Iran and trade are likely on the back burner for now; the dollar is clawing back its post-jobs data losses
During the North American session, there is little scheduled ahead of the US data deluge later this week
Weak UK data and an increasingly dovish BOE are weighing on sterling
Taiwan President Tsai Ing-wen was reelected in a landslide, creating another political headache for China; Bank Indonesia signaled it will not lean against rupiah appreciation
The dollar is mostly firmer against the majors as the new week begins. The euro and Swissie are outperforming, while sterling and yen are underperforming. EM currencies are mostly firmer. IDR and KRW are outperforming, while HUF and RUB are underperforming. MSCI Asia Pacific ex-Japan was up 0.6% on the day, with Japan closed for holiday. MSCI EM is up 0.6% so far today, with the Shanghai Composite rising 0.8%. Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 2 bp at 1.84%, while the 3-month to 10-year spread is up 3 bp at +32 bp. Commodity prices are mixed, with Brent oil flat, copper up 0.1%, and gold down 0.7%.
The recent developments regarding the downing of the Ukraine jet has likely changed the reaction function regarding the risk of further retaliation against the US. The government’s admission that the plane was shot by mistake has sparked protests around the country and flipped the narrative of support following the killing of General Soleimani. In our assessment, this will force the Iranian regime to re-focus on domestic matters, further reducing the risk of escalation of the conflict with the US. This should be supportive of risk assets.
Elsewhere, trade tensions are also likely to remain on the back burner. A Chinese delegation goes to Washington to sign the Phase One deal Wednesday. President Trump has said that Phase Two talks will begin immediately, but we do not expect much progress this year. That said, we think both sides have stepped back from the brink and will be hesitant to reignite the trade war. This too should be supportive of risk assets.
The dollar weakened after the weak jobs report, but it is clawing back those losses today. We remain bullish on the dollar and DXY appears on track to test the December 23 peak near 97.817. Break above the 97.71 area would set up a test of the November 29 high near 98.544. The euro remains heavy above the $1.11 area, while sterling has been pushed back below the $1.30 area (see below). Meanwhile, USD/JPY is trading at new highs for the cycle and is testing the 110 area, and the May 21 high near 110.65 looms ahead.
During the North American session, there is little scheduled ahead of the US data deluge later this week. US December budget statement will be reported (-$15.0 expected). In terms of the Fed, Rosengren and Bostic speak today. Last week, virtually every Fed speaker was on the same page, highlighting a solid 2020 outlook for the US that supports steady monetary policy. With BOE easing expectations rising (see below), this should be a good reminder to markets that the US remain relatively attractive compared to the rest of the major currencies.
The US economy is still doing better than anticipated in Q4. The Atlanta Fed’s GDPNow model estimates Q4 GDP growth at 2.3% SAAR, steady from the previous reading. Elsewhere, the NY Fed’s Nowcast model has Q4 growth at 1.1% SAAR, down from 1.2% previously, while its estimate for Q1 growth was steady at 1.2% SAAR. The Atlanta Fed is likely overstating growth a bit and the NY Fed understating it, and we suspect the truth is somewhere in between. Either way, we are far from recession and the Fed is right to pause for now to assess the landscape. Because we are upbeat on the US outlook, we do not see further easing in 2020.
Weak UK data is weighing on sterling. November GDP, IP, trade, and constriction output were all reported today and were largely weaker than expected. IP fell -1.2% m/m vs. flat expected, while GDP fell -0.3% m/m vs. flat expected. Elsewhere, the trade balance came in at a surplus of GBP4 bln vs. an expected -GBP2.5 bln deficit, while construction output rose 1.9% m/m vs. 0.6% expected. December CPI will be reported Wednesday, then December retail sales will be reported Friday. The data have taken on added importance.
The BOE continues to lean more dovish and easing bets have been reignited. Following Carney’s comments last week, Vleghe said he would vote for a rate cut this month if there are no signs of improvements in the economy. We still think talk of easing sounds very premature ahead of the likely fiscal stimulus from the new Tory government and improved sentiment from the US-China trade deal. Even though we are far from a final resolution on the UK EU relationship, there is less uncertainty and the risk of a sudden hard-Brexit is smaller than before. That said, the CME model suggests a 20% chance of a cut at the January 30 meeting, up from 5% a week ago, while Bloomberg’s WIRP model suggests a whopping 51% chance vs. 5% a week ago.
We suspect the true odds lie somewhere in between the two models, but these developments are weighing on sterling. Cable traded at its lowest level since December 26 near $1.2960 and is on track to test the November 22 low near $1.2825 and then the November 8 low near $1.2770. Looking further out, a break below the $1.27 area (major retracement objective and 200-day moving average) would set up a test of the October 8 low near $1.22. The euro has also been soft, limiting the rise in the EUR/GBP cross. That said, we expect sterling underperformance to continue, which should drive the cross higher to the .8700 area.
Taiwan President Tsai Ing-wen was reelected in a landslide, creating another political headache for China. The ruling Democratic Progressive Party advocates a formal independence from China, though in practice they know better than to provoke mainland politicians on the issue. Still, the DPP won the most votes since the start of elections in 1996 and so it’s hard to ignore. This victory strengthens the thesis that the experience of Hong Kong (and the “one country, two systems”) has turned into a powerful counterfactual for Taiwan. The TAIEX equity index closed 0.7% higher, in line with the positive moves across the region, while the Taiwanese dollar was modestly stronger against the US dollar.
Bank Indonesia signaled it will not lean against rupiah appreciation, leading to strong rally in the currency. In the end of last week, Bank Indonesia’s monetary policy director said the bank will let the currency appreciate “in accordance with the market mechanism, as long as the volatility is manageable.” This will continue to underpin investor demand for the country’s assets, especially the bond market and the currency. Implied rates in 3-month IDR NDFs are now at 4.7%, well below the roughly 8% level in mid-2019, but still high-enough to be a good carry trade story alongside the Mexican peso.