Dollar Mixed as New Week Begins

  • Despite last week’s setback, we remain dollar bulls; the three key issues for risk assets have not been resolved yet
  • The US economy remains in solid shape, at least for now; China reported weak August trade data
  • Germany reported July trade and current account data; UK reported July GDP, IP, construction output, and trade
  • Mexico August CPI is expected to rise 3.16% y/y

The dollar is mostly softer against the majors as the new week begins.  Sterling and Kiwi are outperforming, while yen and Swissie are underperforming.  EM currencies are mixed.  ZAR and RUB are outperforming, while CNY and TRY are underperforming.  MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.6%.  MSCI EM is up 0.2% so far today, with the Shanghai Composite rising 0.8%.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 4 bp at 1.60%, while the 3-month to 10-year spread has steepened 4 bp to stand at -35 bp.  Commodity prices are mostly higher, with Brent oil up 0.6%, copper down 0.5%, and gold up 0.2%.

Despite last week’s setback, we remain dollar bulls.  If you are a dollar bear, where else do you go?  We believe the US still stands out in a field of generally weak economies.  DXY retraced nearly two thirds of its August-September rally before seeing a bounce Friday.  The euro has fallen back towards $1.10 and remains heavy.  Sterling is creeping higher but its recent gains are vulnerable if the euphoria of lower hard Brexit risks wears off.  USD/JPY remains stuck near 107.

We think the three key issues for risk assets have not been resolved yet.  Hong Kong protests continued over the weekend, while reports suggest the US and China remain far apart.  Even Brexit has likely been given only a three month reprieve.  We remain negative on risk assets and EM until these key issues have been ultimately resolved.

The US economy remains in solid shape, at least for now.  The Atlanta Fed’s GDPNow model is tracking 1.5% SAAR growth in Q3, down from 1.7% previously.  This is below trend (~2%) and below the revised 2.0% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.55% SAAR growth in Q3, down from 1.8% the previous week.  It also provided its first forecast for Q4 growth at 1.1% SAAR.  This bears watching.

The media embargo for the September 18 FOMC has gone into effect.  As such, there are no Fed speakers until Chair Powell gives his post-decision press conference.  Last Friday, we believe Powell gave a very balanced viewpoint that did not paint the Fed into a corner.  Yet markets are 100% convinced that the Fed will cut rates again by 25 bp next week.  July consumer credit will be the only US data reported today.

China reported weak August trade data.  Exports contracted -1% y/y vs. +2.2% expected, while imports contracted -5.6% y/y vs. -6.4% expected.  Some reports suggest the weak data seen so far for August will lead the PBOC to add more stimulus.  While that is likely, the bank just cut reserve requirements last week and so we see nothing imminent.  Indeed, the PBOC is likely to wait to see how the banking system reacts to this latest cut before easing again.

Germany reported July trade and current account data.  Both surpluses came in larger than expected, as exports rose 0.7% m/m vs. -0.5% expected and imports fell -1.5% m/m vs. -0.3% expected.  This comes after Germany reported extremely weak factory orders and IP data last week, as the eurozone’s largest economy slides towards recession.

The euro remains heavy ahead of the ECB decision Thursday.  It is finding some support just above the $1.10 area but continues to have trouble moving to the upside.  Much will depend on what Draghi delivers this week.  WIRP suggests 100% odds of a rate cut and 40% odds of a 20 bp move.

The UK reported July GDP, IP, construction output, and trade.  All came in better than expected, with GDP up 0.3% m/m vs. 0.1% expected, IP up 0.1% mm vs. -0.3% expected, construction output up 0.5% m/m vs. 0.2% expected, and the trade gap at -GBP219 mln vs. -GBP1.5 bln expected.  Recessions risks appear to have receded, though the outlook still hinges critically on what form Brexit will take.

Indeed, the fundamentals are secondary to Brexit.  Prime Minister Johnson saw another defection as Work and Pensions Secretary Hudd resigned over the weekend over his handling of Brexit.  Johnson travels to Ireland today to meet Prime Minister Varadkar and then returns to address the House of Commons in the afternoon. He is likely to continue his efforts to call early elections before the October 31 deadline.  At this point, the base case seems to be a three-month delay in Brexit and elections in November.

Firm data and perceived lower hard Brexit risks have helped sterling trade at a marginal new high for this move near $1.2365.  It is trading at the highest level since July 29 and a clean break of the $1.2345 area sets up a test of the July 15 high near $1.2585.

Mexico August CPI is expected to rise 3.16% y/y vs. 3.78% in July.  If so, inflation would be the lowest since October 2016 and nearing the 3% target.  Next policy meeting is September 26 and another 25 bp cut to 7.75% is expected.  July IP will be reported Wednesday, which is expected to contract -1.8% y/y vs. -2.9% in June.