Dollar Firms as Equity Markets Remain Under Pressure

  • The dollar continues its rebound as global equity markets remain under pressure
  • We think that the market is overreacting to two Fed speeches and underreacting to ongoing firmness in the US data
  • We are going to go out on a limb and reiterate our strong dollar call
  • Markets await the European Commission’s report on member states’ draft budgets tomorrow
  • BOE Governor Carney testified today before parliament
  • Taiwan and Poland reported firm October data; Hungary is expected to keep policy steady

The dollar is mostly firmer against the majors as equity markets remain under pressure.  Kiwi and sterling are outperforming, while Aussie and euro are underperforming.  EM currencies are mostly weaker.  PHP and INR are outperforming, while TRY and RUB are underperforming.  MSCI Asia Pacific was down 1%, with the Nikkei falling 1.1%.  MSCI EM is down 1.2% so far today, with the Shanghai Composite falling 2.1%.  Euro Stoxx 600 is down 0.7% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 3.05%.  Commodity prices are mixed, with Brent oil down 0.4, copper flat, and gold flat.  Of note, Bitcoin remains under pressure, down nearly 9% and trading at its lowest level since October 2017.

The dollar continues its rebound as global equity markets remain under pressure.  The plunge in US markets carried over into Asia, with the Nikkei dropping 3% and the Shanghai Composite 2.1%.  The DAX is down 1% near midday, while US stocks are likely to open weaker.  Markets are slipping back into risk-off mode despite what we describe as a seismic shift in Fed expectations to the dovish side.

We think that the market is overreacting to two Fed speeches and underreacting to ongoing firmness in the US data.  Yes, the US economy is slowing but nothing beyond what was within expectations.  Growth, while slowing from the blistering 4.2% SAAR pace in Q2, is still robust.  Indeed, Bloomberg consensus sees US y/y growth remaining above the trend rate of 2% (give or take) through Q1 2020.  We prefer looking at y/y readings to avoid issues with seasonal adjustment embedded in the SAAR readings.

The dollar has stabilized despite continued adjustment in Fed expectations.  The implied yield on the January 2020 Fed Funds futures contract fell 5 bp to 2.72% yesterday.  It is up 1 bp today.  Since peaking at 2.95% on November 8, the implied yield has fallen 22 bp to 2.73%.  This is the lowest since September 6 and basically takes out the second 2019 hike that had been priced in.

Equites are running with the weaker US growth storyline.  S&P 500 has retraced nearly two-thirds of the October November bounce, but NASDAQ is leading the move lower and has retraced nearly all of its bounce.  Several corporate scandals haven’t helped market sentiment.  These include but are by no means limited to scandals involving a leading global car company, a large European bank, and the largest social media company.

We are going to go out on a limb and reiterate our strong dollar call.  Fundamentally speaking, we do not think there have been any significant changes in the dollar-positive drivers.  That is, the US economy remains strong despite the sequential slowing now under way.  Looking elsewhere, the odds of a no-deal Brexit continue to climb even as the European Commission looks likely to start excessive deficit procedures against Italy this week.

During the North American session, the US reports October housing starts and building permits.  The former is expected to rise 1.8% m/m and the latter to fall -0.8% m/m.  Yesterday, the National Association of Home Builders reported a weaker than expected housing market index.  It fell to 60 in November vs. 67 consensus and 68 in October.  This is the lowest reading since August 2016 and reflects widespread weakness in this interest rate-sensitive sector.

Markets await the European Commission’s report on member states’ draft budgets tomorrow.  Ahead of that, Italy’s 10-year bond spread with Germany has risen to 324 bp, just shy of the cycle high near 327 bp from October 18.  The euro made a marginal new high for this move near $1.1470 but has since fallen back.  We suspect the $1.15 area will be tough to break.

Brexit uncertainty continues.  Tory rebels are reportedly still short of the 48 lawmakers needed to trigger a no-confidence vote for Prime Minister May.  Furthermore, a date for a full parliamentary vote on the Brexit deal has not been set yet.  Sterling appears to be marking time, trading well within recent ranges as the Brexit drama goes into a quiet lull for now.

BOE Governor Carney testified today before parliament.  He endorsed May’s deal and warned of the dangers stemming from a no-deal Brexit, the risk of which he called “uncomfortably high.”  Carney added that the bank welcomed the transition arrangements that were included and noted the possibility of extending that transition period.  Carney made a case for hiking rates if excess demand materialized due to a weaker pound.      

The bank will release a report to the Treasury Committee of parliament on November 29.  This report will offer its official assessment of Prime Minister May’s Brexit deal.  The BOE said the report will focus on how the Brexit agreement will affect its ability to maintain monetary and financial stability.  The BOE added that the analysis will include a no-deal scenario.

Taiwan reported October export orders and Q3 current account.  Orders rose 5.1% y/y vs. 3.9% expected and 4.2% in September.  October IP will be reported Friday, which is expected to rise 4.0% y/y vs. 1.5% in September.  The slowdown in mainland China is having a negative impact on Taiwan.

Poland reported stronger than expected October industrial and construction output and PPI.  The data all picked up y/y from September, rising 7.4%, 22.4%, and 3.2%, respectively.  Central bank minutes will also be released Thursday.  The economy remains very robust, but price pressures have eased in recent months.  For now, the bank is sticking with its forward guidance of steady rates through 2019.

National Bank of Hungary is expected to keep policy steady.  The economy remains robust and price pressures remain elevated.  CPI rose 3.8% y/y in October, a cycle high and near the top of the 2-4% target range.  We think that the central bank may start to shift away from its ultra-dovish stance at this meeting.