Dollar Hangs on to Recent Gains as US-China Tensions Enter Next Stage

  • There are a lot of moving parts regarding the US-China relations as we move deeper into the next mini-cycle of escalation; the dollar has hung on to its recent gains
  • Stimulus talks remain dead in the water; Trump signed four executive orders over the weekend, as expected
  • The UK labor market is likely to remain under stress; Norway’s July CPI surprised slightly on the upside
  • China July CPI and PPI came in slightly higher than expected

There are a lot of moving parts regarding the US-China relations as we move deeper into the next mini-cycle of escalation. The US placed sanctions on Chinese officials in reaction to the events in Hong Kong. The measure targeted 11 officials, including Hong Hong’s Chief Executive Carrie Lam. In a show of determination, Hong Kong’s police arrested pro-democracy media figure Jimmy Lai. Moreover, China reciprocated by sanctioning 11 American officials, including Senators Marco Rubio and Ted Cruz. All this is happening as the US Secretary of Health and Human Services, Alex Azar, is visiting Taiwan. There is further escalation to go, in our view, but the proximity of the US elections means that the downside for Trump is very high. As such, we still think the confrontation will remain more in the rhetoric space than commercial – for now, at least.

The dollar has hung on to its recent gains. However, we continue to view this dollar bounce with skepticism, as risks of US economic underperformance continue to rise due to the lack of an aggressive stimulus bill. DXY is flat on the day but remains near the highs from last week and appears to be on track to test the high near 94 from last Monday. The euro is down for the second straight day, trading near $1.1750 and likely to test last Monday’s low near $1.17. Sterling looks likely to test last week’s low near $1.2980, while USD/JPY is trying to break above the 106 level.

AMERICAS

Stimulus talks remain dead in the water. After the last round of talks ended Friday, the finger-pointing began. Top Democrats said they had offered to cut $1 trln from their proposed $3.5 trln plan in exchange for Republicans raising their proposed $1 trln plan by the same amount. However, Treasury Secretary Mnuchin said that the Democrats offered no concessions on enhanced unemployment benefits and aid to state and local governments. He said he stands ready to listen to any new proposals from the Democrats.

President Trump signed four executive orders over the weekend, as expected. These include an eviction moratorium, an extension of enhanced employment benefits at $400 per week, deferral of payroll taxes, and student loan relief. All are likely to be challenged in court for subverting Congress’ power of the purse. President Trump said the orders “will take care of, pretty much, this entire situation.” We disagree. Even if they were to be fully enacted, these measures fall far short of what’s needed. For instance, there would be no aid to neither schools nor state and local governments.

This is all political brinksmanship at its finest. Coming less than three months ahead of elections, however, it carries heightened risks. To state the obvious, it also carries economic risks as the nearly 30 mln collecting unemployment benefits will take a huge hit. Without aid, state and local governments are likely to announce layoffs. This will hurt consumption and retail sales in the coming weeks. At this point, no talks are planned but we continue to believe that some sort of compromise will eventually be reached. Simply put, the stakes are too high for all involved.

Tensions in fixed income markets continue to get exposed by rising inflation breakeven rates and falling real yields. We interpret the moves with a degree of nuance. While most market participants do not expect inflation to pick up in the near term, they still want to hedge this risk, and may be willing pay a lot for protection. The reason is that if they are wrong (i.e. inflation rises fast), the consequences of this outcome could be disastrous. As such, we expect the demand for real assets to continue, helping to underwrite the rally in risk assets. This week’s quarterly refunding by the US Treasury may be true test of the markets, as record high debt sales may prove difficult if inflation concerns are truly rising. The refunding starts tomorrow with $48 bln of 3-year notes to be sold.


It’s a quiet day in terms of data here in the US. The only report is June JOLTS job openings, which are expected to rise to 5300 from 5397 in May. Evans speaks. With the US economy losing some momentum in Q3, we suspect Fed officials will maintain the very dovish tone established at the July 29 meeting.

EUROPE/MIDDLE EAST/AFRICA

The UK labor market is likely to remain under stress. A survey of employers shows that one in three plan to cut jobs this quarter. At the same time, wages are likely to remain subdued as employers plan to increase basic pay by only 1%, half of what was expected last year. All eyes are on the labor market ahead of the October expiry of the government’s furlough program. This is another likely headwind that makes the Bank of England’s upbeat outlook last week all the more unlikely to come to fruition.

Norway’s July CPI surprised slightly on the upside. Headline inflation rose 1.3% y/y and 0.7% m/m. Of note, the Norges Bank’s preferred core inflation measure rose 3.5% y/y, a four-year high. It’s still too early to think of a shift in the bank’s dovish guidance, which envisions tightening only in 2022. There was little reaction in fixed income markets or the krone.

ASIA

China July CPI and PPI came in slightly higher than expected. The former rose 2.7% y/y while the latter fell -2.4% y/y, both a tick higher than expected. Much of this was due to food prices, which were pushed higher from flooding last month in parts of the country. Core inflation eased to 0.5% y/y vs. 0.9% in June. Money and loan data will be reported during the week, with new loans and aggregate financing expected to slow from June to CNY1.2 trln and CNY1.85 trln, respectively. It appears that the PBOC is shifting out of emergency mode and into sustainable recovery mode. As a result, we expect steady policy for the time being as the recovery progresses.