Dollar Mixed as US Yields Plunge Ahead of Holiday

  • US yields continue to drop despite the Fed’s dovish capitulation and the US-China trade truce
  • The fact that the dollar is holding up well in this environment suggests the move in US yields is not occurring in a vacuum
  • ADP today will round out the jobs picture, where a 140k gain is expected
  • Swedish Riksbank kept rates steady at -0.25%, as expected; BOJ tweaked its bond purchase program
  • Caixin reported weak June services and composite PMI readings; Poland is expected to keep rates steady at 1.5%

The dollar is narrowly mixed against the majors ahead of the US holiday. The Antipodeans are outperforming, while Nokkie and sterling are underperforming. EM currencies are mostly weaker. THB and TRY are outperforming, while KRW and RUB are underperforming. MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.5%. MSCI EM is down 0.5% so far today, with the Shanghai Composite falling 0.9%. Euro Stoxx 600 is up 0.8% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 2 bp at 1.95%, while the 3-month to 10-year spread has inverted 3 bp to stand at -23 bp. Commodity prices are mostly higher, with Brent oil up 1.0%, copper down 0.2%, and gold up 0.5%.

US yields continue to drop despite the Fed’s dovish capitulation and the US-China trade truce. The 10-year yield is trading near 1.95%, the lowest since November 2016. After flirting with a positive slope last month, the 3-month to 10-year curve is back to -23 bp, the most inverted since June 3. Lastly, the January 2020 Fed Funds futures contract is back to fully pricing in three cuts this year.

The fact that the dollar is holding up well in this environment shows that the move in US yields is not occurring in a vacuum. The ECB is likely to cut rates in September, while the BOJ is likely to ease further this fall. The BOE just took a dovish turn (see below), while the Antipodeans are already cutting rates. Relatively speaking, US interest rates remain attractive.

So far, we have three pieces of the NFP puzzle for June. Employment component for both Chicago PMI and ISM manufacturing PMI as well as weekly jobless claims for the survey week all point to a solid number Friday. Consensus is currently 164k vs. 75k in May. Average hourly earnings are expected to tick up to 3.2% y/y, while unemployment is seen steady at 3.6%.

ADP today will round out the jobs picture, where a 140k gain is expected. June Challenger job cuts, May trade (-$54.0 bln expected), weekly jobless claims (223k expected), May factory orders (-0.6% m/m expected), and ISM non-manufacturing PMI (56.0 expected) will also be reported today. There are no Fed speakers scheduled for today.

EU leaders came up with candidates for the top leadership positions. Christine Lagarde makes for an interesting and ultimately excellent choice as Draghi’s successor at the ECB. She is pragmatic and was able to push the IMF into taking a big role in fighting the eurozone crisis. In terms of monetary policy, we believe she would be as activist as Draghi is. There were always doubts about whether a German like Weidmann would be willing to do “whatever it takes.” We think Lagarde would pretty much be Draghi 2.0.

In related news, President Trump has indicated he will nominate Judy Shelton and Christopher Waller to the two vacancies on the Fed’s Board of Governors. Shelton had already been floated, but the choice of Waller is new. Of the two, Waller is the more conventional choice since he is currently director of research at the St. Louis Fed under James Bullard. Shelton is the more unconventional choice. Both would likely favor looser monetary policy.

Eurozone reported final June services and composite PMI readings. Both improved slightly from the flash reading to 53.6 and 52.2, respectively. Germany’s composite reading was steady at 52.6, while France’s fell a couple of ticks to 52.7. Spain’s composite reading was steady at 52.1, while Italy’s improved a couple of ticks to 50.1, the first time above 50 since March. Data suggests some modest improvement in the eurozone periphery even as the core remains soft. If this carries over into Q3, we think it’s likely that the ECB cuts rates in September.

UK reported weak June services and composite PMI readings of 50.2 and 49.7, respectively. This follows the trend set by manufacturing and construction PMI readings earlier this week. The composite PMI is below 50 for the first time since July 2016. However, unlike that brief post-Brexit vote dip, this time the PMI is likely to remain below 50 for a longer spell. No wonder we got such dovish comments from BOE Governor Carney yesterday. He warned that global trade tensions have increased downside risks, adding that Q2 growth was “considerably weaker.” Carney admitted that it’s “unsurprising” that markets see a lower bank rate, adding that the BOE will reassess trade and Brexit risks in August.

Swedish Riksbank kept rates steady at -0.25%, as expected. It kept its forward guidance for the next hike toward end-2019 or early 2020 and kept its rate path forecast through Q3 2021 unchanged. That path implies two hikes between now and Q3 2020 followed by one more hike by Q3 2021 that would take the policy rate to 0.52%. The bank cut its 2019 and 2020 growth forecasts to 1.8% and 1.6%, respectively, noting that global uncertainties have increased.

The Bank of Japan tweaked its bond purchase program. The bank cut its purchases in the 3- to 5-year zone and in the 10- to 25-year zone both by JPY20 bln. At the same time, the bank increased its purchase in the 1- to 3-year zone, suggesting it wants the yield curve to steepen a bit. The moves support our view that the lower interest rate environment is a global phenomenon that virtually all central banks are grappling with.

Caixin reported weak June services and composite PMI readings. They fell to 52.0 and 50.6, respectively. Next week sees the deluge of Chinese real sector data, and the PMI readings (both official and Caixin) suggest further weakness. While the trade truce means no escalation of tariffs, the existing ones will continue to hurt the mainland economy as well as the US. That is why our base case remains that a deal will be struck by late Q3.

Turkey June CPI rose 15.72% y/y vs. 16.10% expected and 18.71% in May. Inflation is the lowest since June 2018, though far from the 3-7% target range. Next policy meeting is July 25. If the lira remains firm, we think the central bank is likely to start the easing cycle.

National Bank of Poland is expected to keep rates steady at 1.5%. CPI rose 2.6% y/y in June, higher than expected and the highest since November 2012. Inflation is now in the top half of the 1.5-3.5% target range, making it harder for the bank to maintain its forward guidance of steady rates through 2021.