Dollar Firms Even as US Rates Fall and Curve Inverts

  • The dollar is getting traction even as US rates continue to fall
  • The US data highlight is April retail sales
  • Trump’s efforts to influence the Fed continue
  • China reported weak April IP and retail sales
  • Canada reports April CPI
  • Turkish lira remains under pressure; Poland is expected to keep rates steady at 1.5%.
  • Argentina April CPI is expected to rise 56.3% y/y; Brazil COPOM minutes were surprisingly dovish

The dollar is mostly firmer against the majors as markets search for direction. The yen and Swissie are outperforming, while the dollar bloc is underperforming. EM currencies are also mostly weaker. RUB and PHP are outperforming, while TRY and THB are underperforming. MSCI Asia Pacific was up 0.5%, with the Nikkei rising 0.6%. MSCI EM is down 0.1% so far today, with the Shanghai Composite rising 1.9%. Euro Stoxx 600 is down 0.2% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 4 bp at 2.37%, while the 3-month to 10-year spread has flattened 3 bp and inverted at -2 bp. Commodity prices are mixed, with Brent oil down 0.9%, copper up 0.6%, and gold up 0.1%.

The dollar is getting traction even as US rates continue to fall. The 10-year yield has fallen below 2.40% and is approaching the March low near 2.34%, while the 2-year yield is already at its March low near 2.16%. Clearly, the perceived threat of Chinese UST sales does not carry much impact. More importantly, the 3-month to 10-year US curve has inverted again, the first time since late March.

The war of words between the US and China continues, which decreases the chances of a trade deal near-term. Many are pinning their hopes on the late June G20 summit, but in market terms, that is an eternity away. In the meantime, markets are left looking at the data for clues as to which side will blink first.

The US data highlight is April retail sales. Headline sales are expected to rise 0.2% m/m vs. 1.6% in March, while ex-auto sales are expected to rise 0.7% m/m vs. 1.2% in March. Lastly, the so-called control group used for GDP calculations is expected to rise 0.3% m/m vs. 1.0% in March. Auto sales were a weaker than expected 16.4 mln annualized last month, which warns of downside risks to headline sales.

In the US, May Empire manufacturing index (8.0 expected) and April IP (flat m/m expected) will also be reported today. So will March business inventories (flat m/m expected) and TIC data.

The parade of Fed speakers continues. Quarles and Barkin speak today. So far this week, all have been consistent in saying it’s too early to gauge the likely impact of the escalating trade war. We expect Fed officials to follow this theme for the time being.

Trump’s efforts to influence the Fed continue. Regarding the trade tensions with China, Trump predicted that the PBOC will be “pouring money into their system and probably reducing interest rates.” Trump added that if the Fed matched the PBOC, “it would be game over, we win!” Press reports suggest the White House may nominate Judy Shelton to the Fed’s Board of Governors. Stay tuned.

We do not believe getting the Fed to ease is the major reason behind the trade war. Why risk a full-blown recession just to get the Fed to ease? For better or for worse, Trump has remained consistent in his efforts to pries open China’s markets. Lower interest rates from the Fed would simply soften the blow to the economy.

Canada reports April CPI. Headline inflation is expected to rise a tick to 2.0% y/y, while common core is seen steady at 1.8% y/y. Canada also reports April existing home sales, which are expected to rise 1.8% m/m. Next BOC meeting is May 29. With its recent move to a neutral stance, the bank is likely to keep rates steady for the time being. However, market is pricing in some odds (20%-ish) of a cut in September.

Eurozone Q1 GDP grew 1.2% y/y, as expected. Germany reported Q1 GDP too and growth was a tick lower than expected at 0.6% y/y. Both readings were steady from Q4, suggesting some semblance of stability is emerging. Yet elsewhere, Italy industrial orders weakened in March, contracting -3.6% y/y vs. a revised -3.1% (was -2.9%) in February. Downside risks remain high, supporting our view that the ECB will eventually have to add more stimulus.

China reported weak April IP and retail sales. The former was expected to rise 6.5% y/y but instead rose 5.4%, while the latter was expected to rise 8.6% y/y but instead rose 7.2%. This confirms our suspicions that the Q1 bounce was exaggerated. Trade talks ended Friday with no breakthrough, and so we see downside risks for the mainland economy going forward.

With a nudge from the Chinese data, AUD continues to make new lows for this move. The recent break of .6955 sets up a test of the January low near .6740. WIRP shows a nearly 40% chance of a cut at the next RBA meeting June 4.

The Turkish lira remains under pressure. A 0.1% tax on some FX transactions was re-imposed and is adding to the general gloom. So too are reports that Turkey will go ahead with its purchase of a Russian missile defense system. The tax may be meant to lend the lira some support, but it will clearly discourage foreign investment.

National Bank of Poland is expected to keep rates steady at 1.5%. CPI rose 2.2% y/y in April, well in the bottom half of the 1.5-3.5% target range. Q1 GDP was reported earlier. Growth was expected at 4.4% y/y vs. 4.9% in Q4.

Argentina April CPI is expected to rise 56.3% y/y vs. 54.7% in March. With nominal LELIQ rates around 72%, that would translate into a real rate of around 16%. While that should be enough to stabilize the peso, it’s too soon to say as the currency has already weakened nearly 1.5% this month.

Brazil COPOM minutes were surprisingly dovish. At last week’s meeting, COPOM saw balanced risks to inflation. Yet the minutes highlighted the weak economic outlook, noting “a relevant probability” that GDP contracted q/q in Q1. We disagree with this dovish outlook and see upside risks. IPCA inflation was 4.94% y/y in April, the highest since January 2017 and near the top of the 2.75-5.75% target range. Next COPOM meeting is June 19, and no change is expected then.