Dollar Firmer as UST Yields Turn Supportive

Dollar Firmer as UST Yields Turn Supportive

  • The eurozone PMI confirms an irony of economic data holding up well just as Draghi makes his case for more easing
  • UST yields continue to edge higher, widening the interest differential in favor of the dollar
  • Overnight, the RBA left rates steady at 2.0%
  • During the North American session, the US reports October ISM New York, September factory orders, and October auto sales
  • Korea reported higher than expected CPI, while Turkey reported lower than expected

Price action:  The dollar is broadly stronger against the majors.  The exception is the Aussie, up 0.5% after the RBA left rates unchanged.  The Kiwi and the euro are underperforming, with the latter trading back below the $1.10 level.  Sterling is trading back near $1.54 after soft UK construction PMI, while dollar/yen is testing the 200-day MA near 121.  EM currencies are mostly softer.  IDR and RUB are outperforming, while ZAR and TRY are underperforming.  MSCI Asia Pacific ex-Japan rose 1.1%, with Japan markets closed for holiday.  China markets were mixed, with the Shanghai Composite down 0.3% and the Shenzen Composite flat.  The Dow Jones Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 1 bp to 2.18%, while European bond markets are mostly firmer.  The 2-year US-German differential is at 107 bp, the highest since 2006.  Commodity prices are mostly lower, though oil is up nearly 1%.

