Dollar Firm as US-China Developments Feed Risk-Off Sentiment

  • US bond and equity markets reopen today amidst a backdrop of risk-off sentiment
  • US-China relations are likely to remain on edge after the arrest of Huawei’s CFO Meng in Canada
  • Because of yesterday’s holiday, the ADP report was delayed until today; yesterday’s Beige Book gave a balanced view of the economy
  • Prime Minister May’s government is contemplating concessions to win over Brexit rebels
  • Oil is coming under severe pressure again after Saudi officials highlighted difficulties in agreeing to a significant output cut
  • Canada reports October trade and November Ivey PMI; Australia reported trade and retail sales
  • EM is coming under renewed pressure despite lower US rates; South Africa reported Q3 current account data

The dollar is mostly firmer against the majors as the arrest of a Chinese executive is feeding into risk-off sentiment.  Yen and sterling are outperforming, while Nokkie and Aussie are underperforming.  EM currencies are broadly weaker.  PHP and CZK are outperforming, while ZAR and TRY are underperforming.  MSCI Asia Pacific was down 1.9%, with the Nikkei falling 1.9%.  MSCI EM is down 2.2% so far today, with the Shanghai Composite falling 1.7%.  Euro Stoxx 600 is down 2.3% near midday, while US equity futures are pointing to a significantly lower open.  The US 10-year yield is down 1 bp at 2.90%.  Commodity prices are lower, with Brent oil down 3.2%, copper down 2.1%, and gold down 0.1%.

US bond and equity markets reopen today amidst a backdrop of risk-off sentiment.  US yields resumed their drop, with the 10-year falling as low as 2.87% before recovering.  This is the lowest since September 7 and is on track to test the August low near 2.81%.  Meanwhile, global equity markets are struggling, and commodity prices are slumping.   The dollar and yen are well bid, while EM currencies are selling off.

US-China relations are likely to remain on edge after the arrest of Huawei’s CFO Meng in Canada over potential violations of US sanctions on Iran.  She faces extradition to the US, but China demanded her immediate release.  This comes at a truly delicate time, as both sides put their own spin on what was clearly a difficult meeting last weekend between Trump and Xi.  To put it bluntly, we think this will force China to take a more aggressive and confrontational approach with the US.

Because of yesterday’s holiday, the ADP report was delayed until today.  Consensus sees +195k ahead today ahead of an expected +198k gain in nonfarm payrolls tomorrow.  November Challenger job cuts, October trade and factory orders, weekly jobless claims, and November ISM non-manufacturing PMI will also be reported.  The Fed’s Bostic, Williams, and Powell all speak today.

Yesterday’s Beige Book gave a balanced view of the economy.  As such, it did nothing to dissuade markets of a 25 bp hike this month.  Yet expectations of tightening in 2019 continue to fall.  The implied yield on the January 2020 Fed Funds futures contract has fallen to 2.65%, the lowest since August 23.  With the effective Fed Funds rate currently around 2.20%, this means that the lone hike that was priced in next year is no longer seen as a sure thing.

Press reports suggest that Prime Minister May’s government is contemplating concessions to win over Brexit rebels in her own party.  May reportedly tasked Chief Whip Julian Smith to negotiate a solution.  The planned compromise is said to include giving Parliament veto power over the Irish backstop, though this strikes us as a deal-breaker elsewhere.  The problem here is that the EU has clearly said that it is this deal or no deal.  Allowing parliament to amend or compromise would appear to be a non-starter.

Oil is coming under severe pressure again after Saudi officials highlighted difficulties in agreeing to a significant output cut.  OPEC is meeting in Vienna and is awaiting news from Russia.  Russia’s oil minister is reportedly meeting with President Putin to discuss his country’s contribution (if any) to OPEC+ efforts to support the oil market.  OPEC official said he sees “stiff resistance for a large cut” from Russia.  Both Brent and WTI oil are approaching their cycle lows from last week.

Canada reports October trade and November Ivey PMI.  Yesterday, the Bank of Canada delivered a dovish hold.  It noted that there may be more room for non-inflationary growth, adding that the future policy stance depends on oil, investment, and capacity.  The bank also noted that the economy has less momentum going into Q4.  Governor Poloz speaks today.

The dovish hold and falling oil prices are weighing on CAD.  A new high for this move in USD/CAD near 1.3445 was recorded today.  Our next target is the June 2017 high near 1.3545.  Looking further out, we target the May 2017 high near 1.38.

Australia reported trade and retail sales overnight.  The trade surplus was narrow than expected at AUD2.3 bln, while sale came in right at the consensus 0.3% m/m.  Due to combination of weaker than expected Q3 GDP data earlier this week and renewed US-China tensions, AUD is testing the .7200 area.  A break below .7165 is needed to set up a test of the cycle low from October 26 near .7020.

EM is coming under renewed pressure despite lower US rates.  We have always expressed doubt that lower US rates due to recession risks would be beneficial for EM, and recent price action confirms this.  EM benefits from strong global growth and trade flows, and this current environment is one of rising risks to both.  We remain negative on EM near-term

South Africa reported Q3 current account data.  The deficit was -3.5% of GDP and widened from a revised -3.4% (was -3.3%) in Q2.  Q3 GDP was reported Tuesday and came in much stronger than expected at 2.2% SAAR.  Going forward, there is not much room for upside growth surprises since the SARB started the tightening cycle.  Next policy meeting is January 17.  It will be a tough call, and much will depend on how the rand is trading then.