Dollar Firm as Markets Get a Reality Check

  • Excitement about the Brexit deal has started to fade after strong objections by the DUP
  • US-China tensions are rising again, but this time because of Hong Kong
  • Russian President Putin has stepped into the vacuum of power between Turkey and Syria
  • The US data highlight is September retail sales; Fed Beige Book for the upcoming October 30 FOMC meeting will be released
  • Canada reports September CPI; UK and eurozone reported soft September CPI
  • New Zealand Q3 CPI rose 1.5% y/y; BOK cut rates 25 bp to 1.25%, as expected

The dollar is mostly firmer against the majors as markets get a reality check on recent optimism.  Swissie and yen are outperforming, while Nokkie and Kiwi are underperforming.  EM currencies are mostly weaker.  TRY and INR are outperforming, while ZAR and CNY are underperforming.  MSCI Asia Pacific was up 0.7% on the day, with the Nikkei rising 1.2%.  MSCI EM is up 0.2% so far today, with the Shanghai Composite falling 0.4%.  Euro Stoxx 600 is flat near midday, while US futures are pointing to a lower open.  10-year UST yields are down 5 bp at 1.73%, while the 3-month to 10-year spread has fallen 2 bp and stands at +10 bp.  Commodity prices are mostly lower, with Brent oil flat, copper down 1.5%, and gold up 0.1%.

Markets have gotten a reality check.  Two actually.  Maybe even three.  A Brexit deal remains hard to pin down, while tensions between the US and China are rising again.  Add in a rapidly shifting situation in Syria and one has to wonder why markets remain so optimistic.  Trading has been reduced to headline ping pong, but we look past this noise to reiterate our broad macro calls.  That is, we look for another delay in Brexit as well as ongoing US-China tensions that periodically move from a simmer to a boil.  We are keeping our broad strong dollar call as market expectations of Fed easing should fall.  EM is likely to get some limited traction as further escalation of the trade war now seems likely.

Excitement about the Brexit deal has started to fade after strong objections by the DUP.  This Northern Irish party is allied with the Conservatives and its support is crucial. It seems that one of the concessions that Boris Johnson was forced to make to the EU was accepting some customs checks between Northern Ireland and the rest of the UK. This is hard for the DUP and hardline Brexiteers to accept. Johnson reportedly tried to bribe the region with cash payments, but it doesn’t seem to be enough. All this could be just hard bargaining by the DUP, using their leverage in the situation to extract more concessions, but we don’t think so.  Yet now we have gotten optimistic comments from the EU’s Barnier, and so the ping pong continues.  Once again, the situation points to an extension and elections shortly after.  The good news is that the odds of a hard Brexit seem to have fallen.  Off the cuff, we put 50% odds on a delay, 30% odds of a deal, and 20% odds of hard Brexit.

US-China tensions are rising again, but this time because of Hong Kong.  The US House of Representatives passed a bill that would require an annual review of whether Hong Kong is sufficiently autonomous from China to justify special trading status.  The Hong Kong Human Rights and Democracy Act calls for sanctions against any officials “responsible for undermining fundamental freedoms and autonomy in Hong Kong.”  The bill still needs to be passed by the Senate, and China officials vowed retaliation if it becomes law.  This comes a week after the US sanctioned eight Chinese companies for human rights violations against Muslim Uighurs.  This sort of foreign interference in internal affairs will not be taken well.  Stay tuned.



The US data highlight is September retail sales.  Headline sales are expected to rise 0.3% m/m, ex-autos 0.2%, and the so-called control group 0.3%.  With manufacturing weakness starting to spread to the wider economy, strong consumption is vital to avoiding a recession.  The next slug of tariffs planned for October 15 have been suspended, but that was just a five percentage point increase to 30%.  The 25% tariffs already in place will remain in place and that remains a big risk to consumption.

The Fed Beige Book for the upcoming October 30 FOMC meeting will be released.  We suspect it will highlight softer manufacturing and some growing risks of spillover to the wider economy.  WIRP suggests 75% odds of a cut October 30, which still seems too high to us.  There is also a full slate of Fed speakers this week before the media embargo goes into effect nest week.  Evans and Brainard speak today.  The US 3-month to 10-year curve remains positive at 9 bp but was as high as 14 bp earlier today, the highest since April 23.  If sustained, this move to positive slope will significantly push down perceived recession risk.