  • The eurozone PMI confirms an irony: economic data from the eurozone has held up well, pointing to fairly steady even if unimpressive growth.  Draghi made a case for setting policy based on risk scenarios.  The data does not seem to support such sense of urgency.  At 52.3, the eurozone manufacturing PMI was slightly better than the flash (52.0) and is a little above the Q3 average.  Of note, on a national level, Germany’s flash PMI was revised higher (52.1 from 51.6) and Italy was a pleasant surprise at 54.1 (consensus 53.1 after 52.7 in September).  The service PMIs may also surprise on the upside.  Although the market has treated Draghi’s comments as if they were a commitment to ease policy at the December 3 meeting, it may not be a done deal.
  • Many still are unconvinced that the Fed will hike in the middle of December.  Some argue against it on technical grounds.  Raising rates in so close to the end of the year may inject extra volatility into the markets and complicate year-end activity.  As a matter of fact, the Federal Reserve has taken action in the month of December.  It hiked rates in December 2004 and December 2005, for example.  It cut rates in December 2001 and December 1995.
  • If one assumes that Fed funds, which have been averaging 13 bp over the past 50 and 100 days, continues to do so in the first half of December, and then after the rate hike averages 30 bp, then the December Fed funds contract is pricing in a 75% chance of a hike.  Some assume that it will average the middle of the range, but besides the fact that it has been averaging around the middle of the range now, there is no compelling argument to assume this remains the case.  Indeed, we suggest the possibility that in order to maintain maximum control, the Fed will want to provide sufficient liquidity to keep the Fed funds rate relatively low to ensure the attractiveness of one of the new tools in this cycle, the interest paid on excess reserves (which is the top of the Fed funds target range).  It is true that no one really knows where Fed funds will trade after the hike, and we need to take the “odds” only in the context of that assumption.  Our work suggests that the conventional measure may under-estimate the market-based probability of a Fed hike in December.
  • UST yields continue to edge higher.  The 10-year yield rose to 2.19% Monday, the highest since mid-September.  The 2-year yield rose to 0.76%, also the highest since mid-September.  The 2-year US-German differential has just broken above the 105 bp cycle high from last week to near 107 bp currently, and now at a level not seen since late 2006.  The wide differential is consistent with our strong dollar view.
  • The euro remains trapped in a particularly narrow range.  The $1.1060-75 band is blocking the upside, while $1.10 had been holding the downside in check.  Today’s break of $1.0990 could see the euro retesting its recent lows near $1.09. On the upside, the new shorts likely will not be pressed unless the $1.11 area gives, which was the high prior to the Chinese rate cut.
  • The dollar has not traded below JPY120 since October 22.  If that is support, then the top-side of the current range is in the JPY121.50-JPY121.60 area.  As we anticipated, the incremental additional stimulus for the Japanese economy may come from a supplemental budget rather than monetary policy.  Meanwhile the focus is on the Japan Post IPO, which is expected to raise the equivalent of $12 bln, when Japan returns from today’s holiday.
  • Despite better than expected manufacturing PMI Monday, sterling ran into a wall of sellers near $1.55, and was unable to recover.  There was talk of Asian central banks on the offer.  It finished the North American session just off its lows near $1.54.  The implied yield of the June 2016 short-sterling futures has risen by 10 bp over the past four sessions.  Sterling has gained a net 1% over those four sessions.  The market may turn cautious ahead of Super Thursday (MPC decision, minutes and quarterly inflation report).  Technical support may be found in the $1.5340-1.5370 area.
  • Barring a strong rally in oil, the US dollar is unlikely to slip much further against the Canadian dollar ahead of this week’s slew of data, which includes trade and employment data to which the Loonie seems particularly sensitive.  For the trade figures, to be released on Wednesday, the focus should be on non-oil exports, which may be turning higher.  The employment data at the end of the week may be overshadowed by the US figures released at the same time. Although the Bank of Canada’s two rate cuts this year are thought to have completed the mini-easing cycle, another rate cut cannot be completely ruled out.  In September, Canada lost nearly 62k full-time jobs.  Another dismal report and rate cut talk may resurface, even if the new government wants to pursue a small fiscal deficit.  Technical support for the US dollar is seen in the CAD1.3040-1.3060 range.
  • Overnight, the RBA left rates steady at 2.0%.  This was expected, but of the central banks meeting this week, the RBA was widely seen to be the closest call.  The derivatives market put the odds at nearly 50/50.  However, strong domestic credit growth may have bought the RBA some time.  Governor Stevens left the door open for further easing, but also noted that “prospects for an improvement in economic conditions had firmed a little.”  The RBA will update its forecasts in its Statement on Monetary Policy on Friday.  The next policy meeting is December 1.
  • During the North American session, the US reports October ISM New York, September factory orders, and October auto sales.  Auto sales may slow slightly from the nearly 18.1 mln unit annualized pace in September.  There are no Fed speakers today in an otherwise speaker-filled week.  Singapore reports October PMI, and is expected at 48.9 vs. 48.6 in September.
  • Korea reported October CPI at 0.9% y/y vs. 0.7% consensus and 0.6% in September.  This was still well below the 2.5-3.5% target range, but the highest since November 2014.  Over the weekend, Korea reported October trade data, the first snapshot for last month.  Exports contracted -15.8% y/y, and imports by -16.6% y/y, both weaker than expected.  We think downside risks could move the BOK to a more dovish stance in 2016.  However, core inflation rose 2.3% y/y vs. 2.1% in September and so the overall rising inflation trajectory, if sustained, could give the central bank pause.
  • Turkey reported October CPI at 7.58% y/y, lower than the consensus 7.8% and 7.95% in September.  This is still well above the 3-7% target range.  The larger than expected rise in core inflation to 8.9% y/y should keep the central bank from hiking near-term, but the headline disinflation trend, if continued, would revive prospects of further easing.  Weekend elections were surprising, but have now removed political uncertainty.  With Erdogan and his AKP now firmly in power, what happens to economic policy?  Will the government put more pressure on the central bank to ease?  If so, the post-election lira rally probably won’t last.
  • Brazil reports October trade, with both exports and imports expected to continue contracting y/y.  It reports September IP Wednesday, and is expected at -11.4% y/y vs. -9.0% in August.  October IPCA inflation will be reported Friday, and is expected to rise 9.90% y/y vs. 9.49% in September.  Despite inflation moving further above the 2.5-6.5% target range, COPOM minutes suggest rates will remain on hold for the time being.