Dollar Firms on Higher US Rates and Italy Challenges

  • US rates are moving higher and has helped the dollar firm
  • Markets will be particularly sensitive to US September PPI data today and CPI tomorrow
  • Deputy Prime Minister Salvini said he’s “absolutely sure” that Italy’s 10-year spread to Germany won’t reach 400 bp
  • UK reported August trade, IP, and monthly GDP but markets are focusing more on reports that a Brexit compromise is within reach
  • Norway reported September CPI
  • EM FX remains under broad pressure, but some unexpected developments have allowed some currencies to catch a bid

The dollar is mostly firmer against the majors in narrow ranges.  Nokkie and sterling are outperforming, while the dollar bloc and yen are underperforming.  EM currencies are trading softer.  INR and IDR are outperforming, while ZAR and MXN are underperforming.  MSCI Asia Pacific was flat, with the Nikkei rising 0.2%.  MSCI EM is down 0.1% so far today, with the Shanghai Composite rising 0.2%.  Euro Stoxx 600 is down 0.4% near midday, while US futures are pointing to a higher open.  The US 10-year yield is up 2 bp at 3.22%.  Commodity prices are mostly lower, with Brent oil down 0.1%, copper down 0.3%, and gold down 0.2%.

US rates markets reopened yesterday with a whimper, not a bang.  This allowed some of the foreign currencies to find some limited traction against the dollar, as the 10-year yield fell 3 bp to 3.21%.  The 3.25% level is proving tough to crack but we think it eventually will.

Today, US rates are moving higher and has helped the dollar firm.  The US 10-year yield is up 2 bp to 3.23%, while the 2-year yield is up 1 bp to 2.90%.  Fed speakers today are Evans and Bostic.  Williams spoke earlier from the sidelines of the IMF meetings in Bali.

Markets will be particularly sensitive to US September PPI data today and CPI tomorrow.  Headline PPI inflation is seen easing to 2.7% y/y from 2.8% in August, while core is seen accelerating to 2.5% y/y from 2.3% in August.  Tomorrow, headline CPI inflation is seen easing to 2.4% y/y from 2.7% in August, while core is seen accelerating to 2.3% y/y from 2.2% in August.

Deputy Prime Minister Salvini said he’s “absolutely sure” that Italy’s 10-year spread to Germany won’t reach 400 bp.  This spread is currently around 300 bp, the highest since 2013 and rising.  The spread hit a high of 534 bp back in July 2012, and last traded at 400 bp back in September 2012.  Earlier, Finance Minister Tria expressed concern over Italy’s widening bond spreads.  He said that the high spreads were not justified by the fundamentals but was savvy enough not to challenge the markets.

The euro recovered from early selling yesterday that took it down to $1.1430 but has had trouble breaking above $1.15 and now feels heavy and trading back below the figure.  With Italian spreads likely to continue widening amidst budget concerns, the euro should test the August low near $1.13 in the coming weeks.

UK reported August trade, IP, and monthly GDP.  The trade deficit was slightly lower than expected at -GBP1.27 bln, while IP was slightly stronger than expected and rose 0.2% m/m despite a -0.2% m/m contraction in manufacturing production.  The new monthly GDP series was flat m/m vs. 0.1% expected, but the 3M/3M change was steady at 0.7%.

At this point, markets are focusing less on the data and more on press reports that suggest a Brexit compromise is within reach.  Press reports suggest intensive negotiations over the Irish border issue will be held over the next five days, with the aim of getting a provisional agreement by Monday.  Helping matters were positive comments by Democratic Unionist Party leader Arlene Foster, who is particularly sensitive to the Irish border issue.

Sterling remains bid.  Break of $1.3155 sets up a test of the September 20 high near $1.33.  After that is the July high near $1.3365.  Given the opposing trajectories of sentiment in the UK and eurozone, we think EUR/GBP can continue to make new lows for this move as it did today near 0.8723.  Indeed, this pair is on track to test the April low near 0.8621.

USD/JPY found some support near the 113 area but has yet to get much traction.  Break below 112.50 would likely signal a deeper correction.  On the other hand, a move back above the 113.70 area would argue for another stab at the upside.  It’s a quiet data week in Japan, and so markets have little fundamental news to trade on.  Today, September machine tool orders were reported at 2.8% y/y, down from 5.1% in August.

Norway reported September CPI.  Headline rose 3.4% y/y vs. 3.3% expected, while underlying rose 1.9% vs. 1.8% expected.  The Norges Bank just started a tightening cycle with a 25 bp hike to 0.75% last month, and the data support further tightening.  However, the bank signaled a very modest pace of hikes.  Next policy meeting is October 25, and no change is expected then.  Bloomberg consensus sees the next hike in Q1 followed by another in Q3.

With markets perhaps doubting the Riksbank’s resolve to hike in either December or February, Nokkie has been outperforming.  The NOK/SEK cross has been rising and today broke above the year’s high near 1.1040 to trade near 1.1055.  Big target ahead is the May 2015 high near 1.1275.

EM FX remains under broad pressure, but some unexpected developments have allowed some currencies to catch a bid.  Yesterday, BRL remained bid on optimism regarding Bolsonaro’s first-round margin of victory, while ZAR recovered after news that President Ramaphosa replaced Finance Minister Nene with Tito Mboweni.  This was a quick and decisive move to take care of the bad optics surrounding Nene.  Mboweni was SARB Governor from 1999-2009 and is very well-respected by the markets.  The rand has since given back some of those gains today.  Like the real, the rand will have trouble posting absolute gains in a broad EM bear market, but it may be able to post relative gains.  Stay tuned.