Dollar Firm as Risk Off Impulses Overpower the Blue Wave

  • Democrats are moving ahead with efforts to remove President Trump from office; the US curve continues to steepen; supply will come into focus this week due to a heavy UST auction schedule
  • The UK financial sector is suffering after Brexit; Chancellor Sunak hinted potential for another “Big Bang”; Turkey’s current account deficit widened by more than expected to -$4.06 bln in November
  • US-China tensions continue escalating into the final moments of the Trump presidency, now through Taiwan; China reported CPI and PPI; cryptocurrencies saw large corrections over the weekend, though a portion has already retraced

The dollar continues to firm as the Blue Wave trades give way to a classic risk off episode.  Equity markets are lower, US yields are higher, and the dollar is higher.  DXY is up for the fourth straight day and is trading above 90.50 for the first time since December 23.  Given the position skew, we see potential for a test of the December 21 high near 91. That said, we view this bounce as temporary and continue to target the February 2018 low near 88.25.  The euro broke below $1.22 and may test the December 21 low near $1.2130. Sterling broke below $1.35 and may test the December 28 low near $1.3430.  USD/JPY is trading at the highest level since December 11 and may test the December 10 high near 104.60.

 

AMERICAS

Democrats are moving ahead with efforts to remove President Trump from office. Speaker Pelosi said they will first request unanimous consent in the House today for a resolution urging Pence to convene the cabinet to invoke the 25th Amendment “to declare the President incapable of executing the duties of his office.” If this fails, Pelosi said impeachment legislation will be brought to the floor. With less than ten days before Biden’s inauguration, any efforts to remove Trump are purely symbolic and would have no impact on policy. Indeed, reports have emerged that if the House votes to impeach, it may delay sending the article of impeachment to the Senate for trial in order to allow Biden to first address his legislative priorities.

The US curve continues to steepen.  At 102 bp, the 3-month to 10-year curve is the steepest since late March and is approaching the year’s high from March 18 near 120 bp.  The 10-year yield of 1.10% is the highest since March 19, while 10-year TIPS inflation breakeven inflation rate of 2.07% is the highest since October 2018.  Clearly, the rise in the long end is driven in part by rising inflation expectations here in the US as markets brace for another slug of fiscal stimulus. For now, higher yields appear to be helping the dollar but we have not yet seen the deluge of UST supply that is to come. So far, the rise in rates has been slow and steady and easily digestible for the markets, but the pace has picked up since last week. Stay tuned.

Indeed, supply will come into focus this week due to a heavy UST auction schedule. $58 bln of 3-year notes will be sold today, followed by $38 bln of 10-year notes Tuesday and $24 bln of 30-year bonds Wednesday. These come on top of $54 bln in 3-month and $51 bln of 6-month bills to be sold today as well. Simply put, this is a lot of paper for the market to digest and bidding may be cautious ahead of the inflation data. Looking ahead, the next round of stimulus will have to be funded by increased debt issuance and so it’s not too surprising that curve steepening continues. Bostic and Kaplan speak today, while the Bank of Canada releases its Q4 business outlook survey.

 

EUROPE/MIDDLE EAST/AFRICA

The UK financial sector is suffering after Brexit. Data show that London lost EUR6.3 bln ($7.7 bln) in daily stock trades to EU financial centers on January 4, the first business day after Brexit went into effect. The loss has added a sense of urgency for UK policymakers to quickly negotiate new rules for trade in services with the EU, something that was conspicuously absent from the final deal. Yet with the EU gaining business, there is no sense of urgency to cede any ground back to the UK. We suspect we will see more and more evidence in the coming months that Brexit is not the cash cow for UK that Brexiteers had promised. Instead, Brexit is likely to be a net negative for UK finances.

Chancellor Sunak hinted potential for another “Big Bang.” He noted that those calling for a repeat of former Prime Minister Thatcher’s deregulatory agenda in the 1980s “make a really, really good point.” He added that the UK financial industry has always managed to adapt over the years and could do so again, “whether you want to call it Big Bang 2.0 or whatever.” Meanwhile, efforts will be made to plug the holes. The UK Treasury said it plans to allow trading in Swiss shares, reversing an EU ban on such activity. This may help compensate for some of the loss in EU share trading, but the move also drives another wedge between the UK and EU.

Turkey’s current account deficit widened by more than expected to -$4.06 bln in November, adding further depreciation pressure to the lira. The figure is double the average over the last five years and brings the 12-month total up to -$38 bln, the largest since September 2018. The trade deficit widened to $5.03 bln, a 150% increase from last November. Important as the external accounts can be, the fulcrum of confidence on Turkish assets at the moment lies mostly on whether the central bank’s newfound orthodoxy will remain in place and, of course, the broad dollar trend impacting all emerging markets. Next policy meeting is January 21 and another hike is likely if the lira remains under pressure.

 

 

ASIA

US-China tensions continue escalating into the final moments of the Trump presidency, now through Taiwan. Secretary of Sated Pompeo declared “all contact guidelines regarding relations with Taiwan […] to be null and void.” These policies have been in place for decades. Now US ambassador to the UN Kelly Craft is set to visit Taiwan this week, putting China’s “One China” policy in check. While state-controlled expressed outrage, we doubt Beijing will overreact to these provocations with the Biden administration about to take over in a matter of days. That said, it sets up the Taiwan issue as a far more important flashpoint going forward; in other words, this tail risk got a lot fatter. The yuan was unfazed by these headline and, in fact, was little changed by the reversal of the broad dollar trend with spot and the fixing little changed on the day.

China reported CPI and PPI. The former rose 0.2% y/y vs. flat expected and -0.5% in November, while the latter fell -0.4% y/y vs. -0.7% expected and -1.5% in November. The data support our view that deflation fears in China are overblown. For now, there is no reason for policymakers to change their stance. December money and loan data will be reported sometime this week and are expected to show continued reliance on monetary stimulus.

 

COMMODITIES AND ALTERNATIVE INVESTMENTS

Cryptocurrencies saw large corrections over the weekend, though a portion has already retraced. There was no obvious trigger for the move, though today’s risk off backdrop supports our view that this asset class is a purely speculative one that trades in tandem with other risk assets. There have been signs of retail participation rising rapidly over the last week. Indeed, many of the major crypto exchanges (including Coinbase, Binance, and Kraken) experienced technical issues due to high demand when bitcoin reached $40,000, while eToro increased its investment limit from $200 to $1,000 due to “unprecedented demand.” Despite the dramatic headlines, the 23% or so peak-to-trough drawdown has happened four times in similar magnitudes several times over the last few months, suggesting we are still in the early stages of discovery in this volatile market.