Dollar Narrowly Mixed as Shutdown Drags On

  • The dovish choir at the Fed is getting quite loud; the FOMC minutes delivered a rare surprise
  • Fitch warned of a possible cut to the AAA rating for the US
  • Reports suggest President Trump walked out of a meeting with Democratic congressional leaders yesterday
  • UK Prime Minister May is weakened ahead of the next week’s Brexit vote
  • The US-China trade talks ended with a positive tone, but China is not giving US anything that it hasn’t promised before
  • China reported softer than expected inflation readings for December
  • Peru central bank is expected to keep rates steady at 2.75%

The dollar is narrowly mixed against the majors.  Aussie and yen are outperforming, while sterling and Swissie are underperforming.  EM currencies are mixed.  TRY and IDR are outperforming, while RUB and BRL are underperforming.  MSCI Asia Pacific was flat, with the Nikkei falling 1.3%.  MSCI EM is up 0.3% so far today, with the Shanghai Composite falling 0.4%.  Euro Stoxx 600 is down 0.3% near midday, while US equity futures are pointing to a lower open.  The US 10-year yield is down 1 bp at 2.70%.  Commodity prices are mixed, with Brent oil down 0.6%, copper flat, and gold up 0.1%.

The dovish choir at the Fed is getting quite loud.  Bostic, Evans, Rosengren, Mester, and Bullard have all come out swinging this week, fully mirroring Powell’s more conciliatory tone from last week:  Yes, all of us at the Fed are getting the market’s message and we will remain cautious this year.  We will be sending out an updated Fed outlook for 2019 later today.

Yet the FOMC minutes delivered a rare surprise.  The December minutes showed that many felt the Fed could be patient on further hikes, and that the timing and extent of such hikes was less clear then.  Indeed, a few officials favored no hike at all in December, noting that downside risks had increased.  Given how hawkish Powell came across at the presser last month, the minutes instead surprisingly show a Fed that was a bit less confident then what we were seeing in public.  The complete 180 in Fed messaging should keep the dollar under pressure.

Yesterday, Fitch warned of a possible cut to the AAA rating for the US.   The agency said that if the shutdown continues to March 1 and the debt ceiling becomes a problem a couple months later, it may need to consider whether the policy framework and the inability to pass a budget are consistent with a AAA rating for the US.  Yet Fitch made it clear that while the shutdown could be the trigger, the root cause of a US downgrade would be a deteriorating fiscal and debt outlook that is not being addressed properly.

Back in October, we wrote that the US improved modestly and moved back (barely) into AAA territory.  It has been going back and forth between AAA and AA+ for several quarters and bears watching.  So basically, the US was already skating on thin ice with the rating agencies and this shutdown is just making things worse as it drags on.

Reports suggest President Trump walked out of a meeting with Democratic congressional leaders yesterday.  Both sides have dug in, and the shutdown will become the longest ever if a compromise is not reached that allows the government to reopen by this Saturday.  The House has started to pass spending bills designed to open the government piecemeal.  Some Republicans have crossed over the aisle and voted but so far, not in enough numbers to suggest the high hurdle in the Senate can be overcome.

UK Prime Minister May is weakened ahead of the next week’s Brexit vote.  She has now lost two procedural votes in parliament this week that will severely limit her ability to control the Brexit narrative in the event of a no vote, which by the way appears more and more likely.  Given the Brexit uncertainty, sterling has lagged and continues to have trouble breaking above the $1.28 area.

France has been out of the headlines since the Yellow Vest protests died down, but the economic outlook continues to worsen.  November IP contracted -1.3% m/m vs. an expected flat reading, which dragged the y/y rate down to -2.1% vs. -0.2% expected.  France is teetering on recession, which will worsen the fiscal outlook even as markets stop worrying as much about Italy’s.

Despite weakness in the eurozone, the softer dollar has allowed the euro to post some gains.  Yesterday’s break above $1.15 fed into some follow-through buying today, as the single currency traded near $1.1570 before running out of steam.  A test of the October 16 high near $1.1620 appears likely in the coming days.  That area coincides with the 200-day moving average (~$1.1630) and may prove tough to break.

The US-China trade talks ended with a positive tone, but China is not giving US anything that it hasn’t promised before.  Indeed, press reports suggest there were no major breakthroughs and that a resolution remains elusive ahead of higher-level talks planned.  Indeed, one source said the two sides remain “far apart” on Chinese subsidies to state-owned companies.

Perhaps offsetting this positive news, China reported softer than expected inflation readings for December.  CPI rose 1.9% y/y vs. 2.1% expected, while PPI rose 0.9% y/y vs. 1.6% expected.  Both readings were also new cycle lows, underscoring the deflationary forces gripping China right now.  Expect further stimulus measures from China in the weeks ahead.

The rally in EM FX and optimism on US-China trade talks have pushed USD/CNY to its lowest level since July 26.  USD/CNH was lagging a bit but is finally following USD/CNY lower.  Press reports also suggest the government is prepared to widen the budget deficit this year to help stimulate the economy.

Peru central bank is expected to keep rates steady at 2.75%.  CPI rose 2.2% y/y in December, above the 2% target but well within the 1-3% target range.   Bloomberg consensus sees the first rate hike coming in Q1.  However, due to downside global growth risks, we suspect the bank will keep rates steady in H1.