practical Brexit solutions would be considered by the EU.  However, she added that this did not include reopening the existing Brexit agreement and so it appears markets overreacted to the initial headlines.  We believe risks of a hard Brexit continue to rise.  For our latest thoughts on Brexit, please read our recent piece “UK Brexit Scenarios Narrowing.”

Markets merely shrugged yesterday to news that Italian Prime Minister Conte resigned.  He declared the ruling coalition “terminates here.”  President Mattarella said consultations will being today at 4 PM local time, though talks with the largest parties aren’t scheduled until Thursday.

Press reports suggest Mattarella will give Five Star and the opposition Democratic Party a chance to form a government before calling for new elections.  This would be the best possible outcome for the markets.  However, there is no guarantee that this government would be any more stable than the previous one.  For now, the news has helped boost European equities today.

Canada reports July CPI.  Headline is expected to fall sharply to 1.7% y/y from 2.0% in June, while common core is seen steady at 1.8% y/y.  With the data softening, market expectations for BOC easing have picked up.  WIRP suggests 17% odds for a cut September 4, rising to 64% October 30.  This along with lower oil prices have weighed on the Loonie.  USD/CAD is trading near the top of recent trading ranges.  A break of the 1.3355 area is needed to set up a test of the May 31 high near 1.3565.

Japan reported weak July supermarket and department store sales.  Supermarket sales contracted -7.1% y/y vs. -0.5% in June, while nationwide department store sales contracted -2.9% y/y vs. -0.9% in June.  Data have come in softer and so market expectations for BOJ easing have also picked up.  WIRP suggests 45% odds of a cut September 19, up from 22% at the beginning of August.  Yet the yen remains firm, powered by safe haven demand.  For now, 107 is likely to cap USD/JPY.

Korea reported weak trade data for the first 20 days of August.  Exports contracted -13.3% y/y vs. -13.6% in July, while imports contracted -2.4% y/y vs. -10.3% in July.  Like the rest of the region, the Korean economy remains under pressure.  If tensions with Japan worsen, then the outlook for exports and growth gets even worse.  Bank of Korea started the easing cycle with a 25 bp cut in July.  Next policy meeting is August 29 and another cut then is possible.

South Africa July CPI is expected to rise 4.3% y/y vs. 4.5% in June.  If so, inflation would move into the bottom half of the 3-6% target range.  SARB started the easing cycle with a 25 bp cut to 6.5% in July.  Next policy meeting is September 19 and much will depend on the rand and global conditions then.