Dollar Firms as US Rates Edge Higher

  • The two-day FOMC meeting ends with a decision today at 2 PM ET
  • The US drivers that have proven dollar-supportive this year will reassert themselves
  • China reported stronger than expected trade data for October
  • The EU sees Italy’s budget deficit rising above the -3% of GDP limit
  • RBNZ kept rates steady at 1.75%, as expected; Bank Negara kept rates steady at 3.25%, as expected
  • MXN has been underperforming this week; Peru central bank is expected to keep rates steady at 2.75%

The dollar is mostly firmer against the majors as US rates rise.  The Scandies are outperforming, while sterling and Kiwi are underperforming.  EM currencies are mostly weaker.  PHP and KRW are outperforming, while TRY and ZAR are underperforming.  MSCI Asia Pacific was up 0.9%, with the Nikkei rising 1.8%.  MSCI EM is up 0.3% so far today, with the Shanghai Composite falling 0.2%.  Euro Stoxx 600 is up 0.3% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 3.22%.  Commodity prices are mostly lower, with Brent oil up 0.2%, copper down 1.5%, and gold down 0.3%.

The two-day FOMC meeting ends with a decision today at 2 PM ET.  There is no press conference after this meeting and there will be no new forecasts or dot plots.  Note that this will be 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.

We expect the FOMC to paint a fairly upbeat picture.  That is, the economy remains robust and price pressures are starting to rise.  Of course, it will likely note downside risks from persistent trade tensions.  We would be surprised if the Fed makes any mention of recent equity market volatility, as that is simply not in its purview right now.  Bottom line:  The Fed is unlikely to dissuade markets from expecting another 25 bp hike in December.

Because of the press embargo, no Fed officials speak ahead of the FOMC decision.  Afterwards, Williams, Harker, and Quarles all speak Friday.  Next week sees a full slate of Fed speakers who will undoubtedly be asked about today’s FOMC meeting.

Indeed, the US 10-year yield rose to trade near 3.25% yesterday.  This was the highest since the cycle high near 3.26% from October 9.  It has since eased back to 3.22% today.  Elsewhere, the US 2-year yield traded as high as 2.96% yesterday, a new cycle high.  It has since eased back to 2.95% today but if this recent rise in US yields can be sustained, then the dollar should extend its recovery.

As we wrote yesterday, 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.

China reported stronger than expected trade data for October.  This was due largely due to companies expanding activity to avoid tariffs before they kick in.  Exports rose 15.6% y/y and imports rose 21.4% y/y, resulting in a trade surplus of $34 bln.  This was up from $31.3 bln in September and this will surely keep the US in a bad mood as the Xi-Trump talks take place at month-end.

The EU sees Italy’s budget deficit rising above the -3% of GDP limit.  Press reports suggest that the EU is forecasting the gap at -2.9% in 2019 and over -3% in 2020 vs. -2.4% targeted by the Italian draft budget due to slower than expected growth.  Other reports suggest that the EU sees Italy’s debt to GD ration rising through 2020.  Italy has been asked to present a revised draft budget to the EU by November 13.

The euro traded yesterday at its highest level since October 22 near $1.15 but ran out of steam.  That $1.15 level is the 62% retracement objective of the October drop.  Due to rising Italy concerns ahead of next week’s EU deadline, we think the euro will trade heavily.  A break below the $1.1380 is needed to set up a test of the October 31 low near $1.13.

RBNZ kept rates steady at 1.75%, as expected.  However, it was a hawkish hold as the bank brought forward the expected timing of the first rate hike to Q2 2020 from Q3 2020 previously.  On the other hand, it noted that below-target inflation requires continued supportive policy and added that it will look through faster inflation caused by higher oil prices.  Lastly, the RBNZ removed the reference to a possible cut, although we don’t think anyone was really looking for a cut anymore.

Kiwi rose yesterday to its highest level since August 1 just above .6800 but then ran out of steam.  Clean break of the .6815 would set up a test of the June high near .7060.

Bank Negara kept rates steady at 3.25%, as expected.  CPI rose only 0.3% y/y in September.  While the central bank does not have an explicit inflation target, low price pressures should allow it to keep rates steady well into 2019.  While it warned of higher headline inflation next year due to high oil prices, the bank noted headwinds will come from fiscal tightening.

MXN has been underperforming this week.  Some attribute peso weakness to concerns that the new Democratic-controlled House won’t allow USMCA to be kept as it currently stands.   The current Republican-controlled congress is in office until January 2019, when the new one is sworn in.  This lame duck can pass USMCA by the planned November 30, but we think the new House could reopen it next year to renegotiate areas of concern.

Mexico October CPI is expected to rise 4.89% y/y vs. 5.02% in September.  If so, inflation would remain above the 2-4% target range.  Next policy meeting is November 15.  If the peso remains under pressure, we think a 25 bp hike to 8% is likely then.

Peru central bank is expected to keep rates steady at 2.75%.  CPI rose 1.8% y/y in October, just below the center of the 1-3% target range.  With growth picking up, the central bank is likely to start the tightening cycle in Q1 2019.  Political uncertainty has risen with the arrest of opposition leader Keiko Fujimori on corruption charges.