Dollar Firm as Trade Optimism Caps a Volatile Week

  • Investors appear to be looking for some positive movement in US-China trade talks
  • US reported firmer than expected data yesterday; the US economy remains in solid shape
  • The data are dollar-positive and support our strong dollar call
  • ECB official Rehn spoke yesterday of the need for a “significant” easing package in September
  • Yesterday, Banco de Mexico delivered a dovish surprise and cut rates 25 bp to 8.0%

The dollar is mostly firmer against the majors as another eventful week draws to a close.  Sterling and Nokkie are outperforming, while Swissie and Kiwi are underperforming.  EM currencies are mostly firmer.  ZAR and PLN are outperforming, while RON and THB are underperforming.  MSCI Asia Pacific was up 0.3%, with the Nikkei rising 0.1%.  MSCI EM is up 0.4% so far today, with the Shanghai Composite rising 0.3%.  Euro Stoxx 600 is up 1.0% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 3 bp to 1.56%, while the 3-month to 10-year spread has steepened 3 bp to stand at -32 bp.  Commodity prices are mixed, with Brent oil up 1.8%, copper flat, and gold down 0.7%.

Investors appear to be looking for some positive movement in US-China trade talks.  Late yesterday, President Trump hinted that he would be speaking “very soon” with President Xi.  Trump added that his team has been having “very good” talks with their Chinese counterparts.  Market optimism comes despite reports of China preparing retaliatory measures against the US for its latest round of 10% tariffs that become effective September 1.

As a result, equity markets are higher today.  Bond markets are seeing some outflows, with most yields rising.  Swissie and yen are underperforming, while growth-sensitive major currencies and EM currencies are getting some traction.  We warn against getting too optimistic on the trade talks.  Even though the two sides appear to be talking, an actual deal seems to be a 2020 story.

Press reports that President Trump pressured Treasury Secretary Mnuchin to label China a currency manipulator.  While not a surprise, the pressure is unprecedented, turning what should be seen as an economic decision into a political one.  As we all know, China only meets one of the three criteria to be labeled a manipulator.  Trump reportedly ratcheted up the pressure after the yuan weakened past 7 per dollar last week, in the hopes that he could force China back to the negotiating table.

Reports suggest the US will go ahead with plans for an $8 bln fighter jet sale to Taiwan.  It would be the largest sale to Taiwan in years and comes despite strong objections by mainland China.  It remains to seen whether this will be used as a bargaining tool by the US in its trade talks with China.  However, the moves risks worsening an already tense atmosphere.

US reported much firmer than expected data yesterday.  Headline retail sales rose 0.7% m/m vs. 0.3% expected, while ex-autos rose 1.0% m/m vs. 0.4% expected.  The so-called control group used for GDP calculations jumped 1.0% m/m vs. 0.4% expected.  The small back month revisions were totally overwhelmed by the broad-based July gains.  On top of that, the Empire and Philly Fed manufacturing surveys came in double what was expected.  Only weak note was IP, which fell -0.2% m/m vs. +0.1% expected.  However, June was revised up to 0.2% from flat previously.

Obviously, the data are dollar-positive and support our strong dollar call.  With July core CPI rising a larger than expected 2.2% y/y and continued strength seen in the real economy, how can the Fed justify another cut in September?  We don’t think the Fed should cut just to satisfy the markets, but stranger things have happened.  During the North American session today, the US reports July housing starts and building permits, as well as August preliminary Michigan consumer sentiment.

Overall, the US economy remains in solid shape.  The Atlanta Fed’s GDPNow model is tracking 2.2% SAAR growth in Q3, up from 1.9% previously.  This is above trend (~2%) and little changed from the preliminary 2.1% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.6% SAAR growth in Q3 but will likely be revised higher in today’s weekly update.

Yet the US rates markets remain incredibly pessimistic.  WIPR suggests 100% odds of a cut September 18, with 33% odds of a 50 bp cut then.  Meanwhile, the Fed Funds futures strip shows 75 bp of easing nearly fully priced in for this year and nearly 50 bp more next year.

St. Louis Fed President Bullard gave a television interview yesterday afternoon.  He stressed that the US economic fundamentals are good, but that policy must be forward-looking.  Bullard said the US consumer also looks good, but that we are in the midst of a global slowdown that bears watching.  Bottom line:  this was a balanced view from Bullard and doesn’t sound like someone who wants a 50 bp cut next month.

On the flip side, ECB official Rehn spoke yesterday of the need for a “significant” easing package in September.  He added that when working with markets, it’s better to overshoot than to undershoot.  WIRP suggests 100% odds of a cut September 12, and odds of a larger 20 bp cut have risen to 64% from 42% at the start of the week.  This helped push the euro lower yesterday.  Weakness continues today and charts point to a test of the August 1 low near $1.1025.

Yesterday, Banco de Mexico delivered a dovish surprise and cut rates 25 bp to 8.0%.  It wasn’t a huge surprise, however, as the market was nearly evenly split between no move and a 25 bp cut.  The vote was not unanimous, with one member favoring steady rates.  The bank cited external and yield curve behavior, downside growth and inflation risks, and global trade tensions as reasons for the cut.

Singapore reported July trade data.  NODX were expected to contract -15.4% y/y but fell only -11.2%.  Electronics exports fell -24.2% y/y vs. -33.2% expected.  We can’t get too excited yet as the regional exporters should continue to suffer from the US-China trade war.  Until that has been resolved and tariffs cut, regional trade and growth are likely to remain weak.  MAS next meets in October and odds of easing then have risen.