Dollar Mixed as Post-G20 Euphoria Wanes

  • Markets are searching for direction and three of them warn of a reversal in risk sentiment for the worse
  • Just as US tensions with China seem to be easing, they are picking up with Europe
  • The euro is benefiting from reports that Italy is backing down from its budget confrontation with the EU
  • UK PMI readings for June continued today with a much weaker than expected construction PMI of 43.1
  • RBA cut rates 25 bp to 1.0%, as expected
  • Korea June CPI was steady at 0.7% y/y; USD/HKD traded at its lowest level since September

The dollar is narrowly mixed against the majors as the post-G20 euphoria wanes. Aussie and Nokkie are outperforming, while Kiwi and sterling are underperforming. EM currencies are mostly weaker. The CEE currencies are outperforming, while KRW and RUB are underperforming. MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.1%. MSCI EM is flat so far today, with the Shanghai Composite also flat. Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 2 bp at 2.01%, while the 3-month to 10-year spread is down 5 bp to stand at -14 bp. Commodity prices are mostly lower, with Brent oil down 0.4%, copper down 0.5%, and gold up 0.6%.

Markets are searching for direction as G20 euphoria wears off and three of them warn of a reversal in risk sentiment for the worse. AUD, NZD, and copper are all likely to post outside down days today, which points to further losses ahead for three very growth-sensitive markets.

Indeed, just as US trade tensions with China seem to be easing, they are picking up with Europe. The US has added more EU products to a list of retaliatory tariffs due to the ongoing dispute between Boeing and Airbus. A public hearing on the proposed tariffs on an additional $4 bln worth of additional EU imports will be held August 5. And don’t forget that the auto tariff threat continues to simmer ahead of a mid-November deadline to resolve the issue based on national security grounds.

DXY retraced over half its late June drop before falling back today. A break above 97.031 would set up a test of the June 18 high near 97.766. EUR nearly retraced two thirds of its late June rally before recovering today on Italy news and ECB comments (see below). A break below $1.1270 is needed to set up a test of the June 18 low near $1.1180.

The euro is benefiting from reports that Italy is backing down from its budget confrontation with the EU. The government lowered its 2019 budget deficit target to -2.04% of GDP, while the 2020 deficit will remain in line with a previous target of -2.1%. The move is meant to avoid an excessive deficit procedure. More importantly, it is another time when, despite tough talk, the populists in Italy have backed down in the face of fines and sanctions. We suspect the theatrics will pick up again this fall as the 2020 budget process unfolds.

During the North American session, the only US data release is June auto sales. Sales are expected at a 17.0 mln annualized pace, down from 17.3 mln in May. Strength in retail sales in April and May are one major reason why we remain constructive on the US economic outlook.

The Fed’s Williams and Mester speak today. Expectations for three cuts this year followed by up to two cuts next year simply seems too aggressive to us. And apparently to the Fed as well, as comments last week represented a pushback of sorts to the market’s extremely dovish take on the Fed. That pushback should continue.

Germany reported weak May retail sales. Rather than gaining the consensus 0.5% m/m, sales fell -0.6%. However, the April drop was revised to -1.0% m/m from -2.0% previously. ECB officials were quoted as saying they are in no rush to cut rates in July. Given continued softness in key eurozone data, a consensus seems to be building for the ECB to give a dovish sign July 25 that sets up a rate cut September 12.

UK PMI readings for June continued today with a much weaker than expected construction PMI of 43.1 vs. 49.2 expected. Yesterday, manufacturing PMI came in at 48.0, the lowest reading on record since February 2013. Services and composite PMIs will be reported tomorrow (51.0 expected for both). Short sterling futures continue to push out BOE tightening expectations, with the next hike fully priced in by Q1 2024 now.

Reserve Bank of Australia cut rates 25 bp to 1.0%, as expected. Governor Lowe signaled that the bank would likely pause after back-to-back cuts to see how the economic outlook evolves, adding that he stands ready to cut further if needed. Next policy meetings are August 6, September 3, October 1, November 5, and December 3. If the economy remains weak, we suspect the next cut will be seen at one of the Q4 meetings.

Korea June CPI was steady at 0.7% y/y vs. 0.8% expected. Inflation remains well below the 2% target. Next policy meeting is July 17 and no change is expected then. Exports contracted -13.5% y/y and imports by -11.1% y/y in June, while manufacturing PMI dropped to 47.5.

USD/HKD traded at its lowest level since September and briefly entered the strong half of its 7.75-7.85 trading band. The gains may seem paradoxical given heightened political risk from the protests, but the key driver is once again rising local interbank rates. 3-month HIBOR is trading near 2.44%, the highest levels since October 2008. Some are linking tighter liquidity to companies hoarding cash to pay quarterly dividends. If so, liquidity should recover in the coming weeks once these payouts are made, driving HIBOR lower and USD/HKD higher.