Dollar Marks Time Ahead of FOMC

  • The dollar is trading largely sideways as the two-day FOMC meeting begins today
  • Press reports suggest that Italy will present a compromise budget deficit equal to -1.9% of GDP for 2019
  • Reports suggest that UK opposition Labour Party would consider holding a second Brexit referendum in order to avoid a hard Brexit
  • Brazil COPOM minutes will be released today, while the quarterly inflation report will be released Thursday

The dollar is mixed against the majors as the two-day FOMC meeting gets under way.  Sterling and the euro are outperforming, while Swissie and Aussie are underperforming.  EM currencies are mixed.  TRY and PLN are outperforming, while IDR and CNY are underperforming.  MSCI Asia Pacific was up 0.2%, with the Nikkei up 0.3% after returning from holiday.  MSCI EM is down 0.2% so far today, with the Shanghai Composite down 0.6% after returning from holiday.  Euro Stoxx 600 is up 0.4% near midday, while US futures are pointing to a higher open.  The 10-year US yield is up 2 bp at 3.11%.  Commodity prices are mixed, with Brent oil up 0.5%, copper down 1%, and gold up 0.1%.

The dollar is trading largely sideways as the two-day FOMC meeting begins today.  A decision to hike rates 25 bp tomorrow pretty much seen as a sure thing and the US 10-year yield is trading today at a new high near 3.11%.  Markets will instead be focused on the forecast revisions and Dot Plots.  That said, we suspect there will not be any significant changes to either in light of Powell’s more cautious stance at Jackson Hole last month.  The US data calendar today is light, with the September Richmond Fed index (20 expected) and Conference Board consumer confidence (132.1 expected) on tap.

Press reports suggest that Italy will present a compromise budget deficit equal to -1.9% of GDP for 2019.  Five Star leader Di Maio had suggested that Italy could emulate France with a deficit of -2.8% but later walked that back.  On the other hand, Finance Minister Tria wants to keep the gap at -1.6% of GDP.  The budget must be presented by Thursday and would then go to the EU for approval.

If these reports are true, we think markets would breathe a sigh of relief.  Indeed, 10-year Italian government bond yields are down 11 bp on the day, with the spread narrowing even more with German yields up 2 bp on the day.

However, there has not been much impact in FX markets and the euro is basically flat on the day.  The euro saw a bit of a pop yesterday on some hawkish Draghi comments.  However, the gains were short-lived as he restated the ECB’s forward guidance.  Given softness in German and eurozone data in recent months as well as rising risks from global trade tensions, we really think that it would be unusual (and risky) for the ECB to take a more hawkish stance at this juncture.

Reports suggest that UK opposition Labour Party would consider holding a second Brexit referendum in order to avoid a hard Brexit.  In an ideal situation for Labour, the party would reportedly vote against any deal put to Parliament.  If the government proposal is defeated, Labour would then push for a general election.  On the other hand, if a hard Brexit looms in the absence of any deal, Labour would push for a second Brexit referendum.

Whilst Bremainers might appreciate Labour’s stance on Brexit, markets can’t be happy with the hard left turn taken by the party at its annual conference.  Among other nuggets, the party would nationalize the railroads and other utilities.  Labour would also require large companies to set aside 10% of its shares for their workers and also giving workers a third of the seats on their boards.   Labour seems to be doubling down on a strategy that saw it do better than expected in the last elections.  Recent polls suggest Labour is trailing the Tories by only a few percentage points.

Meanwhile, the EU seems to be following a “good cop, bad cop” strategy.  Merkel and Macron are filling out their respective roles after the harsh reception given to May’s proposals at Salzburg.  Merkel called for negotiations to be done “in friendship” while Macron pushed for a Brexit deal to e struck by October rather than November.  All this maneuvering comes ahead of the Tory’s annual conference next week, where Prime Minister May is likely to come under attack from a variety of factions within her party.

Brazil COPOM minutes will be released today, while the quarterly inflation report will be released Thursday.  The language in the COPOM statement last week sets up a start of the tightening cycle at the next meeting on October 31.  IPCA inflation was 4.28% y/y in mid-September.   Markets remain nervous about the recent rise in popularity of PT’s Haddad. While Bolsonaro remains popular, his high rejection rate raises the odds that he will ultimately lose to Haddad in the second round vote.