Dollar Firms as Risk Off Sentiment Picks Up

  • Risk off sentiment is picking up
  • The FOMC left rates steady yesterday, as expected; it painted a fairly upbeat picture
  • To repeat, we think the US drivers that have proven dollar-supportive this year will reassert themselves
  • Italian officials are pushing back against EU criticism of the budget
  • EM FX remains under pressure as the dollar recovers and risk off sentiment picks up

The dollar is mostly firmer against the majors as risk off sentiment picks up.  Yen and Swissie are outperforming, while the Scandies are underperforming.  EM currencies are broadly weaker.  INR and BRL are outperforming, while KRW and ZAR are underperforming.  MSCI Asia Pacific was down 1.1%, with the Nikkei falling 1.1%.  MSCI EM is down 1.5% so far today, with the Shanghai Composite falling 1.4%.  Euro Stoxx 600 is down 0.6% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 3 bp at 3.21%.  Commodity prices are mostly lower, with Brent oil down 1.2%, copper down 1.3%, and gold down 0.5%.

Risk off sentiment is picking up.  Global equity markets are sharply lower, while the usual havens are gaining.  China is unsettling markets again after reports that the government is targeting how much banks should be lending to non-state firms.  Whilst good for the economy perhaps, markets are instead focusing on the growing financial risks as deleveraging has been for the most part abandoned.  Chinese stocks fell, with the Shanghai Composite down for the fifth straight day.

The FOMC left rates steady yesterday, as expected.  There was no press conference after this meeting nor were there any new forecasts or dot plots.  Note that this was the last FOMC meeting with no accompanying press conference.  The December meeting will have one, and then every FOMC meeting will be followed by one starting in 2019.

The FOMC painted a fairly upbeat picture.  That is, it noted that “economic activity has been rising at a strong rate” and that job gains “have been strong.”  The Fed did note that business fixed investment has moderated, but it made no mention of recent equity market volatility.  Bottom line:  The Fed did nothing to dissuade markets from expecting another 25 bp hike in December.

During the North American session, the US reports October PPI, September wholesale inventories, and November Michigan consumer sentiment.  PPI will be the most important reading today and will be followed by CPI Monday.  Headline PPI is expected to rise 2.5% y/y and core by 2.3% y/y, both slipping a bit from September.  Fed speakers today include Williams, Harker, and Quarles.  Next week sees a full slate of Fed speakers who will undoubtedly be asked about yesterday’s FOMC meeting.

The US 10-year yield has been unable to break above 3.25%.  However, the US 2-year yield traded as high as 2.97% today, a new cycle high.  It has since eased back to 2.95% today but if this recent rise in US yields can be sustained as we expect, then the dollar should extend its recovery.

To repeat, we think the US drivers that have proven dollar-supportive this year will reassert themselves.  That is, US rates will continue rising as price pressures rise.  President Trump’s economic team remains intact, which suggests that confrontational trade policies will continue.  Globally, risks from Italy and Brexit remain in play.

Italian officials are pushing back against EU criticism of the budget.  Finance Minister Tria accused the EU of using “inadequate and partial analysis” in predicting Italy’s budget deficit will rise to -2.9% in 2019 and over -3% in 2020 vs. -2.4% targeted by the Italian draft budget.  Deputy Prime Minister Di Maio also dug in and dismissed the threat of EU sanctions. Italy has been asked to present a revised draft budget to the EU by November 13.  So far, comments suggest little effort by Italy to compromise.

The euro has reversed sharply lower after it traded Wednesday at its highest level since October 22 near $1.15.  Due to rising Italy concerns ahead of next week’s EU deadline, we think the euro will likely continue to trade heavily.  The break below the $1.1380 area sets up a test of the October 31 low near $1.13.  That area has held tough but if it goes, the next target is the June 2017 low near $1.1120.

The UK reported September trade, IP, construction output, and Q3 GDP.  The trade deficit was lower than expected while IP was flat y/y vs. 0.4% expected.  Construction output was stronger than expected, rising 3% y/y.  This past week, the UK reported weaker than expected PMI readings for October that suggest momentum continues to wane in Q3.

Elsewhere, Brexit uncertainty remains in place and that is weighing on sterling.  After trading as high as $1.3175 Wednesday, sterling turned lower and traded briefly below $1.30 today before bouncing modestly.  Break of the $1.2880 area is needed to set up a test of the October 30 low near $1.2960.

EM FX remains under pressure as the dollar recovers and risk off sentiment picks up.  The usual suspects (ZAR, TRY, BRL) remain vulnerable but we can add MXN to this group again.  AMLO is quickly proving that markets have underestimated political risk in Mexico.  Yesterday, the Senate leader for his Morena party introduced a bill to eliminate certain bank fees and commissions.  USD/MXN is on track to test the October 31 high just below 20.50 and then the June 15 high near 20.96.