Dollar Mixed as it Consolidates Recent Gains

  • The dollar is mixed today as it consolidates recent gains
  • The Italian government aims to narrow the budget deficit to -2% of GDP by 2021
  • Sterling continues to trade heavy ahead of Prime Minister May’s speech today at the Tory party conference
  • During the North American session, ADP reports its estimate for private sector job growth
  • Indonesia is reportedly considering a cut in capital gains taxes on fixed income investments to attract more capital
  • Turkey September CPI rose 24.5% y/y; National Bank of Poland is expected to keep rates steady at 1.5%

The dollar is mixed against the majors as it consolidates recent gains.  The euro and Stockie are outperforming, while the Antipodeans are underperforming.  EM currencies are mixed too.  MXN and PHP are outperforming, while TRY and INR are underperforming.  MSCI Asia Pacific was down 0.7%, with the Nikkei falling 0.7%.  MSCI EM is down 0.2% so far today, with China on holiday all week.  Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a higher open.  The 10-year US yield is up 1 bp at 3.07%.  Commodity prices are mostly higher, with Brent oil up 0.1%, copper up 0.5%, and gold up 0.1%.

The dollar is mixed today as it consolidates recent gains.  We believe the drivers supporting the dollar remain intact, namely higher US rates.  Furthermore, political uncertainty in the eurozone (Italy) and the UK (Brexit) are likely to continue weighing on the euro and sterling.  Overnight, Australia reported much weaker than expected building approvals data (-9.4% m/m vs. +1.0% expected), which supports the notion of steady RBA policy through much of next year.

The Italian government aims to narrow the budget deficit to -2% of GDP by 2021.  Press reports suggest Italy will also target a -2.2% deficit in 2020 after -2.4% in 2019.  Previously, the government was targeting a deficit equal to -2.4% of GDP in all three years.

While this may sound positive at first blush, recall that this is the same government that proposed that -2.4% deficit in 2019.  They should get no credit for any plan to narrow the deficit when they are responsible for widening it in the first place.  More importantly, we need to see the underlying growth assumptions as we remain skeptical that Italy can grow its way out of this mess as some senior officials are claiming.

Italian bonds have staged a modest recovery today.  The 10-year BTP yield is now around 3.39% after it touched 3.45% Tuesday, the highest since early 2014.  Upward pressure on Italian yields looks likely to continue in the face of overall Italian intransigence.  Note that Italy 10-year yields are still up 53 bp over the last week, while German yields are -9 bp.  In the 2-year space, Italy is up 59 bp and Germany is -5 bp.

Eurozone final services and composite PMIs for September were reported at 54.7 and 54.1, respectively.  Spanish and German readings were revised down from the flash report, while Italian and French readings were revised up.  Elsewhere, eurozone retail sales came in at -0.2% m/m vs. +0.2% expected.  Data have been a bit soft of late, but the ECB is maintaining its forward guidance.

The euro has held up relatively well after failing to break below the $1.15 area yesterday.  With Italian concerns still bubbling, we think the downside remains open for the euro.  Break of $1.15 would set up a test of the August low near $1.13, while a rebound above $1.1660 could negate the move lower.

UK reported services and composite PMI readings for September at 53.9 and 54.1, respectively.  Both readings eased from August.  This comes after a firmer than expected manufacturing PMI and a weaker than expected construction PMI.  Markit estimated that the UK grew just under 0.4% q/q in Q3, the same pace as Q2.  That’s a solid outlook but it should not lead the BOE to significantly alter its pace of tightening.

Sterling continues to trade heavy ahead of Prime Minister May’s speech today at the Tory party conference.  It is on track to test the September low near $1.2785, while a break of $1.29 is needed to set up a test of the August low near $1.2660.  Yesterday, Boris Johnson played good cop, bad cop all by himself.  Johnson first derided May’s proposed Brexit plan as “politically humiliating” and “a cheat.”  Yet he went on to end his speech with a call for Tories to back May.  Her response today will be interesting, to say the least.

During the North American session, ADP reports its estimate for private sector job growth.  Consensus sees +184k, the same as consensus for nonfarm payrolls this Friday.  ISM non-manufacturing PMI will also be reported, with consensus at 58.0 vs. 58.5 in August.  Evans, Barkin, Brainard, Mester, and Powell all speak today.

Indonesia is reportedly considering a cut in capital gains taxes on fixed income investments to attract more capital.  Policymakers are also thinking about extending tax breaks to exporters that park their dollars in local banks for a longer period.  While we applaud policymakers there for their efforts, we’d note that a heavy borrowing load is one of the major reasons investors are wary of Indonesia.

Turkey September CPI rose 24.5% y/y vs. 21.1% expected and 17.9% in August.  Inflation moves further above the 3-7% target range, which quite frankly has become irrelevant.  With a policy rate of 24%, the real rate is back to negative and the most recent 625 bp has basically been wiped out.  Next policy meeting is October 25.  While most central banks would hike, no change seems likely until markets force the next move.  Much will depend on how the lira is trading then.

National Bank of Poland is expected to keep rates steady at 1.5%.  On Monday, Poland reported September CPI at 1.8% y/y vs. 1.9% expected and 2.0% in August.  Inflation remains in the bottom half of the 1.5-3.5% target range.  We suspect the low inflation reading will give the bank cover to maintain its ultra-dovish forward guidance of no hikes until 2020.