Dollar Mixed as Markets Await Fresh Drivers

  • US rates have yet to recover back to last week’s highs
  • Yesterday, the US reported a budget deficit for FY2018 ended in September of -$779 bln
  • We believe that the deficit is the elephant in the room with regards to the dollar
  • Italy formally submitted its draft budget to the EU; UK reported labor market data
  • RBA released its minutes overnight; New Zealand reported Q3 CPI
  • China reported September CPI and PPI
  • Turkey August IP rose 1.7% y/y; National Bank of Hungary is expected to keep rates steady at 0.90%

The dollar is mixed against the majors as markets await fresh drivers.  Stockie and Kiwi are outperforming, while the yen and Swissie are underperforming.  EM currencies are mixed.  KRW and ZAR are outperforming, while RON and PLN are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 1.3%.  MSCI EM is up 0.5% so far today, with the Shanghai Composite falling 0.9%.  Euro Stoxx 600 is up 0.5% near midday, while US futures are pointing to a higher open.  The US 10-year yield is up 1 bp at 3.17%.  Commodity prices are mostly lower, with Brent oil down 0.7%, copper down 0.3%, and gold up 0.1%.

US rates have yet to recover back to last week’s highs.  Soft retail sales data yesterday, especially coming after softer than expected PPI and CPI data last week.  This is keeping the dollar on its back foot.  However, due to the usual idiosyncratic risks, the euro and sterling have been unable to truly take advantage of the dollar’s overall softness.

Yesterday, the US reported a budget deficit for FY2018 ended in September of -$779 bln.  This is the widest since FY2012 and up from -$666 bln in FY2017.  Spending rose 3.2% while revenue ropes a mere 0.4%.  As a percentage of GDP, the gap rose 0.4 percentage points to -3.9%.  The numbers certainly undermine the supply side argument that tax cuts will pay for themselves.  They aren’t, they won’t, and at some point, they will require painful offsetting adjustments by the US.

Indeed, we believe that the deficit is the elephant in the room with regards to the dollar.  While worrisome now, we don’t think we’re anywhere near the tipping point where markets turn very negative on the US.  That will likely be when the next US downturn hits.  Then, the budget deficit will blow out and could require fiscal tightening just as the Fed starts cutting rates.  This combination of tight fiscal policy and loose monetary policy would be dollar-negative and is the opposite of what we are seeing now.

After the retail sales data, the Atlanta Fed’s GDPNow estimate for Q3 growth was cut to 4.0% SAAR from 4.2% previously.  It noted that “After this morning’s retail sales report from the U.S. Census Bureau, the nowcast of third-quarter real personal consumption expenditures growth fell from 3.6 percent to 3.3 percent.”

During the North American session, the US reports September IP, August JOLTS job openings, and August TIC flows.  Daly is the only Fed speaker today.  Note that Bloomberg’s WIRP shows market odds of a December hike are still quite high at 76%.

Italy formally submitted its draft budget to the EU late yesterday.  The EU now has a week to make its initial assessment.  As noted yesterday, some polls suggest that the popularity of the Italian government has risen during this budget drama and so Salvini and Di Maio really have no reason to give in to EU criticism.  Despite falling Italian bond yields today, the euro feels heavy and is having trouble getting above the $1.16 area.  A break back below the $1.15 area is needed to set up a test of the October low near $1.1430.

The UK reported labor market data today ahead of September CPI data Wednesday and retail sales Thursday.  Labor data was mixed.  Average weekly earnings and earning ex-bonus both accelerated to 2.7% y/y and 3.1% y/y in September, respectively.  However, employment fell -5k in August vs. +15k expected and was the first drop since October 2017.  Unemployment held steady but only because of a rise in laborers that were counted as inactive.

Short sterling futures implied yields have backed off modestly in recent days and today’s data added to the trend.  They now show the market is fully pricing in the next 25 bp hike by June and the one after by March 2020.  We think this trajectory assume some sort of Brexit compromise is reached.  To us, a no deal hard Brexit poses downside risks to the economy.

It’s being reported that Prime Minister May will address the EU leaders ahead of their dinner tomorrow.  Then the leaders of the EU-27 will decide whether to call the November EU summit.  May is meeting with her cabinet today.  Sterling remains bid despite Brexit uncertainty and mixed jobs data.  We think markets are being overly optimistic on both Brexit risk and the economic outlook, and the two are intertwined.

RBA released its minutes overnight.  The minutes echoed the dovish tone of the RBA statement, and most do not expect the tightening cycle to begin until Q4 2019.  The RBA noted that currency weakness was likely helpful for growth.  It also noted that while the next move in rates is likely to be up, there was no strong case for a near-term hike.

Note AUD has staged a modest recovery from the year’s low this month near .7040, recouping about a third of the September-October drop.  We remain bearish on AUD but a break above the .7210 area would suggest a larger than anticipated correction back up to the September 26 high near .7315.

Elsewhere down under, New Zealand reported Q3 CPI.  Inflation picked up to 1.9% y/y vs. 1.7% expected and 1.5% in Q2.  This is the highest since Q3 2017 and is nearing the 2% target.  Yet the RBNZ has signaled that it is in no hurry to hike rates, with markets pricing in Q4 2019 too.   Next policy meeting is November 8 and no change is expected then.

With today’s rally, NZD has nearly retraced two thirds of the September-October drop.  Break of the .6590 area would set up a test of the September 26 high near .6700.   Recent NZD outperformance has seen the AUD/NZD trade at its lowest level since June 28. The 200-day moving average near 1.0830 was tested today but it has held so far.

China reported September CPI and PPI.  CPI rose 2.5% y/y, as expected, while PPI rose 3.6% y/y vs. 3.5% expected.  We know that at this point, policymakers are entirely focused on stabilizing growth, not on limiting potential inflation.  China reports September money and new loan data this week, but no date has been set.  M1, M2, and loan growth are all expected to pick up a bit, as past stimulus works its way through the system. 

Turkey August IP rose 1.7% y/y vs. 1.0% expected and 5.6% in July.  The economy is slowing sharply, as evidenced by the collapse in imports.  While this led to the first monthly current account surplus in August since 2015, this is not a reason to turn positive on the lira.  Not when inflation is still rising with no policy response.  Next policy meeting is October 25.  If the lira remains firm, then no change is seen then.

National Bank of Hungary is expected to keep rates steady at 0.90%.  CPI rose 3.6% y/y.  While above the 3% target, inflation is still within the 2-4% target range.  The bank has started to talk about exiting unconventional policy, but we think that is unlikely until 2019.