Dollar Firmer as July Draws to a Close

  • The US dollar is mostly firmer, with the dollar bloc underperforming
  • We identify eight things investors should know before the weekend
  • Yesterday, Banco de Mexico announced changes to its FX intervention program
  • Colombia central bank meets and is expected to keep rates steady at 4.5%
  • China will report official July PMI reading on Saturday, expected at 50.1 vs. 50.2 in June
  • The slowing mainland economy has taken a toll on Taiwan

Price action:  The dollar is mostly firmer against the majors.  The Swiss franc and the euro outperforming, while the dollar bloc is underperforming.  The Aussie made a new cycle low near .7245.  The euro is little changed, trading just below $1.10.  Sterling is trading just below $1.56, while dollar/yen is trading around 124.25.  EM currencies are mostly weaker, with RUB, IDR, and ZAR underperforming.  USD/RUB was already back above 60 ahead of the central bank decision, and then rose further after it cut 50 bp to 11%.  The CEE currencies are outperforming.  MSCI Asia Pacific was up 0.6%, with the Nikkei up 0.3%.  The Shanghai Composite fell 1.1%, while the Shenzhen Composite fell 0.8%.  Nearly 20% of Chinese stocks are still not trading.  MSCI EM is up 0.4% today, but was off 7.7% this month.  Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a lower open.  The US 10-year yield is up 1 bp to 2.27%, while European bond markets are also mostly softer.  Oil prices are lower on the day.

