Dollar Remains Resilient as Eurozone and UK Outlooks Worsen

  • The dollar’s continued resilience is remarkable
  • President Trump will give his delayed State of the Union address tonight
  • Eurozone data show continued weakness; UK reported weak PMI readings
  • Czech Republic, Slovakia, and Hungary reported weak retail sales for December
  • Reserve Bank of Australia left rates steady at 1.50%, as expected
  • Colombia January CPI is expected to rise 3.26% y/y vs. 3.18% in December

The dollar is broadly firmer against the majors as the economic outlook for the eurozone and UK continues to worsen.  The dollar bloc is outperforming, while sterling and Swissie are underperforming.  EM currencies are mixed.  INR and MXN are outperforming, while the CEE currencies are underperforming.  MSCI Asia Pacific was up 0.3%, with the Nikkei falling 0.2%.  MSCI EM is up 0.1% so far today, with China markets closed all week for the Lunar New Year holiday.  Euro Stoxx 600 is up 1% near midday, while US equity futures are pointing to a higher open.  10-year UST yields are up 1 bp at 2.73%.  Commodity prices are mostly higher, with Brent oil up 0.6%, copper up 0.5%, and gold up 0.1%.

The dollar’s continued resilience is remarkable.  The greenback continues to build on its post-FOMC recovery against the majors as US rates have staged a reversal from last Thursday’s lows.  The 10-year yield has risen to 2.73% while the 2-year yield has risen to 2.54%, both post-FOMC highs.  Yet Fed tightening expectations for this year remain virtually non-existent.  The implied yield on the January 2020 Fed Funds futures contract stands at 2.40%, which suggests no move either way this year.

As uncertain as things are here in the US, the outlook has deteriorated everywhere else.  This makes the dollar shine on a relative basis.  Today, data out of the eurozone and UK underscored this (see below).  Until US rates rise more, however, it will likely take some time for the dollar to stage a deeper turnaround.

President Trump will give his delayed State of the Union address tonight.  This is usually a PR exercise, and we would expect Trump to tout recent strength in the jobs numbers.  Internationally, we would expect him to focus on US-China relations, as well as the geopolitical hotspots in Iran, Syria, and North Korea.

Press reports suggest that Trump may use the opportunity to lay out plans to declare a state of emergency over border wall funding.  If so, this could upend ongoing negotiations to keep the government open and would not be taken well by the markets.  While the government is temporarily funded until February 15, Speaker Pelosi has said that the House-Senate conference committee needs to get a deal done by Friday to leave time for votes.

Other reports suggest Senate Republicans are pushing back against a state of emergency.  Why?  Under the National Emergencies Act (NEA), both chambers of Congress can pass a resolution against a national emergency declared by the president.  If the House were to pass one (likely), then the Senate would then be forced to hold a vote.  Vulnerable Republican Senator would be hesitant to reveal their preferences to the voters.

It appears that the CFTC positioning will trickle out a week at a time.  There is now data available for the week ended December 25.  Before the shutdown, the last week reported was the one ended December 18.  ISM non-manufacturing PMI for January will be reported today (57.1 expected), as will final Markit US services and composite PMIs.  There are no Fed speakers.

Eurozone data show continued weakness.  Eurozone headline December retail sales contracted -1.6% m/m, as expected.  Final eurozone services and composite PMIs were also reported and were a mixed bag. Both headline numbers improved, to 51.2 and 51.0, respectively.  However, the county breakdown is worrisome.  Both of Italy’s readings fell below 50, at 49.7 and 48.8, respectively.  While France showed modest improvement, both of its readings remained below 50 at 47.8 and 48.2, respectively.  Germany’s readings were basically steady, while Spain improved to 54.7 and 54.5, respectively.

The euro remains heavy.  It was unable to make a clean break above $1.15 last week and is now probing the downside.  Break of $1.1375 is needed to set up a test of the January 24 low near $1.1290. 

Czech Republic, Slovakia, and Hungary reported weak retail sales for December.  The CEE region is the most vulnerable to a slowdown in Western Europe, and recent data support this.  We have been critical of the ultra-dovish stances taken by the central banks of Hungary and Poland in particular, but in retrospect, this was probably correct.  Czech National Bank has hiked aggressively but is likely now on hold.

UK reported weak PMI readings.  Services PMI fell to 50.1 vs. 51.0 expected, while composite PMI fell to 50.3 vs. 51.4 expected.  Both are getting perilously close to falling below the 50 boom/bust level.  Yesterday, construction PMI came in at 50.6 vs. 52.5 expected, while manufacturing PMI was reported Friday at a weaker than expected 52.8.  The Brexit uncertainty continues to take a toll on the economy.

Sterling also remains heavy and is likely to trade back below $1.30 soon.  Today, it broke below the 200-day moving average near $1.3035.  At the very least, we look for a move back to the $1.2830 area, which represents half of this year’s rally.

Reserve Bank of Australia left rates steady at 1.50%, as expected.  Inflation forecasts were tweaked downward.  While Governor Lowe acknowledged that downside risks have increased, the bank did not shift to an easing bias as many expected.

While we hesitate to call this a hawkish hold, AUD has benefitted nonetheless.  It is the best performer in the majors today after support near .7200.  However, the upside will be limited by overall USD resilience and concerns about the Chinese economy.  Inflation remains low and the economy faces downside risks.  As such, we see steady rates from the RBA through 2019 and into 2020.

Ahead of the RBA decision, Australia reported December trade and retail sales.  Sluggish exports were offset by an even larger slowdown in imports, leading to a larger than expected trade surplus of AUD3.68 bln.  Retail sales contracted -0.4% m/m vs. flat expected.  Both point to a weakening economy.

Colombia January CPI is expected to rise 3.26% y/y vs. 3.18% in December.  If so, inflation would remain well within the 2-4% target range.  Central bank minutes will be released Thursday.  Next policy meeting is March 29, no change is expected then.  Rather, the market sees the first rate hike coming in Q2.