Dollar Firmer in Subdued Trading; Sterling Shines

Dollar Firmer in Subdued Trading; Sterling Shines

  • The US data yesterday was mostly disappointing
  • Yet the US 2-year premium jumped yesterday to its highest level since 2006
  • Final Eurozone CPI for August eased to 0.1% y/y vs. 0.2% preliminary
  • UK reported firm labor market data
  • S&P cut Japan a notch from AA- to A+ and moved to a stable outlook
  • Bank of Thailand met and kept rates steady at 1.5%, as expected; Brazil reports July retail sales

Price action:  The dollar is mostly firmer in subdued trading ahead of the FOMC tomorrow.  Sterling is outperforming after strong jobs data, while the euro is underperforming in the wake of softer CPI data.  The euro is testing the 200-day MA near $1.1235, while cable is trading back above $1.54.  Dollar/yen shrugged off the S&P downgrade and is trading flat near 120.40.  EM currencies are mixed.  MYR, RUB, and KRW are outperforming while IDR and the CEE currencies are underperforming.  MSCI Asia Pacific was up 1.4%, with the Nikkei rising 0.8%.  Chinese markets broke their losing streak, with the Shanghai Composite up 4.9% and the Shenzen Composite up 6.5%.  Euro Stoxx 600 is up 1.1% near midday, while S&P futures are pointing to a higher open.  The US 10-year yield is down 1 bp to 2.27%, while European bond markets are mostly softer.  Commodity prices are mostly higher, with oil prices up nearly 2%.

  • The US data yesterday was mostly disappointing.  Headline August retail sales and industrial production (including manufacturing) missed expectations.  The fact that the July series were revised higher may mitigate the impact on Q3 GDP.  However, the data plays into fears that what is happening “over there” (the knock on effects of developments in China) and the tightening of financial conditions setback the US economy.
  • That would seem to play into ideas that the Fed will not hike rates this week.  Yet, US yields were higher yesterday, and have hung on to the bulk of the gains today.  One may be tempted to say that this was a result of the stock market rally, but the September Fed funds futures imply a slightly higher yield and the dollar is stronger.
  • Yet the US 2-year premium jumped yesterday to its highest level since 2006, pushing just over 103 bp (where it stands today).  It began the year near 75 bp.  Yesterday, the US 2-year yield reached a four-year peak near 81 bp.  Despite many not expecting the Fed to hike tomorrow, the backing up of the 2-year yield stands out.  Some want to dismiss it as a function of liquidity, but this is hard to verify.  At the same time, the German 2-year yield is at -23 bp.  Since it is lower than the deposit rate, it cannot be bought in the ECB’s asset purchase program.  While the timing of the Fed’s lift-off remains the key focus, ECB’s Constancio has reiterated Draghi’s intimation that there is scope to expand the ECB’s QE.
  • We suspect if the Fed does not hike rates this week, its statement will be rather hawkish, suggesting a rate hike has been delayed, but that it is still forthcoming.  Parallels could be drawn between this and September 2013, when nearly everyone (not us) thought that the Fed could announce the tapering of QE3+.  Instead it waited until December.
  • Final Eurozone CPI for August eased to 0.1% y/y vs. 0.2% preliminary.  Core CPI came in at 0.9% y/y vs. 1.0% preliminary.  The ECB recently cut its inflation forecasts, and this recent slide shouldn’t be too surprising.  Yet it does feed into the notion that the ECB will eventually have to expand or extend its QE program.  The euro is lower as a result, and is currently testing the 200-day MA near $1.1235 today.
  • UK reported firm labor market data.  July employment change rose 42k vs. 18k expected, average weekly earnings rose 2.9% vs. 2.5% expected, and unemployment fell to 5.5% vs. 5.6% expected.  The data helps offset the soft August CPI (flat y/y, as expected and down from 0.1% in July) reported yesterday, and strengthens the notion that the BOE will hike rates in the coming months.  Next BOE meeting is October 8, and no change in policy is expected then.  Still, sterling caught a bid and is the best performer in the majors.   Cable held support at the 200-day MA near $1.5350, and is currently trading back above $1.54.
  • During the North American session, US reports weekly mortgage applications, August CPI, and July TIC data.  CPI consensus is at 0.2% y/y for headline and 1.9% y/y for core.  The Fed’s preferred measure of inflation (core PCE) was 1.3% y/y in Q2, falling to 1.2% y/y in July.  US consumption has been soft in recent months, but we think the Fed puts more weight on the state of the labor market in terms of real sector data.
  • S&P cut Japan a notch from AA- to A+ and moved to a stable outlook.  The move was not surprising, as it brings S&P more into line with Moody’s (A1) and Fitch (A).  Our own sovereign ratings model shows Japan at A+/A1/A, and so we agree with S&P’s move today.  The yen was unfazed, with dollar/yen trading flat near 120.45.
  • Bank of Thailand met and kept rates steady at 1.5%, as expected.  A small handful looked for a 25 bp cut to 1.25%.  CPI fell -1.2% y/y in August, well below the 1-4% target range.  BOT has been on hold since April, when it cut rates 25 bp to 1.5%.   We are surprised it has remained on hold since then, as price pressures are non-existent and the economy remains weak.  We see a strong chance of a cut in Q4 if current trends continue.  Fiscal stimulus is also expected ahead.
  • Brazil reports July retail sales, and is expected at -3.8% y/y vs. -2.7% in June.  The second preview of September IGP-M wholesale inflation will be released Thursday, and is expected to rise 8.0% y/y vs. 7.6% in August.  Lastly, monthly GDP proxy for July will be reported Friday, and is expected at -4.6% y/y vs. -1.2% in June.  The economic outlook is worsening, which will keep pressure on the fiscal outlook.  We see more rating downgrades ahead.