Dollar Gains, Trade Tensions Rise Ahead of US Jobs Report

  • Powell’s failure to deliver a huge cut may have spurred President Trump to ratchet up trade tensions
  • We remain dollar bulls; the US July jobs report has been relegated to a sideshow
  • Japan removed Korea from its so-called “white list” of trusted export destinations
  • UK July PMI readings continued today; BoJo’s parliamentary majority was reduced to one
  • The risk-off backdrop is clearly bad for EM

The dollar is mostly firmer against the majors ahead of the US jobs report.  Swissie and yen are outperforming, while Kiwi and Nokkie are underperforming.  EM currencies are broadly weaker.  THB and TRY are outperforming, while RUB and KRW are underperforming.  MSCI Asia Pacific was down 1.4%, with the Nikkei falling 2.1%.  MSCI EM is down 1.7% so far today, with the Shanghai Composite falling 1.4%.  Euro Stoxx 600 is down 1.8% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 6 bp at 1.83%, while the 3-month to 10-year spread has inverted 5 bp to stand at -23 bp.  Commodity prices are mostly lower, with Brent oil up 2.6%, copper down 1.9%, and gold down 0.6%.

Powell’s failure to deliver a huge cut may have spurred President Trump to ratchet up trade tensions.  He said 10% tariffs will be slapped on the remaining $300 bln of Chinese imports that have not yet been affected, effective September 1.  Trump added that the tariffs could easily go “well beyond” 10% if needed.  China pledged that it would retaliate.

US rates markets reacted quickly to the renewed tariff threats.  The implied yield on the January 2020 Fed Funds futures contract fell to 1.62% from 1.80% the previous day.  Two more cuts are now back to being fully priced in, with WIRP suggesting 95% odds of a cut at the next meeting September 18.  Powell himself admitted that the Fed is still trying to figure out how to react to global trade tensions.  Markets clearly believe the Fed will bail Trump out again.

We’ve said it before and we’ll say it again: it simply makes no sense to risk a global recession in order to get the Fed to cut rates.  Easier monetary policy is a second best response to a trade war.  What’s the first best?  End the war by eliminating the tariffs.  The 3-month to 10-year curve inverted further to -23 bp, the most since the July 4 cycle low near -25 bp and signaling greater recession risk.

We remain dollar bulls.  But just like the Fed, we are struggling with how to compensate for a trade war.  That the dollar continues to rally suggests the safe haven bid is overwhelming the slide in US interest rates.  Or perhaps the greenback’s gains still reflect the fact that the US economy is likely to be the most resilient.

The US July jobs report has been relegated to a sideshow.  Consensus sees 165k jobs added vs. 224k in June.  The 3-, 6-, and 12-month moving averages for this series currently stand at 171k, 172k, and 192k, respectively.  Average hourly earnings are seen steady at 3.1% y/y, while the unemployment rate is seen falling a tick to 3.6%.

We have several clues that point to a solid NFP reading today.  Initial jobless claims for the survey week were 216k, which remains near the cycle lows.  ADP jobs data came in at 156k vs. 150k expected.  On the other hand, the employment components for Chicago PMI and ISM manufacturing PMI suggest some weakness in hiring.

There are other US data reports today.  June trade (-$54.6 bln expected), factory orders (0.7% m/m expected), and July Michigan consumer sentiment (98.5 expected) will all be reported.  While the FOMC media embargo has ended, there are no Fed speakers until Bullard Tuesday.

We think Powell was right to refrain from pre-committing to more cuts.  The US economy remains in solid shape.  The Atlanta Fed’s GDPNow model is tracking 2.2% SAAR growth in Q3 vs. 2.0% previously, above trend (~2%) and little changed from the preliminary 2.1% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 2.2% SAAR growth in Q3.  That number will be updated later today.

Speaking of trade tensions, Japan removed Korea from its so-called “white list” of trusted export destinations.  Effective August 28, Japanese exports to Korea will be subject to much stricter regulation and scrutiny.  Tensions between the two nations stem from the issue of reparations for Japan’s actions during its colonial period.  This move will further dampen regional trade and growth.

UK July PMI readings continued today.  Construction PMI came in at 45.3 vs. 46.0 expected and will be followed Monday by services (50.3 expected) and composite (49.8 expected) readings.  Manufacturing PMI was reported yesterday at 48.0 vs. 47.6 expected.  Data are expected to remain soft ahead of the October 31 Brexit deadline.  Sterling remains heavy, trading just above yesterday’s cycle low near $1.2080.  Next target is the January 2017 low near $1.1985.

Boris Johnson’s parliamentary majority was cut to one seat after a by-election yesterday.  As expected, the Liberal Democrats easily won the seat in Wales that was held by the Tories.  They now hold 310 seats along with 10 held by the Democratic Unionist Party, whilst the opposition now holds 319 seats.  This will simply make Johnson’s job navigating Brexit even tougher.

Australia reported June firm retail sales and Q2 PPI overnight.  Sales rose 0.4% m/m vs. 0.3% expected, while PPI accelerated to 2.0% y/y from 1.9% in Q1.  The RBA has signaled that it wants to gauge the impact of its back-to-back cuts before moving again.  As such, it is not expected to move at the next meeting August 6.  However, WIRP shows rising odds of a cut as we move into Q4, with 61% chance of a cut October 1 and 80% November 5.

The risk-off backdrop is clearly bad for EM.  However, it has been under pressure for quite some time already.  MSCI EM is down eight straight days and nine of the past ten.  MSCI EM has also significantly underperformed MSCI World (DM) so far this year, up 5.8% and 16.2%, respectively.  The global growth story remains weak, and it’s clear that the global liquidity story is simply not enough on its own to support EM.  Positioning isn’t helping matters, as we think investors got hugely overweight in recent weeks by underestimating the rising risks to EM.