Dollar Firm In New Week with Same Drivers

  • The dollar remains firm as the same supportive drivers remain in place
  • The situation in Hong Kong is deteriorating; the yuan was fixed weaker overnight
  • Italian political leaders will meet today
  • After posting a new cycle low earlier, sterling saw a small bounce
  • NZ Treasury Department identified the lower bound for the policy rate at -0.35%
  • Fitch upgraded Russia one notch to BBB with stable outlook; Argentina is likely to come under pressure today after the weekend primary

The dollar is mostly firmer as the new week begins.  Yen and sterling are outperforming, while the Scandies and Antipodeans are underperforming.  EM currencies are broadly weaker.  CNY and RON are outperforming, while MXN and ZAR are underperforming.  MSCI Asia Pacific ex-Japan was down 0.4%, with Japan closed for holiday.  MSCI EM is down 0.3% so far today, with the Shanghai Composite rising 1.5%.  Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 5 bp at 1.69%, while the 3-month to 10-year spread has inverted 5 bp to stand at -29 bp.  Commodity prices are mostly lower, with Brent oil down 0.9%, copper down 0.4%, and gold up 0.5%.

The dollar remains firm as the same supportive drivers remain in place.  Italian politics and Brexit risks continue to weigh on sterling and the euro, while ongoing US-China trade tensions continue to crush EM FX.  The US economic outlook has almost become a sideshow for now, though US rates markets remain too pessimistic. That the dollar is gaining even as US rates are pinned to the lows supports our view that as bad as things may get in the US, the rest of the world is even worse off.  We remain dollar bulls.

The US July budget statement will be reported today.  A deficit of -$120 bln is expected.  If so, the 12-month total would rise to -$962.1 bln and nearing the cycle high of -$985 bln back in May.  The -$1 trln mark will likely be surpassed soon, something we haven’t seen since February 2013.  There are no Fed speakers scheduled for today.

The situation in Hong Kong is deteriorating.  Flights were canceled today after protestors swarmed the main airport terminal building, leading to further disruptions.  This led to heightened criticism from the mainland, with senior official saying the protestors had committed serious crime and showed signs of “terrorism.”  The Hong Kong economy is already suffering form the US-China trade war, and these ongoing protests will only make things worse.  That said, we see no risks to the HKD peg.

The yuan was fixed weaker overnight.  While it was another new high for USD/CNY since 2008 at 7.0211, it was within expectations.  Recent moves support our view that China is not weaponizing the yuan, but rather letting market forces drive its movements.  CNH is firmer than the cycle lows seen earlier this week, but CNY is making new lows.  We expect weakness to continue along with the rest of EM FX.

Italian political leaders will meet today to determine when Prime Minister Conte will have to face a no-confidence vote.  The intrigue deepens, as reports suggest coalition partner Five Star has approached opposition parties in an effort to block the vote.  Regardless of the outcome, it is clear that the working alliance between these two coalition partners is history.  Unless Five Star’s plan works, most observers expect snap elections in the fall, just in time for the annual budget process.

The euro traded at its lowest level since August 5 earlier today and remains heavy.  It has posted series of lower highs since peaking on August 6 and has retraced about a third of this month’s rally.  A break below $1.1110 is needed to set up a test of the August 1 low near $1.1025.

After posting a new cycle low earlier, sterling saw a small bounce.  The main driver was press reports that UK lawmakers are drawing up plans to force Prime Minister Johnson to seek an extension of the October 31 Brexit deadline.  Despite the maneuverings, we believe the risks of a hard Brexit are rising.  Continued uncertainty should keep sterling on track to testing the October 2016 low near $1.1840.  After that, there are no significant chart points until the February 1985 low near $1.0520.

New Zealand’s Treasury Department identified the lower bound for the policy rate at -0.35%. Policymakers are studying potential unconventional monetary policy.  The Treasury said -0.35% is the lower bound because market interest rates paid by households and businesses need to remain positive and assumed the current spread to the Official Cash Rate would remain steady.  Its finding are contained in draft paper titled “Policy Response to an Economic Downturn.”

RBNZ just surprised markets last week with a 50 bp cut to 1.0%.  Next policy meeting is September 25 and WIRP suggests 23% odds of a 25 bp cut then.  Kiwi is likely to remain under pressure, with a test of the cycle low near .6380 seen in the coming days.

Fitch upgraded Russia one notch to BBB with stable outlook.  Our own model shows Russia’s implied rating steady at BBB/Baa2/BBB after falling a notch last quarter.  There is still upgrade potential for Moody’s Baa3, but S&P and Fitch both appear to be on target now.  With additional sanctions on tap and oil prices slumping, we suspect this will be the high water market for Russian sovereign ratings this year.

Argentina is likely to come under pressure today after the weekend primary, with the peso to plumb new lows.  With 94% of the ballots counted, opposition candidate Alberto Fernandez won 47% vs. 32% for incumbent Mauricio Macri.  These results suggest that if the October election were to be held today, Macri would lose in a landslide.  A return to power of the Kirchner-Fernandez wing of the Peronists would be taken as a disaster.  While October seems far away, this is an incredibly large margin of loss for Macri.