The Fed will start its balance sheet expansion today.  Recall that it will buy $60 bln of T-bills monthly into Q2.  This should address the dislocations in the repo and Fed Funds markets once and for all.  It’s interesting that the Fed announced the expansion ahead of the October 30 FOMC.  We think it did this to stress that the purchases are not part of its monetary policy stance and that it was purely technical.  That said, recent developments should take some pressure off of the Fed to cut this month.

Canada reports September CPI.  Headline is expected to rise 2.1% y/y vs. 1.9% in August, while common core is expected to remain steady at 1.8% y/y.  Data have been coming in firm, leading markets to push out BOC easing expectations.  WIRP suggests only 3% odds of a cut October 30 and 9% for December 4, rising to only 17% in Q1 2020.  Relatively high carry has helped CAD to outperform during this recent bout of USD weakness, though USD/CAD is seeing some support near 1.32.  This coincides with the 50% retracement objective of the July-September rise.  The 62% level comes in near 1.3155 and a break below that would set up a test of the July low near 1.3015.



UK reported September CPI.  Headline and CPIH both rose 1.7% y/y vs. 1.8% expected.  September data so far have been coming on the soft side, as Brexit uncertainty continues to take a toll on the economy.  WIRP suggests 12% odds of a cut November 7 and 25% for December 19.  If our base case of another delay until early 2020 comes true, then the BOE is likely to remain on hold for the rest of this year.  Odds of a cut rise as we move through H1 2020, with WIRP putting the odds of a cut by mid-year around 50%.  That seems reasonable to us.

Final eurozone CPI slipped a tick from the preliminary reading to 0.8% y/y.  This is the lowest reading since November 2016 and slips further below the 2% target.  Core held steady at 1.0% y/y, but it’s clear that the economy is losing momentum.  ECB easing measures taken last month were timid and further stimulus will likely be needed.  The euro has been dragged higher by sterling’s bounce on Brexit optimism but feels heavy above $1.10.

Russian President Putin has stepped into the vacuum of power between Turkey and Syria. Reports claim that he is trying to temper Turkish President Erdogan’s incursion, while also supporting its Syrian ally.  So far, Turkey has rejected calls for a cease-fire, setting itself up for a possible confrontation with Russia, especially after the Kurdish-dominated Syrian Democratic Forces turned to al-Assad for support. The lira has stabilized over the last couple of sessions, but this is surely due to official efforts to suppress the move.  Aside from the usual dollar selling by public banks, reports claim that regulators have been unofficially directing local lenders to hold back on offering lira liquidity offshore to cut off short sellers. Similarly, authorities were said to prohibit short-selling in seven banks involved in a US investigation into money laundering.  The Istanbul 100 index is down 1.5% today and over 10% so far this month.



Meanwhile, Russia September IP is expected to rise 3.0% y/y vs. 2.9% in August.  Real retail sales will be reported Thursday, which are expected to rise 1.0% y/y vs. 0.8% in August.  Inflation fell to 4.0% y/y in September, right at the target.  Lower oil prices will be a drag on growth and so the economy is likely to remain sluggish.  Next policy meeting is October 25 and a 25 bp cut to 6.75% is expected then.



New Zealand Q3 CPI rose 1.5% y/y vs. 1.4% expected and 1.7% in Q2.  This matches the Q1 low for the year and moves further below the 2% target but still within the 1-3% target range.  RBNZ Deputy Governor Bascand said overnight that lower rates may still be needed, adding that the RBNZ continues its preparatory work on unconventional monetary policy tools in case the policy rate hits its effective lower bound.  WIRP suggests nearly 100% odds of a 25 bp cut to 0.75% on November 13.  NZD is trading at its lowest level since October 3 and is on track to test the October 1 low near .6205.

Bank of Korea cut rates 25 bp to 1.25%, as expected.  The economy remains under pressure from the US-China trade war.  It noted that growth and inflation are likely to run below July projections adding that it will observe the effects of two rate cuts taken before judging ether to adjust the degree of accommodation.  CPI fell -0.4% y/y in September, way below the 2% target.  Ahead of the decision, unemployment rose to 3.4% in September from 3.1% in August.