Dollar Firm in Fragile Calm for Equity Markets

  • Reports suggest that the US will go ahead with another round of tariffs if the Trump-Xi talks next month fail
  • We don’t see any obvious turnaround for equities, EM, and other risk assets right now
  • Tech stocks were hit yesterday on news that the UK will move forward with a digital services tax in 2020
  • Hammond promised tax cuts and an end to austerity, though he noted that “discipline will remain”
  • Germany reported firm October labor market data while state CPI readings are running high; Italy reported weak Q3 GDP
  • Japan reported firm September labor market data ahead of BOJ overnight
  • Mexico Q3 GDP is expected to grow 2.4% y/y; “buy the rumor, sell the fact” seen in Brazil

The dollar is mostly firmer against the majors as equity markets try to stabilize amidst continued volatility.  The dollar bloc is outperforming, while the yen and sterling are underperforming.  EM currencies are mixed.  ZAR and TRY are outperforming, while THB and INR are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 1.5%.  MSCI EM is down 0.2% so far today, with the Shanghai Composite rising 1%.  Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a higher open.  The US 10-year yield is up 3 bp at 3.12%.  Commodity prices are mostly lower, with Brent oil down 0.8%, copper down 1.1%, and gold down 0.63%.

Global markets continue to be roiled by the ongoing equity market sell-off.  Yesterday, the main trigger for accelerated selling were reports that the US would go ahead with another round of tariffs on Chinese goods if the Trump-Xi talks next month fail.  It appears that the trade war between the two largest economies is likely to drag on.

CNH sold off on the headlines yesterday during the North American session.  Today, the PBOC fixed the yuan weaker and the market took spot CNY up to 6.9740, the weakest in a decade.  However, we repeat our advice that the market should not read too much into the likelihood that USD/CNY will break above 7.  It is likely to happen within the context of broad-based EM weakness.

We don’t see any obvious turnaround for equities, EM, and other risk assets right now.  Yes, we are getting some pockets of stability here and there but nothing lasting.  Meanwhile, US rates will march higher and trade tensions will persist.  We get our first snapshot for October from China with PMI readings this week, and so you can add China slowdown to the list of potential negative factors ahead.  Meanwhile, China continues to roll out stimulus measures.  Latest reports suggest a potential tax cut on auto purchases to 5%.

Tech stocks were hit particularly hard yesterday on news that the UK will move forward with a digital services tax in 2020.  Whilst the amounts targeted are not high (GBP400 mln per year), the tax sets a precedent as the UK takes the first step in taxing the tech giants.  Furthermore, the tax would be levied on global revenue, not profits.  UK Chancellor Hammond stressed that the tax is not meant to hit consumers or internet startups.  The European Commission is proposing a similar tax but has yet to set forth any terms.

Hammond also promised tax cuts and an end to austerity, though he noted that “discipline will remain.”  Clearly, the Tories are feeling some heat from Labour and its promises to boost spending on public services.  Yet Hammond acknowledged that a no-deal Brexit would likely require an emergency budget.  The UK growth forecast was cut to 1.3% this year, down from 1.5% forecast in March.

Sterling is within striking distance of the August low near $1.2660.  After that comes the June 2017 low near $1.2590 and then the April 2017 low near $1.2350.  It’s probably too soon to talk about the March 2017 low near $1.2110 but longer-term charts point to an eventual test.

Germany reported October labor market data.  Unemployment fell -11k vs. -12k expected, while the unemployment held steady at 5.1%, as expected.  Preliminary October CPI will be reported later today and is expected to rise 2.4% y/y.  Prior to that report, many German states have reported accelerating inflation and so there are upside risks to the national number.

Italy reported weak Q3 GDP, which rose 0.8% y/y WDA vs. 1.0% expected and 1.2% in Q2.  This report is particularly important since so much of the 2019 draft budget hinges on how the economy performs.  Current growth assumptions are 1.5% in 2019, 1.6% in 2020, and 1.4% in 2021.  In light of the Q3 data, it will be even harder for Italy to justify its draft budget assumptions to the EU.  We see conflict ahead.

Like sterling, the euro is within striking distance of the August low near $1.13.  After that comes the June 2017 low near $1.1120.  Here too, it’s probably premature to talk about the May 2017 low near $1.0840 but longer-term charts point to an eventual test.

Japan reported firm September labor market data overnight.  Unemployment ticked down to 2.3%, while the jobs-to-applicant ratio ticked up to 1.64.  This comes ahead of September IP and BOJ decision tonight.  While the BOJ is not expected to change policy, we suspect it will do some jawboning to prevent renewed yen gains.  USD/JPY could not stay below the 112 area and is now probing the upside. Break of 113 and 113.35 would set up a test of the October high near 114.55.

During the North American session, US reports August home prices and October Conference Board consumer confidence.  Due to the FOMC meeting next week, the media embargo has started and there are no Fed speakers until after that meeting November 8.

With the recent underperformance in MXN, there are no longer any EM currencies that are up against USD YTD.  USD/MXN traded yesterday at its highest level since July 2 and the clean break of the 20 area sets up a test of the June 15 high near 20.96.

Mexico Q3 GDP is expected to grow 2.4% y/y vs. 2.6% in Q2.  While the economy remains sluggish, rising inflation has forced Banxico to tilt more hawkish.  Next policy meeting is November 15.  Much will depend on how the peso is trading but if current weakness continues, we now think it’s likely that the bank will hike then.  The AMLO airport fiasco in Mexico warns investors not to get too complacent about potential risks ahead from Bolsonaro in Brazil.

Indeed, the 3.60 area proved too tough for USD/BRL to crack yesterday.  Indeed, it seems that some “buy the rumor, sell the fact” was seen in Brazil assets as the Bovespa fell nearly 2.5% too.  With the rest of EM under pressure, we have felt that it would be very difficult (if not impossible) for BRL to continue gaining in absolute terms.  Perhaps the real can outperform in relative terms, but we remain skeptical that Bolsonaro will easily cure what ails Brazil.