  • The US dollar is mostly firmer, with the dollar bloc underperforming.  Month-end flows appear to be favoring the euro, though the Swiss franc is also firmer.  While the dollar is within yesterday’s ranges against the euro and yen, it is firmer against sterling for the third consecutive session.  Asian stocks and bonds were mostly higher though Chinese shares fell.    In Europe, bond yields are slightly higher, and the equity markets are narrowly mixed.  The Shanghai Composite fell 1.1%, bringing the monthly decline to 15%, which is the worst monthly performance in six years.  The Hong Kong China Enterprise Index, which had previously held up better, lost 14% in July, though only 0.1% today.
  • Margin use in China has fallen by more than a third (down roughly $145 bln to $220 bln since mid-June peak through mid-week).  Regulators reportedly have asked financial institutions in Hong Kong and Singapore for stock -trading recovers to help investigate investor behavior.
  • We identify eight things investors should know before the weekend:
  • 1.   The combination of the FOMC statement and GDP report has generally increased the odds of a Fed hike in September.  Next week’s employment report is an important data point.  Weekly initial jobless claims did correct higher last week after falling to more than 40-year lows, but not as much as expected, and another ~220k increase in nonfarm payrolls is expected.   Today’s data includes Q2 Employment Cost Index. In the 2010-2013 period, the quarterly average was just shy of 0.5%.  It rose to 0.55% last year and appears to be rising slightly faster this year.  The Chicago PMI is expected to rise back above the 50 boom/bust level after dipping below there in recent months.  In the last three quarters, the first month has been the strongest.  The headline was above 50 in January and April this year, only to fall below there in the other months.  The University of Michigan’s consumer sentiment report poses headline risk, especially if there is disappointment.
  • 2.  Canada reports May GDP.  The consensus calls for a flat report.  It has fallen each month this year.  With the year-over year rate expected to slow to 0.8% from 1.2%, and oil prices under pressures, it is difficult not to see further Canadian dollar weakness.  The immediate target is last week’s high just above CAD1.31 though short-term technicals have been stretched by the sharp three-day advance from near CAD1.2860 in the middle of the week.
  • 3.  The eurozone confirmed a 0.2% rise in July’s CPI.  What surprised the market was the upward revision to the core rate from 0.8% to 1.0%.  This matches last year’s high.  Although the euro ticked up on the news, we don’t think it changes anything.  We share the IMF’s concerns that the ECB will likely not achieve its inflation objective, and rather than end its asset purchase program early, the risk lies in the other direction.
  • 4.  The US 2-year premium over Germany continues to trend higher.  It is one manifestation of the divergence of monetary policy.  Of course, it also is sensitive to safe-haven flows.  The premium is just below 100 bp today and is at the highest level since 2007.  Many basic models trying to forecast the euro-dollar exchange rate have a role for interest rate differentials.  As the bill market is subject to a number of distortions, economists often use the two-year differential as a key input.
  • 5.  Japanese data was disappointing.  However, it is unlikely to change the outcome of next week’s BOJ meeting.  The unemployment rate ticked up (3.4% from 3.3%), and the job-to-applicant was unchanged (1.19) even as the market had looked for improvement.  The main disappointment was with overall household spending.  It fell 2.0% year-over-year.  The market had expected an increase of nearly the same magnitude.  It makes the May increase (4.8%) appear as a fluke as it had broken the streak of contractions since the retail sales tax was hiked in April 2014.  The report underscores our fear that the Japanese economy probably contracted in Q2.  Separately, the inflation data was mixed, but key measures were a little better.  While the BOJ targets the core rate, which simply excludes fresh food, officials are keen to look past the drop in oil prices.  While the core rate was unchanged at 0.1% year-over-year, the measure that excludes food and energy rose to 0.6% from 0.4%.  The consensus was for an unchanged report.
  • 6.  The immediate risk that the Greek government would collapse as early as this weekend eased as Syriza’s central committee balked at Prime Minister Tsipras’ offer to hold a party-referendum on the aid package.  A special party congress will be held in September, ostensibly after the completion of negotiations.  Greece’s track record of implementing reforms and the unsustainable debt level are the main reasons why a staff agreement with the IMF is not possible now.  However, this does not end the IMF’s involvement.  It will still be participating in the negotiations along with the ECB, EC and now going forward the ESM.  It could conceivably provide more funds once the implementation has begun, and EU devise a debt relief strategy.
  • 7.  Commodities have had one of the poorest months in a few years.  It is not just oil.  Precious and base metals are near 5-6 year lows.  Wheat has fallen to the lowest level since 2011.  We note reports suggesting that Saudi Arabia may cut back on output starting in September.  This is not surprising and is unlikely to impact their exports.  The kingdom is one of the few countries that burn oil for electricity.  After the summer months, it often reduces output that had been increased to provide for domestic demand.  The reduction in output is expected to be around 200-300k bbl per day (bpd), which would bring its production back to around 10.3 mln bpd.  According to the EIA, its average production in the 2006-2014 period was around 9.22 mln bpd.
  • 8.  The fall in commodity prices, political challenges, and the short-dollar overhang weighed on emerging markets.  Reports that cite the EPFR fund tracker note that in the week ended yesterday, $4.5 bln has left EM funds.  This brings the three-week outflow to $14.5 bln, of which Asia accounted for $12.1 bln.  Asian-oriented funds saw $2.7 bln withdrawal this week.  MSCI EM was off 7.7% this month.
  • Banco de Mexico announced changes to its FX intervention program, which had been rumored since last week.  Extraordinary dollar auctions will now be triggered by a 1% depreciation from the previous day’s fix (vs. 1.5% previously).  Regular daily dollar auctions were increased from $52 mln to $200 mln.  While we were not surprised by the changes, the announcement was enough to start a short-covering rally for the peso, which earlier in the day had hit a new all-time low near 16.50.  Given the negative EM backdrop still in play, we think this short-covering bounce will provide better levels to go short the peso.  It’s important to stress that the measures are really meant to provide extra liquidity in gappy, illiquid markets, and are not meant to protect a level or to reverse the trend.
  • Colombia central bank meets and is expected to keep rates steady at 4.5%.  CPI rose 4.4% y/y in June, above the 2-4% target range.  The economy remains soft, but high inflation and a weak peso have tied the central bank’s hand for the time being.  Lower oil prices will continue to weigh on the economy.   Officials do not seem concerned by the weak peso, which is trading lows not seen since 2003.  There is risk of inflation pass-through as weakness continues.
  • China will report official July PMI reading on Saturday, expected at 50.1 vs. 50.2 in June.  However, after the weaker than expected Caixin (formerly HSBC) flash PMI reading of 48.2, the risk is to the downside for the official reading.  We expect further stimulus measures in H2, but we do not see an effort to weaken the yuan to boost exports.  If the stock market plunge deepens, we also would look for more support measures.
  • The slowing mainland economy has taken a toll on Taiwan.  Q2 GDP growth was much weaker than expected, falling to 0.6% y/y vs. 2.6% expected and 3.4% in Q1.  The central bank has inexplicably remained on hold even as the economy slows, but we think this latest number cannot be ignored.  We expect easing at the next quarterly meeting in September.  USD/TWD is on track to test this year’s high near 32.  A break above 33.65 is needed to signal a test of the March 2009 high near 35.25.