Dollar Firm in Wake of G20 Summit

  • Market sentiment was given a shot in the arm by the G20 meeting
  • Reduced US recession risk supports our view that the market needs to adjust its Fed easing expectations
  • This process should help the dollar gain even more traction
  • Weak eurozone final June manufacturing PMI readings were reported; UK manufacturing PMI was 48.0
  • Oil prices jumped on reports of an extension of OPEC+ output cuts
  • EM so far has reported weak PMI readings for June

The dollar is broadly firmer against the majors in the wake of the G20 meeting. Loonie and Stockie are outperforming, while Swissie and sterling are underperforming. EM currencies are mixed. TRY and PHP are outperforming, while CZK and ZAR are underperforming. MSCI Asia Pacific was up 0.8%, with the Nikkei rising 2.1%. MSCI EM is up 0.5% so far today, with the Shanghai Composite rising 2.2%. Euro Stoxx 600 is up 0.9% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 1 bp at 2.02%, while the 3-month to 10-year spread is up 1 bp and stands at -7 bp. Commodity prices are mostly higher, with Brent oil up 2.4%, copper up 0.8%, and gold down 1.4%.

Market sentiment was given a shot in the arm by the G20 meeting. Trump delayed additional tariffs on Chinese goods while talks resume. Existing tariffs will remain in place, but the US made some concessions on Huawei by allowing the blacklisted company to buy some US products. In return, China will reportedly buy “tremendous” amounts of US agricultural goods.

Geopolitical tensions were also dialed down a notch. Trump made a surprise visit to the Demilitarized Zone (DMZ) that separates the two Koreas and became the first US President while in office to set foot in North Korea. Teams from each side will resume talks over the next few weeks. Sanctions will remain in place, but Trump hinted of potential lifting if negotiations go well.

The feel-good vibe has hurt the US bond market. The 3-month to 10-year curve is at -7 bp and earlier today was at -3 bp, the least inverted since late May and signifying reduced recession risks. If market sentiment about the US outlook continues to improve, the curve should move back to a positive slope in the coming weeks.

Reduced US recession risk supports our view that the market needs to adjust its Fed easing expectations. That process has begun, with the implied yield on the January 2020 Fed Funds futures contract rising to 1.68% today, the highest since June 18. The market is still pricing in between 2-3 cuts this year and should continue to adjust.

This process should help the dollar gain even more traction. What’s also helping is data from the rest of the world that shows the economic outlook dimming (see below). DXY is trading at its highest level since June 21. Our bullish dollar call would be bolstered by a move above the 200-day moving average near 96.687 and then the 50% retracement objective of the June drop near 96.805.

There will be several US data releases today. June ISM manufacturing PMI will be reported and is expected at 51.0 vs. 52.1 in May. However, there are clear downside risks given weak regional Fed surveys and Chicago PMI. May construction spending (flat m/m expected) will be reported today.

Fed Vice Chair Clarida speaks today. Expectations for three cuts this year followed by up to two cuts next year is simply too aggressive to us. And apparently to the Fed as well, as comments last week represented a pushback of sorts. We suspect Clarida will take a similar approach today.

Atlanta Fed GDPNow is tracking Q2 growth at 1.5% SAAR, down from 1.9% previously. Elsewhere, NY Fed Nowcast has Q2 growth at 1.3% SAAR, down from 1.4% last week. It also it cut its Q3 reading to 1.2% SAAR from 1.3% previously. While a slowdown from Q1 (3.1% SAAR) was to be expected, markets will be particularly sensitive for signs of a larger than expected drop-off. For now, a recession seems far off.

Weak eurozone final June manufacturing PMI readings were reported. Headline eurozone reading fell to 47.6 from the 47.8 flash reading. Germany worsened to 45.0 from 45.4 flash, while France worsened to 51.9 from 52.0 flash. Spain fell to 47.9 from 50.1 in May, whilst Italy fell to 48.4 from 49.7 in May. This suggests the eurozone economy was losing momentum going into Q3. Final services and composite PMIs will be reported Wednesday.

Elsewhere, Germany reported June unemployment. Claims fell -1k while the rate remained steady at 5.0%. Germany reports May retail sales Tuesday and May factory orders will be reported Friday. Given continued softness in the data, consensus seems to be building for the ECB to give a dovish sign July 25 that sets up a rate cut September 12.

UK PMI readings for June began today with a weaker than expected manufacturing reading of 48.0. It was the lowest reading on record since February 2013 and compares to consensus forecast of 49.5. Construction PMI will be reported tomorrow (49.2 expected), followed by services and composite PMIs Wednesday (51.0 expected for both).

Oil prices jumped on reports that Saudi Arabia and Russia signaled their support for an extension of OPEC+ output cuts. The cuts would likely be extended by 6-9 months. WTI is leading the move, as the near month futures prices has retraced nearly two thirds of the April-June plunge and already above the 200-day moving average near 58.80. Break of the 60.50 area for WTI would set up at test of the April high near 66.60. Brent has retraced less than half of the April-June plunge and is only now approaching the 200-day moving average near 67.50.

Bank of Japan released its Q2 Tankan report. Large manufacturers came in at 7 vs. 9 expected while small manufacturing came in at 1 vs. 2 expected. Capex is expected to rise 7.4% y/y vs. 8.1% expected. Overall, a sense of gloom hangs over Japan due to regional tensions and ahead of the October consumption tax hike. These were the weakest Tankan readings in nearly three years, but the survey was conducted before this weekend’s G20 summit. We expect the BOJ to add stimulus in H2.

EM so far has reported weak PMI readings for June. Official China PMI was weaker than expected at 49.4. Caixin also reported weaker than expected PMI falling to 49.4 vs. 50.1 expected. Indeed, most of the regional PMI readings worsened. Of not, Taiwan fell to 45.5, Malaysia fell to 47.8, Korea fell to 47.5, and Indonesia fell to 50.6. Philippines bucked the trend and rose a tick to 51.3. Otherwise, the countries in China’s supply chain continue to feel the heat from the US-China trade war.

EMEA PMI readings were also weak. Russia, Poland, and Czech Republic all fell further below the 50 boom/bust level. Hungary fell to 54.4, while Turkey improved to 47.9 and South Africa improved to 46.2. Brazil and Mexico report later today. This data is a grim reminder that even though trade tensions are not escalating further, the status quo is still negative for EM.