Dollar Recovers as Trade and Brexit Risks Rise

  • The dollar is getting some traction today despite rising US recession fears
  • Trade tensions are back as Chinese officials signaled a much narrower scope for a trade deal with the US
  • As expected, the EU has pushed back hard against the new Brexit plan for the Irish border
  • Bank of Israel is expected to keep rates steady at 0.25%
  • Taiwan reported weak September trade

The dollar is broadly firmer against the majors as rising trade and Brexit tensions trump US recession fears.  Swissie and yen are outperforming, while the Scandies and Antipodeans are underperforming.  EM currencies are broadly weaker.  TWD and KRW are outperforming, while TRY and ZAR are underperforming.  MSCI Asia Pacific was flat on the day, with the Nikkei falling 0.2%.  MSCI EM is also flat so far today, with China markets closed until October 8 due to the National Day holiday.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 1 bp at 1.52%, while the 3-month to 10-year spread is unchanged and stands at -16 bp.  Commodity prices are mixed, with Brent oil up 0.3%, copper down 0.2%, and gold down 0.2%.

The dollar is getting some traction today despite rising US recession fears.  While we believe those fears are overblown, we acknowledge that the dollar is likely to come under periodic pressure if we continue to see weak US data.  That said, today’s dollar gains (as well as Swissie and yen) are being driven largely by haven demand as trade and Brexit risks are on the rise again.  This tends to support our view that despite rising risks to the US economy, it will still outperform in the current environment of downside global growth risks.

 

NORTH AMERICA

Trade tensions are back as Chinese officials signaled a much narrower scope for a trade deal with the US, reportedly taking discussions of industrial policy and subsidies off the table.  Press reports suggest China has been emboldened to take a tougher stance in light of perceived weakness in the US position.  This followed the confrontational actions taken last week by the US, including the threat to delist Chinese companies from stock exchanges and accusing it of dumping wooden cabinets.  This risks another leg lower in US-China relations.

The Chinese trade delegation arrives in Washington Thursday for two days of trade talks.  This latest round comes just days before the next round of tariffs kicks in mid-October.  They were originally planned for October 1 but President Trump deferred them for two weeks as a goodwill gesture.  We see little progress being made at these talks and so these tariffs are likely to kick in, further muddying the waters.  After that, the next round is slated to go into effect mid-December.

The September jobs data was not a game-changer and so we are left waiting for more clues ahead of the October 30 FOMC meeting.  During the North American session, the US reports August consumer credit and Kashkari speaks.  Fed officials continue to stress that the US economy is in “a good place” whilst also noting downside risks.  Clearly, the Fed is waiting for more information to base its next policy decision on.  While a cut this month is becoming more likely, it is by no means a done deal.  WIRP has odds at nearly 80%, while we’d put it a little lower at around 65%.

 

EUROPE

As expected, the EU has pushed back hard against the new Brexit plan for the Irish border.  UK Prime Minister Johnson responded by falling back on his brinkmanship strategy, threatening to leave without a deal or requesting an extension.  UK Parliament will have a say in this.  The EU summit in Brussels October 17-18 is likely to be the last opportunity for the UK to make another proposal.  Basically, we are mostly back to where we started between the EU and the UK.  The only difference is that in the unlikely case that the two sides agree on some version of the current deal, the odds of it passing the UK parliament are higher than what it was during Theresa May’s days.  Sterling is little changed at around $1.23 while implied volatility is ticking higher, but not by much.

There was some more downbeat economic data out of the euro area today.  The region’s Sentix investor confidence index fell by 16.8, the lowest since mid-2013, and well below expectations.  In other words, the ECB’s open-ended QE announcement didn’t convince investors who remain focused on hard data.  Indeed, Germany’s August factory orders release today also disappointed, contracting -6.7% y/y vs. -6.4% expected.  Elsewhere, Norway reported weak August IP.  It contracted -2.1% m/m, which pulled the y/y rate down to -9.2% from -5.7% in July.  The economy is slowing, making it more difficult for Norges Bank to hike rates again.

On the policy front, ECB’s Austrian General Council member Holzmann came out with more criticism of negative rates, saying it leads to “less growth and lower productivity.”  However, the doves are still in control as seen by this last round of QE, and this is unlikely to change when Lagarde takes the reigns. Similarly, calls for fiscal spending in Europe (especially in Germany) have gotten louder recently but there is no evidence that we are about to hit a major inflexion point on that side either.

The Portuguese Socialists expanded the number of seats it controls in Parliament but fell short of establishing an absolute majority, as expected.  Exit polls give current Prime Minister Costa about 37% of the vote compared to 28% for the center-right opposition PSD.  The Socialists should secure 106 of the 230 seats in Parliament, up from 86 previously.  The policymaking record of the current government has been very good, as reflected by asset prices, even though the country’s debt remains very elevated at over 120%.  Portugal’s 10-year spread against German bunds has narrowed over 300 bps since early 2017 and is now at the same level as the equivalent Spanish spread.

Bank of Israel is expected to keep rates steady at 0.25%.  CPI rose 0.6% y/y in August, below the 1-3% target range.  While the bank shifted to an easing bias last meeting, we think it is on hold for now.  However, we would not rule out a start to an easing cycle if the economy were to slow significantly.

 

ASIA

Taiwan reported weak September trade.  Exports contracted -4.6% y/y when they had been expected to rise 0.8% y/y, while imports contracted -0.6% y/y vs. -3.7% expected.  Korea reported dismal trade numbers for September and so we continue to see downside risks for the entire region.  Also, ongoing contraction in Taiwan export orders suggest little relief over the next six months.