Dollar Firm as Shutdown Looms

  • There is a growing sense of chaos emanating from Washington DC
  • The risks of a partial US government shutdown are high
  • US data reports today are pretty minor
  • China pledged “significant” tax cuts and signaled easier monetary policy in 2019
  • Japan reported November CPI
  • Oil continues to get hit; Colombia central bank is expected to keep rates unchanged at 4.25%

The dollar is mostly firmer against the majors as the week ends on a risk-off note.  Sterling and yen are outperforming, while Kiwi and Stockie are underperforming.  EM currencies are mostly weaker.  KRW and PHP are outperforming, while TRY and INR are underperforming.  MSCI Asia Pacific was down 0.6%, with the Nikkei falling 1.1%.  MSCI EM is down 0.1% so far today, with the Shanghai Composite falling 0.8%.  Euro Stoxx 600 is down 0.6% near midday, while US equity futures are pointing to a higher open.  The US 10-year yield is down 1 bp at 2.79%.  Commodity prices are mostly lower, with Brent oil down 2%, copper down 0.7%, and gold flat.

There is a growing sense of chaos emanating from Washington DC.  Markets were already reeling from the FOMC, but now must contend with a potential government shutdown, the withdrawal of US troops from Syria and possibly Afghanistan, and the resignation of Defense Secretary James Mattis.  On their own, any of these developments might have been digested by the markets without much effort. Taken together, they are feeding the risk-off sentiment that’s already there.

How should the dollar trade under these circumstances?  After the FOMC, the dollar seemed to be taking its cue from the bond and equity markets.  That is, recession risk is seen as high and that is totally dollar-negative as the budget deficit would blow out and the Fed would cut rates.

On the other hand, the dollar and USTs remain a favored safe haven destination in times of stress.  Today, the dollar has firmed a bit as the shutdown looms.  Can that haven status be maintained when the source of uncertainty and risk is the US itself?  To be determined.

To repeat, the risks of a partial US government shutdown are high.  A deal must be reached by midnight tonight.  The Senate approved a stopgap spending bill Wednesday without wall funding, but President Trump said he will not sign it.  Elsewhere, House Democrats have the votes to block the bill that House Republicans passed that includes funding for the wall.  This is truly an impasse.  The worst-case scenario is that the shutdown ends when the new House is sworn in.

Markets recognize that shutdowns are largely opportunities for political posturing by all parties.  Eventually, one side blinks and the shutdown ends.  That said, we have seen before that shutdowns can still impact market sentiment negatively.  Going into thin year-end markets that are already nervous about a multitude of risks, it seems a given that a shutdown will roil markets more than usual.

The impact of US troop withdrawals from Syria and Afghanistan are clearly more political than economic.  The geopolitical impact of these moves likely won’t be felt for a long time.  However, perhaps the real story is the abrupt nature of these decisions, reportedly made over the objections of senior US advisors.  It would appear we are entering uncharted waters with regards to US foreign policy.

US data reports today are pretty minor.  Q3 GDP revision and November durable goods orders and personal income and spending are due out.  November core PCE will likely be the most important data point for a market looking for inflationary signals.  It is expected to tick up to 1.9% y/y, putting it closer to the Fed’s 2% target.   At 2.79%, we think that the 10-year US yield is too low considering our constructive outlook for the US economy.

China pledged “significant” tax cuts and signaled easier monetary policy in 2019.  This should be no surprise, as policymakers are struggling to boost growth.  It said fiscal policy will be “proactive” and should be stronger and more efficient.  This also suggests to us that China is preparing for the long haul with regards to US-China trade talks, especially after President Xi struck a very defiant tone earlier this week.

Japan reported November CPI.  Headline fell to 0.8% y/y from 1.4% in October, as expected, while ex-fresh food dropped a tick to 0.9% y/y vs. 1.0% expected.  The yen has benefitted this week from the building risk-off sentiment.  USD/JPY broke below a major retracement objective near 111.60, which sets up a test of the August 21 low near 109.80.  Up next is the 200-day MA near 110.90.

Oil continues to get hit.  WTI is approaching a key level near 45.45 and a break below would target the February 2016 low near 26.05.  For Brent, the equivalent level is 49.90, break of which would target its January 2016 low near 27.10.  RUB, COP, NOK, and CAD are all feeling the pinch from this and are likely to continue underperforming.

Colombia central bank is expected to keep rates unchanged at 4.25%.  CPI rose 3.3% y/y in November, slightly above target but still within the 2-4% target range.  With oil prices still vulnerable, we believe the central bank will be cautious in starting the tightening cycle.