Dollar Firm as Risks Pile Up

  • The dollar remains bid as the usual drivers remain in play
  • The highlight today will be the US October CPI report
  • Oil is making new lows for this move as recent Saudi plan to cut output next year was just a speed bump
  • Eurozone reports Q3 GDP; UK reports October CPI
  • Japan reported Q3 GDP; China reported October retail sales and IP
  • Mexican assets remain under pressure as political risks are rising
  • Bank of Thailand kept rates steady, as expected; Colombia reports September retail sales and IP

The dollar is broadly firmer against the majors as Italy and Brexit continue to pose serious risks.  Kiwi and yen are outperforming, while the Scandies are underperforming.  EM currencies are mixed.  INR and ZAR are outperforming, while TWD and MXN are underperforming.  MSCI Asia Pacific is down 0.2%, with the Nikkei rising 0.2%.  MSCI EM is down 0.3% so far today, with the Shanghai Composite falling 0.9%.  Euro Stoxx 600 is down 1.1% in morning trading, while US futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 3.13%.  Commodity prices are mostly lower, with Brent oil flat, copper down 0.6%, and gold down 0.1%.

The dollar remains bid as the usual drivers remain in play.  Italy is engaged in brinksmanship with the EU, whilst the UK struggles to reach a Brexit compromise.  It’s difficult to predict how this all plays out but suffice to say that the chance of a bad outcome somewhere is not insignificant.  In this environment, EM is likely to remain under pressure.

The highlight today will be the US October CPI report.  Consensus sees headline rising 2.5% y/y and core rising 2.2%.  The larger than expected 2.9% y/y gain in headline PPI reported last week was driven in large part by a 2.7% gain in energy prices.  Still, even core PPI rose a larger than expected 2.6% y/y and near cycle highs.  While PPI and CPI do not always correlate well, we would simply warn of the risk of an upside surprise here.

The Fed’s Quarles and Powell speak today.  Of note, former Fed Chair Yellen said earlier this week that she expects 3-4 hikes next year.  While she no longer has any direct insight into the Fed, we think her view is shared by many of her colleagues that are still at the Fed.  US yields remain depressed from safe haven flows.

Oil is making new lows for this move as recent Saudi plan to cut output next year was just a speed bump.  President Trump criticized that plan, adding to the bearish momentum.  Brent is on track to test the February low near 61.75, but WTI is leading this move and has already broke below its February low near 58.05.  WTI is now on track to test the August 2017 low near 45.60.  As this selloff continues, there will be serious implications for Mexico, Colombia, Brazil, and Canada, amongst others.

Eurozone reports Q3 GDP.  Headline growth is seen remaining steady at 1.7% y/y.  However, there are downside risks after slowing has already been seen in Italy (0.8% y/y) and Germany (1.1% y/y expected).  German officials in particular have stressed that the Q3 slowdown is transitory, but that remains to be seen as PMI readings continue to roll over.

Press reports suggest the Italian government will make no concessions to the EU with regards to the draft budget.  There were some rumblings that the growth forecasts could be tweaked, but there were no changes made to the initial draft budget.  At this point, we think the EU will start the sanctions process for Italy.  While this process is slow, the impact on market sentiment will be negative.

The euro is likely to remain under pressure as a result of Italy.  It is having trouble staying above the $1.13 area and should revisit the lows soon.  The 10-year Italy-German spread continues to rise.  At 315 bp, it still seems too low.

Sterling rallied yesterday on reports that the EU and UK had agreed on the text of a Brexit deal.  That optimism has worn off a bit after various Tory and DUP officials expressed opposition.  First, Prime Minister May must present it to her cabinet for approval today.  If she can ram it through, then the full parliament must approve it within the next couple of weeks.  If it somehow passes, then a UK-EU summit would likely be called for late November.  Color us skeptical that the reported 600-page draft will get that far.

UK reports October CPI.  Headline is expected to rise 2.5% y/y and CPIH by 2.3% y/y, both a tick higher than September.  We believe that what the BOE does next year hinges crucially on Brexit, rather than the economic data.  Next policy meeting is December 20, and no change is expected.  Despite yesterday’s bounce, sterling remains heavy and is struggling to remain above $1.30.

Japanese Q3 GDP contracted -1.2% SAAR vs -1.0% expected.  The weak number may only be temporary.  However, forward-looking orders data have been weak in the last couple of months and this bears watching.  No wonder policymakers are maintaining a cautious outlook with regards to removing stimulus.

The recent rise in USD/JPY will be welcomed by policymakers.  While the 114 area may provide some resistance, charts point to a test of the year’s high near 114.55 from early October.

China reported October retail sales and IP.  The former rose 8.6% y/y vs. 9.2% expected while the latter rose 5.9% y/y vs. 5.8% expected.  We are seeing growing concerns about growth in China, embodied by continued stimulus measures by policymakers.  After yesterday’s weak money and loan data, more stimulus should be forthcoming.

Bank of Thailand kept rates steady at 1.5%, as expected.  However, the vote was 4-3 and suggests that a rate hike will be seen soon.  The next policy meeting is December 19.  While it is tempting to predict that the tightening cycle will begin then, much depends on the global backdrop then.  Note CPI rose 1.2% y/y in October, below the 2.5% target and near the bottom of the 1-4% target range.

Mexican assets remain under pressure as political risks are rising.  AMLO will reportedly hold referendums on a new refinery and rail project at the end of the month.  Put simply, this is not how one runs policy, by asking the public to make every major decision.  That’s what elected officials are supposed to do.  Furthermore, it appears that Morena lawmakers in the Mexican Senate will continue with plans to cut some bank fees despite AMLO’s reversal.

USD/MXN is making new highs for this move and is on track to test the June high near 20.96.  The way things are going, we think the pair will eventually test the all-time high near 22.04 from January 2017.

Colombia reports September retail sales and IP.  It reports Q3 GDP Thursday, which is expected to grow 2.7% y/y vs. 2.5% in Q2.  Lower oil prices are a growing headwind on the economy.  At the same time, USD/COP is on track to test the October high near 3228.  If oil keeps sliding, we cannot rule out a test of the all-time high near 3453 from February 2016.