Dollar Firm, Markets Calm Ahead of US Jobs

  • The US yield curve continues to flatten
  • Fed tightening expectations are still falling
  • The November US jobs report is the data highlight of the week
  • Market sentiment is so negative right now that one data point can’t turn the tide
  • Eurozone final Q3 GDP growth came in lower than expected at 1.6% y/y
  • Press reports suggest UK Prime Minister May is considering a delay to the Brexit vote
  • OPEC talks continue
  • Brazil IPCA consumer inflation is expected at 4.17% y/y; Mexico November CPI is expected to rise 4.6% y/y

The dollar is mostly firmer against the majors even as markets stabilize after yesterday’s large moves.  Euro and Kiwi are outperforming, while Stockie and Aussie are underperforming.  EM currencies are mixed.  IDR and INR are outperforming, while MXN and ZAR are underperforming.  MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.8%.  MSCI EM is up 0.3% so far today, with the Shanghai Composite flat.  Euro Stoxx 600 is up 1.3% near midday, while US equity futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 2.88%.  Commodity prices are higher, with Brent oil up 0.5%, copper 0.8%, and gold up 0.3%.

Markets have regained a semblance of calm after yesterday’s volatile moves.  US equity markets ended down modestly after dropping close to 3%.  Overnight, global equity markets have clawed back a small portion of their recent losses.  Yet US bond yields remain near the lows, suggesting this calm is fragile.

The US yield curve continues to flatten.  The 2- to 10-year spread is now at 13 bp, down from 20 bp last week and nearing inversion.  The San Francisco Fed’s preferred 3-month to 10-year spread has narrowed to 49 bp from 65 bp last week, still far from inversion but the direction is not good.  We still think markets are underestimating inflation and Fed tightening prospects, but we seem to be in the minority.

In keeping with that theme, Fed tightening expectations are still falling.  Implied yield on the January 2020 Fed Funds futures contract has fallen to 2.62% yesterday, the lowest since July 6 and approaching the June low near 2.60%.  With effective Fed Funds at 2.20%, that means the lone 2019 hike is no longer fully priced in.

Brainard speaks and is the last Fed speaker before the press embargo goes into effect before the December 19 FOMC meeting.  We suspect that the Fed is not happy with how markets have reacted to its recent messaging and we hope that Brainard will push back against the extreme dovishness that’s being priced in now.  Last night, Fed Chairman Powell delivered an upbeat assessment of the US economy, calling the labor market “very strong.”

Indeed, the November US jobs report is the data highlight of the week.  Consensus sees +198k nonfarm payrolls vs. +250k in October.  Average hourly earnings are expected to remain steady at the cycle high of 3.1% y/y.  What’s noteworthy is that expectations of Fed dovishness have shifted despite firm US data in Q4 so far.  Ahead of the jobs data, ADP reported +179k jobs yesterday.

Market sentiment is so negative right now that one data point probably can’t turn the tide.  Yet we can’t help but feel that the market is being overly pessimistic.  The US grew 4.2% SAAR in Q2 and 3.5% SAAR in Q3.  The Atlanta Fed’s GDPNow is tracking growth of 2.7% SAAR in Q4 while the New York Fed’s Nowcast tracking 2.5% SAAR.  Bloomberg consensus sees above-trend growth (~2%) into 2020.  All of this is in stark contrast to Europe and Japan, where the slowdowns are much more palpable.

Eurozone final Q3 GDP growth came in lower than expected at 1.6% y/y.  The q/q seasonally adjusted growth rate of 0.2% was left unchanged.   Government expenditures and net exports were the main drags on growth.  Inventories boosted growth but signals weaker demand.  This data comes ahead of the ECB meeting next Thursday.  We believe new staff forecasts then will have to reflect a more subdued growth outlook.

Press reports suggest UK Prime Minister May is considering a delay to the Brexit vote.  Scheduled for December 11, she faces almost certain defeat and so her Tory allies are pushing for a delay to shore up support.  Sterling remains in narrow ranges and is today trading well within yesterday’s range.  The odds of a no-deal Brexit remain high, in our view, and should cap any gains for sterling near-term.

Canada also reports November jobs today.  Total jobs are expected to rise 10k vs. 11.2k in October.  Data have been coming in soft lately.  The resulting dovish hold from the BOC as well as lower oil prices should continue to weigh on the Loonie.  After pushing as high as 1.3345 yesterday, USD/CAD closed back below 1.34 and is hovering near there today.

OPEC talks continue.  Oil prices have stabilized but remain vulnerable to disappointment.  OPEC comments suggest a combined output cut of 1 mln bbl/day by OPEC+ next year is being contemplated.  We think this would not be enough to stabilize sentiment, but Russia is reportedly resisting larger cuts.

This environment is not good for EM, to state the obvious.  Whilst lower US rates should in theory support EM, the rising US recession fears and risk-off sentiment are clearly overwhelming any positive impact.  We expect this dynamic to continue.

Brazil IPCA consumer inflation is expected at 4.17% y/y vs. 4.56% in October.  If so, it would be the lowest since May and in the bottom half of the 3-6% target range.  This has pushed out tightening expectations until late Q1 or early Q2.  Next COPOM meeting is December 12 and rates are likely to be kept steady at 6.5%.

Mexico November CPI is expected to rise 4.6% y/y vs. 4.9% in October.  If so, inflation would be the lowest since June but still above the 2-4% target range.  Next policy meeting is December 20 and it will be a close call.  We think the decision will ultimately depend on how the peso is trading then.