Dollar Mixed as Markets Stay in Risk-Off Mode

  • Markets went right back into full risk-off mode Wednesday and that’s where they remain
  • The dollar is consolidating its recent gains; Trump’s limited tariff walk-back was clearly not enough
  • July retail sales today will be the key US data release this week; we see asymmetric risks
  • UK reported firm July retail sales; Norges Bank delivered a dovish hold
  • Australia reported firm July employment data
  • Mexico is expected to keep rates steady at 8.25%; Argentina July CPI is expected to rise 2.4% m/m

The dollar is narrowly mixed against the majors even as markets move deeper into risk-off territory.  Sterling and Aussie are outperforming, while Nokkie and Kiwi are underperforming.  EM currencies are mostly weaker.  ZAR and TRY are outperforming, while PHP and RUB are underperforming.  MSCI Asia Pacific was down 0.7%, with the Nikkei falling 1.2%.  MSCI EM is down 0.5% so far today, with the Shanghai Composite rising 0.3%.  Euro Stoxx 600 is down 1.0% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 4 bp to 1.54%, while the 3-month to 10-year spread has inverted 3 bp to stand at -40 bp.  Commodity prices are mostly lower, with Brent oil down 2.1%, copper down 0.5%, and gold up 0.2%.

Markets went right back into full risk-off mode Wednesday and that’s where they remain.  Weak data out of China and Germany added to the global gloominess, with equity and bond markets behaving as one would expect.  Negative-yielding debt has risen to a record-high $16 trln.  Gold is bid, not as an inflation hedge but as just another haven asset.  Meanwhile, the 30-year UST yield fell below 2.0% for the first time ever.

The dollar is consolidating its recent gains. We remain dollar bulls for all the same reasons, especially as the outlook elsewhere continues to worsen.  Yen and Swissie are also consolidating today but should resume their climb as well.  EM FX still remains under pressure as the global growth outlook weakens.

President Trump’s limited tariff walk-back was clearly not enough.  Today, China said that the next round of 10% tariffs violate the accord between Trump and Xi.  As a result China will impose retaliatory measures.  The situation has been further complicated by a Trump tweet, in which he called on China to make a deal but to first “humanely solve the Hong Kong problem.”  To China, the two matters are entirely separate and Trump’s tweet plays into suspicions that the US is meddling in what China sees as a domestic dispute with Hong Kong.

Much hay was made about the inversion of the US 2- to 10-year curve yesterday.  It is back to +2 bp today.  As we’ve noted before, the SF Fed has shown that the 3-month to 10-year curve is a better predictor of recession, though the 1- to 10-year and 2- to 10-year curves are almost as reliable.  However, coming on the heels of the UK 2- to 10-year curve inverting, it just added to the sense of gloom.  Note that the US 3-month to 10-year curve is at a cycle low -40 bp today, as is the 1- to 10-year curve at -18 bp.

Here is a list of DM countries with inverted yield curves (3-month to 10-year where possible):  Australia (-13 bp), Canada (-49 bp), Hong Kong (-49 bp), Singapore (-24 bp), Japan (-11 bp), Norway (-18 bp), UK (-40 bp), and US (-40 bp).  Switzerland just joined the club today (-3 bp) while Germany is very close to inverting (+1 bp).  All have inverted rather recently, and so all are likely reflecting the same growing global recession fears.

July retail sales today will be the key US data release this week.  Headline is expected to rise 0.3% m/m and ex-autos 0.4% m/m.  The so-called control group used for GDP calculations is expected to rise 0.4% m/m.  We see asymmetrical risks here.  While a firm reading would be welcome, we suspect markets will look past it as it will take much more before markets allay US recession fears.  On the other hand, a weak reading will simply feed into the recession theme.

US reports a lot of other data today, which carry the same asymmetric risks.  IP will be reported (0.1% m/m expected), as will weekly jobless claims, June business inventories (0.1% m/m expected), and TIC data.  Regional Fed manufacturing surveys for August kick off with Philly Fed and Empire readings today.  They are expected at 9.5 and 2.0, respectively, and would represent slowing from July.

Overall, we believe the US economy still remains in solid shape.  The Atlanta Fed’s GDPNow model is tracking 1.9% SAAR growth in Q3.  This is still close to trend (~2%) and little changed from the preliminary 2.1% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.6% SAAR growth in Q3. Yet the markets perceive much greater risks to the economy.  Until the US-China trade war is resolved, these GDP models will likely have little impact on the markets.

UK reported firm July retail sales.  Both headline and ex-auto fuel were expected to contract -0.2% m/m.  Instead, both rose 0.2% m/m.  Last week saw Q2 GDP contracting q/q, leading easing bets to increase.  However, this week saw firmer than expected inflation and now retail sales readings.  For now, the BOE is on hold but we believe that the rising risks of a hard Brexit will push the bank into a more dovish mode.

Norges Bank delivered a dovish hold.  It kept rates steady at 1.25%, as expected, but warned that “The global risk outlook entails greater uncertainty about policy rates going forward.”.  At its last meeting in June, the bank hiked rates 25 bp to 1.25% and flagged another hike before year-end.  Because it was an “interim” meeting, today’s decision was not followed by a press conference or monetary policy report.  Next policy meeting is September 19 and much will depend on global conditions.  If oil prices remain under pressure, Norges Bank may be on hold indefinitely.

Australia reported firm July employment data.  Employment was seen rising 14k but instead jumped 41.1k.  The mix was healthy, with full-time jobs rising 34.5k and part-time rising 6.7k.  The unemployment rate was steady at 5.2%, as expected.  The RBA has signaled that the labor market will be an important determinant of monetary policy.  WIRP suggests 21% odds of a cut at the September 3 meeting, down from 51% at the start of the week.  However, odds rise to 76% for October 1.

Banco de Mexico is expected to keep rates steady at 8.25%.  However, the market is split.  Of the 31 analysts polled by Bloomberg, 14 see a 25 bp cut, 16 see no cut, and 1 sees a 50 bp cut.  The economy remains weak while inflation is back within the 2-4% target range.  The peso may be the deciding factor, with excessive weakness likely to delay a cut for now.  The next meeting is September 26 and much will depend on the global backdrop.

Argentina July CPI is expected to rise 2.4% m/m vs. 2.7% in June.  If so, the y/y rate would ease slightly to 54.2% from 54.8% in June.  Argentine assets remain under pressure, with USD/ARS moving back above 60 despite tighter monetary policy.  On Monday, the central bank allowed the LELIQ rate to rise over 10 percentage points to 74.782%.  Rates were fairly steady Tuesday as markets calmed a bit.  Surprisingly, the LELIQ was kept basically unchanged yesterday even as the peso slump accelerated.  We think LELIQ rates will have to move even higher.