Dollar Remains Bid as Virus News Stream Worsens

  • The World Health organization said the worst of the pandemic is still to come; the dollar continues to benefit from risk-off sentiment
  • Fed Chair Powell warned of extraordinary uncertainty ahead; June Chicago PMI will be the data highlight; Colombia is expected to cut rates 50 bp to 2.25%
  • German lawmakers are moving to defuse the challenge to the ECB’s QE program; UK Prime Minister Johnson is going full FDR; we see heightened downgrade risks for the UK
  • China approved the controversial security law for Hong Kong; China official PMIs surprised on the upside; Japan IP and employment data continued to deteriorate

The World Health organization said the worst of the pandemic is still to come. On balance, virus news overnight was negative. More states in the US are stepping back from re-opening plans. And perhaps more concerning, hospitalization rates are starting to pick up in some cities such as Los Angeles as they have in Houston. In Australia, Melbourne will reinstate a partial lockdown to contain rising infection rates.

The dollar continues to benefit from risk-off sentiment. DXY is trading at the highest level since June 2 and is on track to test that day’s high near 97.739. It has retraced nearly half of its late May-June drop and a break of the 98.348 area is needed to set up a test of the May 25 high near 99.975. The euro remains heavy and is testing support near $1.12. Sterling is struggling to stay above $1.23, while USD/JPY is edging higher despite the return of risk-off sentiment.

AMERICAS

Fed Chair Powell warned of extraordinary uncertainty ahead. He stressed that “A full recovery is unlikely until people are confident that it is safe to re-engage in a broad range of activities.” Powell and Treasury Secretary Mnuchin speak before the House Financial Panel today and Powell’s prepared remarks were released yesterday. Powell also said “We have entered an important new phase and have done so sooner than expected. While this bounce back in economic activity is welcome, it also presents new challenges — notably, the need to keep the virus in check.” Williams and Kashkari speak today.

June Chicago PMI will be the data highlight. It is expected to come in at 45.0 vs. 32.3 in May. This will be followed by ISM manufacturing PMI Wednesday, which is expected at 49.7 vs. 43.1 in May. So far, the regional Fed surveys have come in better than expected but Chicago PMI often confounds expectations. April S&P CoreLogic house price index and June Conference Board consumer confidence (91.4 expected) will also be reported.

Colombia central bank is expected to cut rates 50 bp to 2.25%. Minutes will be released Wednesday. June CPI will be reported Saturday, with headline expected to rise 2.48% y/y vs. 2.85% in May. If so, inflation would be the lowest since February 2014 and further below the 3% target. Central bank language after this meeting will be particularly important. Some believe the easing cycle may be ending but we think it will leave the door open for further easing.

EUROPE/MIDDLE EAST/AFRICA

German lawmakers are moving to defuse the challenge to the ECB’s QE program posed by the country’s constitutional court. A cross-party coalition (CDU, Greens, and FDP) has agreed on a motion that accepts the proportionality check of ECB’s public sector purchase program (PSPP). As we had previously noted, we always assumed that the court’s challenge would end up being more noise than a material risk to the ECB’s program. Elsewhere, eurozone reported June CPI. Headline inflation came in at 0.3% y/y vs. 0.2% expected and 0.1% in May, while core inflation slowed a tick to 0.8% y/y, as expected.

UK Prime Minister Johnson is going full FDR. Abandoning any pretense of austerity, he said that what is needed is “a New Deal” and promised to “build, build, build. Build back better, build back greener, build back faster and to do that at the pace that this moment requires.” In a speech scheduled today, Johnson will reportedly lay out a plan for GBP5 bln spending on roads, schools, and hospitals. With the fiscal outlook weak, Chancellor Sunak will provide an update on the economy next week. He has already committed to increasing total infrastructure spending over the next five years by GBP100 bln to a total of GBP600 bln.

We see heightened downgrade risks for the UK, even more so in light of Johnson’s spending spree. This may be a part of recent sterling underperformance, though we believe Brexit risks are another factor. EU and UK started intensified talks his week and we expect negative headlines to emerge in the coming days as the two sides remain far apart. Cable is on track to test the May 18 low near $1.2075. However, the key level to watch is $1.1945 as a break below that would set up a test of the March 20 low near $1.1410.

ASIA

China approved the controversial security law for Hong Kong. As promised, the US started escalating the issue by restricting trade with Hong Kong by suspending its special treatment regulation. The idea here is that the US administration will now consider sensitive technology imports from Hong Kong as a security risk since it’s autonomy from China has been compromised. It’s still hard to evaluate the extent of the disruption this new law will cause, but it won’t help Hong Kong’s status as a financial hub in Asia, to say the least. There was little reaction in local equity market as the move was well anticipated. Still, US Commerce Secretary Ross warned that “Further actions to eliminate differential treatment are also being evaluated”

On the data front, China official PMIs surprised on the upside, though external demand remains a drag. The composite PMI improved to 54.2 in June from 53.4 in May. The manufacturing component came in at 50.9 (50.5 expected) and the non-manufacturing at 54.4 (53.6 expected). This confirms that the re-opening plus economic stimulus is working. Export orders increased 7.3 points to 42.6; a substantial improvement but still contracting. Caixin manufacturing PMI will be reported Wednesday, which is expected to fall to 50.5 from 50.7 in May.


Japan’s industrial production and employment data continued to deteriorate in May. IP contracted -8.4% m/m vs. -5.9% expected, while the jobless rate rose to 2.9% vs. 2.8% expected. In y/y terms, IP contracted -25.9% vs. -23.1% expected and -15.0% in April. The data shows the severity of the headwinds from weak domestic and external demand but May probably marks the low point for country’s IP. Elsewhere, the unemployment rate increased to 2.9% from 2.6%, with a concurrent decline in available job offers (-32.1% y/y). The job-to-applicant ratio fell to 1.20 vs. 1.22 expected and 1.32 in May and was the lowest since July 2015. The economy started to turn the corner in June, but full recovery is unlikely until we move through Q3. For now, the Bank of Japan is in wait and see mode.