Dollar Mixed as Geopolitical Tensions Rise

  • The dollar remains under pressure this week, as we expected
  • Geopolitical tensions have risen in the Middle East; US officials sought to downplay expectations for the upcoming Trump-Xi meeting
  • The Chicago Fed National Index (CFNAI) for May came out yesterday at -0.05 vs. -0.20 expected
  • Dallas Fed President Kaplan expressed a counter-trend view regarding lower rates
  • National Bank of Hungary is expected to keep the main policy rate steady at 0.9%

The dollar is mixed against the majors even as geopolitical tensions rise. Stockie and Kiwi are outperforming, while Swissie and Nokkie are underperforming. EM currencies are also mixed. IDR and ZAR are outperforming, while HUF and RUB are underperforming. MSCI Asia Pacific was down 0.2%, with the Nikkei falling 0.4%. MSCI EM is down 0.4% so far today, with the Shanghai Composite falling 0.9%. Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 1 bp at 2.01%, while the 3-month to 10-year spread is steady and stands at -9 bp. Commodity prices are mostly higher, with Brent oil down 0.6%, copper up 0.7%, and gold up 0.8%.

The dollar remains under pressure this week, as we expected. DXY traded at a new low for this move near 95.843 today before rebounding slightly. It likely remains on track to test the March low near 95.74. Likewise, the euro traded at a new high for this move today near $1.1410 but was turned back. It likely remains on track to test the March high near $1.1450. These dollar bounces are likely corrective in nature for now. Why?

The reverberations from last week’s dovish FOMC decision are unlikely to fade anytime soon. The US rates markets continue to price in a very dovish Fed, which should continue to weigh on the dollar near-term. That said, we believe that the bond market is overly pessimistic about the US economy and that upcoming data should be solid. If so, the dollar should regain some traction but we’re simply not there yet.

Geopolitical tensions have risen in the Middle East. Iran said a diplomatic solution had closed after the US imposed sanctions on its leader Ayatollah Ali Khamenei and eight senior military commanders. National Security Advisor John Bolton said there is an “open door” for Iran to negotiate a new nuclear deal, but based on the Iranian comments, the US side may have misjudged the willingness of Iran to restart talks under the threat of sanctions.

Elsewhere, US officials sought to downplay expectations for the upcoming Trump-Xi meeting. Indeed, the US insisted the US won’t compromise on its demands for structural reform in China. While we remain hopeful that a deal will eventually be struck late in Q3, enough pain has not been felt by both sides.

The Chicago Fed National Index (CFNAI) for May came out yesterday at -0.05 vs. -0.20 expected. April was revised to -0.48 from -0.45 previously so as a result, the 3-month average (CFNAIMA3) fell to -0.17 from -0.32 in April. This was the lowest since January and well above the recessionary threshold of -0.7. For those on recession alert, we believe this to be the single most important economic indicator (see Some Thoughts on the US Economy and Fed Policy).

The weak regional Fed manufacturing surveys for June continued with Dallas reporting Monday (-12.1 vs. -2.0 expected). Richmond reports today (2 expected) and Kansas City reports Thursday (1 expected). Last week, the Empire survey came in at -8.6 and the Philly Fed at 0.3, both weaker than expected. The readings all suggest that the trade war is taking a toll on US manufacturing.

There are other minor US data readings out today. May new home sales (1.6% m/m) and Conference Board consumer confidence (131.0 expected) will be reported. The Fed’s Williams, Bostic, Powell, Barkin, and Bullard all speak today. We believe last week’s FOMC decision all but cemented a July cut. However, it will be up to Fed officials to better manage market expectations.   Three cuts this year followed by up to two cuts next year is simply too aggressive.

Indeed, Dallas Fed President Kaplan expressed a counter-trend view regarding lower rates. He is concerned that added stimulus now “would contribute to a build-up of excesses and imbalances in the economy which may ultimately prove to be difficult and painful to manage.” The Fed’s unofficial third mandate of financial stability seems to have fallen by the wayside of late and so Kaplan’s comments are timely as well as noteworthy. We note US financial conditions are looser now than when the Fed started the tightening cycle in December 2015.

The Brexit plot thickens. Senior Tory MP Kenneth Clarke said he would be prepared to bring down a Johnson-led government to prevent a no-deal Brexit. This view was echoed by Defense Minister Tobias Elwood, who predicted that around a dozen Tory MPs could support a no confidence motion with the same aim. Elsewhere, reports suggest opposition Labour is preparing to table a no confidence motion within 24 hours of a new Prime Minister being chosen in July.

National Bank of Hungary is expected to keep the main policy rate steady at 0.9%. CPI rose 3.9% y/y in May, right at the top of the 2-4% target range. We could see some minor tightening measures, perhaps a hike in the overnight rate while keeping the policy rate steady. For now, however, the bank seems to be erring on the side of dovishness.