Dollar Mixed as US-China Relations Improve

  • The dollar got a boost from Fed speakers yesterday; Trump comments snuffed that rally
  • There appears to be a thaw in US-China relations; US companies are finding ways around the Huawei blacklisting
  • RBNZ kept rates steady at 1.5%, as expected
  • MSCI announced that Kuwait will be added to its EM index; Malaysia May CPI was steady at 0.2% y/y
  • Thailand kept rates steady at 1.75%, as expected; Czech National Bank is expected to keep rates steady at 2.0%

The dollar is mixed against the majors as market sentiment improves on an apparent thaw in US-China relations. The Antipodeans and Scandies are outperforming, while Swissie and yen are underperforming. EM currencies are also mixed. TRY and INR are outperforming, while IDR and RUB are underperforming. MSCI Asia Pacific was down 0.4%, with the Nikkei falling 0.5%. MSCI EM is flat so far today, with the Shanghai Composite falling 0.2%. 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 2.02%, while the 3-month to 10-year spread is up 4 bp and stands at -9 bp. Commodity prices are mostly higher, with Brent oil up 1.3%, copper up 0.1%, and gold down 1.3%.

The dollar got a boost from Fed speakers yesterday. Believe it or not, the greenback started to rally when Bullard expressed doubts about the need for a 50 bp cut. Later, Powell said it was important that the Fed not overreact in the short-term, and that it continues to weigh whether uncertainties call for easing.   While we would struggle to classify these comments as hawkish, they were certainly less dovish than hoped for.

The dollar then promptly weakened on comments from President Trump. He reportedly feels that the dollar is too strong and the euro too weak. We have not seen a US official talk down the dollar like this since the days when Lloyd Bentsen was Treasury Secretary. He was succeeded by Bob Rubin, who started the strong dollar mantra that every US official has since used. Until now.

DXY is seeing some follow-though to the upside after the break below 96 yesterday couldn’t be sustained. The euro had trouble sustaining a move above $1.14. Likewise, for sterling and $1.28. Conversely, improving market sentiment has seen USD/JPY move back towards 108 after a brief visit below 107. This corrective bounce in the dollar could continue near-term.

There is a lot of noise in the markets right now. What is the underlying signal? We believe the Fed is prepared to cut rates in July. However, it seems clear from the most recent Fed comments that it is starting to push back a bit on the market’s ultra-dovish take on its policy. We do not believe the Fed will meet market expectations of 75 bp of easing this year and nearly 50 bp next year. Neither does the Fed. When markets readjust expectations, that is when the dollar should gain more traction.

St. Louis Fed President Bullard said that he and the White House held “exploratory discussions” about filling one of the vacant Governor seats. To his credit, Bullard said he was happy in his current position. He was the lone dissent in favor of a cut last week, which would seem to fit one of Trump’s prerequisites.   However, Bullard is also very well-respected and holds a PhD in economics. If Bullard were to take the position, his vacancy would be filled by the St. Louis Fed board, not Trump.

There appears to be a thaw in US-China relations. The US will reportedly suspend the planned tariffs on $300 bln of additional Chinese imports while the two sides resume talking. US officials have downplayed the chances of a near-term breakthrough, but at least the threats have stopped (for now). Indeed, Treasury Secretary Mnuchin said he is “hopeful” and estimated that a deal is 90% complete. Our base case remains a compromise is struck late in Q3.

Press reports suggest US companies are finding ways around the Huawei blacklisting. Micron Technology has reportedly resumed shipments of some components to Huawei after attorneys studied the export restrictions. How the US government reacts to these reports will be a true tell whether the two nations are close to an overarching trade deal. As Trump made clear, trade talks and Huawei have become inextricably linked.

During the North American session, the US reports several minor data points. These include May wholesale and retail inventories (0.5% and 0.3% m/m expected, respectively), durable goods orders (-0.2% m/m expected), and advance goods trade (-$71.8 bln expected). Daly is the only Fed speaker today. She is not a voter this year, but we expect her to stay on message.

RBNZ kept rates steady at 1.5%, as expected. It was a dovish hold, as the bank stressed downside risks and said that more rate cuts may be needed “over time.” After the first cut in May, Governor Orr implied a somewhat neutral stance. Market sees one more cut this year, but the timing is open to question. Next policy meetings are August 7, September 25, and November 13. WIRP suggests 80% chance of a cut in August.

MSCI announced that Kuwait will be added to its EM index. MSCI official noted that this move “reflects the significant steps it has taken to modify its capital-markets infrastructure. With substantial reserves, low levels of debt and a stable banking sector, Kuwait’s fundamentals are attractive in an EM context.” MSCI also said that it may launch a consultation process to reclassify Peru and Iceland as Frontier markets.

Malaysia May CPI was steady at 0.2% y/y vs. 0.3% expected. While Bank Negara does not have an explicit inflation target, low price pressures should keep it on hold at the policy meeting July 9. Neighboring Singapore reported weak May IP, -2.4% y/y vs. -1.8% expected. Most of the countries in the region are part of the China supply chain and are thus suffering from the trade war. MAS should keep policy steady at its semiannual policy meeting October.

Bank of Thailand kept rates steady at 1.75%, as expected. It cut its 2019 growth outlook, as the economy faces downside risks from regional trade tensions. GDP is seen growing 3.3% now vs. 3.8% previously, with exports seen flat vs. 3% growth seen previously. We expect the bank to keep rates on hold in 2019, though pressure to cut has been picking up. Deputy Prime Minister Somkid said that monetary easing is needed this year but also reiterated that the central bank is independent.

Czech National Bank is expected to keep rates steady at 2.0%. Inflation was 2.9% y/y in May, near the top of the 1-3% target range. However, the bank has expressed concern with growing headwinds to the economy. We expect steady rates in 2019.