Dollar Mixed Ahead of FOMC Decision

  • Global equity markets like what Draghi had to say
  • Other good news came in the form of resumed dialogue between the US and China
  • The FOMC decision will be delivered this afternoon even as Trump continues to jawbone the Fed
  • If the Fed disappoints today as we expect by not being more dovish, the dollar should benefit
  • Canada reports May CPI; Boris Johnson continues to dominate the Tory leadership vote
  • Japan reported weak May trade data
  • US is weighing new sanctions on Turkey; Brazil COPOM is expected to keep rates steady at 6.5%

The dollar is narrowly mixed against the majors ahead of the FOMC decision this afternoon. Swissie and sterling are outperforming, while the Antipodeans are underperforming. EM currencies are mixed too. KRW and TWD are outperforming, while TRY and MXN are underperforming. MSCI Asia Pacific was up 1.8%, with the Nikkei rising 1.7%. MSCI EM is up 1.4% so far today, with the Shanghai Composite rising 1.0%. Euro Stoxx 600 is down 0.2% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 3 bp at 2.09%, while the 3-month to 10-year spread has risen 4 bp and stands at -11 bp. Commodity prices are mostly lower, with Brent oil down 0.5%, copper down 0.3%, and gold down 0.3%.

Global equity markets liked what Draghi had to say yesterday, and those gains have mostly carried over today. We had thought that Draghi was setting the table for his successor to add stimulus, but we think it’s quite possible that Draghi takes that step himself before he steps down October 31. The remaining meetings for Draghi are July 25, September 12, and October 24. A lot will depend on the data, but we think he may go out with a bang.

Other good news came in the form of resumed dialogue between the US and China. President Trump said President Xi had agreed to meet him on the sidelines of the G20 meeting next week. Trump added that negotiating teams would begin talks prior to the meeting. While there is still a long road ahead, this is a good sign and supports our view that some sort of compromise will be reached late in Q3.

The FOMC decision will be delivered this afternoon. No change is expected, though WIRP suggests nearly a 25% chance of a cut. This seems to overstate the case. New Dot Plots and staff forecasts will be released. Most observers are looking for the Fed to signal a cut at the July 31 meeting. However, we think that will depend on the data and so we believe the Fed will not paint itself into a corner again. If consumption remains firm and momentum carries over into Q3, the Fed will likely remain on hold next month as well.

President Trump continues to jawbone the Fed. Headlines about possibly demoting Chairman Powell initially hurt the dollar yesterday but the impact faded after it became clear that the discussions took place in February. With Trump still criticizing the Fed during its two-day meeting, these perceived attempts to influence the Fed may have the opposite effect. Trump’s incessant jawboning will only make it that much harder for the Fed to cut due to the bad optics. Indeed, we are hopeful that Chairman Powell makes a strong statement of independence today.

If the Fed disappoints today as we expect by not being more dovish, the dollar should benefit. After making a new high for this move yesterday, DXY has edged lower. Likewise, the euro got some traction below $1.12 and has edged higher today despite the increased likelihood that the ECB will cut rates again this year. BOE and BOJ meetings tomorrow should underscore the divergence theme yet again, which favors the dollar.

Canada reports May CPI. Headline and common core are both expected to rise a tick to 2.1% y/y and 1.9% y/y, respectively. April manufacturing sales came in weaker than expected Monday at -0.6% m/m, and April retail sales will be reported Friday. Jobs data have remained firm, but other data have been soft. Next BOC meeting is July 10 and no change is expected then. However, odds of a cut rise as we move into Q4.

Boris Johnson continues to dominate the Tory leadership vote. Boris Johnson got 126 votes in the second round vs. 114 votes in the first. Runner-up Jeremy Hunt got 46 votes vs. 43 previously.  Gove got 41 vs. 37 votes previously, Stewart got 37 vs. 19 previously, Javid got 33 vs. 23 previously, and Raab got 30 vs. 27 previously. At least 33 votes were needed to advance to the next round and so Raab is out.

Several more rounds of voting by MPs will be held today and tomorrow until there are only two candidates left.  Voting then goes to a full vote of Conservative party members June 22, with the next Prime Minister to be announced July 22.   Elsewhere, Labour leader Corbyn will reportedly push for a second Brexit referendum no matter what.

The UK reported May CPI and June CBI industrial trends. Both headline and CPIH came in as expected, a tick lower at 2.0% y/y and 1.9% y/y, respectively. Data come ahead of the BOE meeting tomorrow. Real sector data have been coming in much weaker than expected in Q2, which supports our view that the BOE will not hike rates anytime soon.

Japan reported weak May trade data. Exports contracted -7.8% y/y vs. -8.2% expected while imports contracted -1.5% y/y vs. +1.0% expected. As a result, the adjusted deficit was slightly lower than expected at -JPY609 bln. This is the sixth straight y/y contraction and nearly the deepest reading yet. Other data have been soft ahead of tomorrow’s BOJ decision. We expect a dovish hold that points to further easing ahead, most likely in H2.

EM FX is seeing a bit of a bounce. Much of this is due to the dovish ECB comments, but we learned after the Fed’s dovish pivot earlier this year that the liquidity story is just not enough to sustain an EM rally. We need a good global growth story much more and we’re not there yet. Yes, US and China are talking again but with Trump complaining about the euro, we suspect trade tensions will remain high into the autumn. We’d look to fade this EM FX bounce.

Reports suggest the US is weighing new sanctions on Turkey. Three sanctions packages are being discussed of varying degree, but the most severe one would reportedly cripple the economy. Sanctions would be retaliation for Turkey going forward with its decision to buy a missile defense system from Russia. President Trump reportedly doesn’t want to decide until after the G20 meeting, where he is likely to meet with President Erdogan.

Brazil COPOM is expected to keep rates steady at 6.5%. With the economy remaining sluggish, markets are once again pricing in increased odds that the next move will be a rate cut, not hike. The CDI market is now pricing in two cuts by year-end that would take the SELIC rate down to 6.0%, while the most recent weekly central bank survey shows market expectations for a year-end SELIC rate of 5.75% vs. 6.5% previously. While it is too early to cut rates now, the central bank should deliver a dovish hold today that suggests easing is possible in H2.