US Dollar Weighed Down by Dovish Fed Governors

Dollar Remains Soft Ahead of US Jobs Data

  • It took only two pieces of data this week to chop the legs off this dollar rally; the movement in US rates markets is noteworthy
  • US September jobs data today will be the data highlight
  • The reception to Johnson’s latest Brexit plan remains mixed
  • Japan officials are downplaying the impact of the consumption tax hike
  • Philippines September CPI rose 0.9% y/y; India cut rates 25 bp, as expected

The dollar is broadly weaker against the majors ahead of US jobs data.  Swissie and Kiwi are outperforming, while sterling and Loonie are underperforming.  EM currencies are mostly firmer.  KRW and RUB are outperforming, while TRY and INR are underperforming.  MSCI Asia Pacific was up 0.1% on the day, with the Nikkei rising 0.3%.  MSCI EM is up 0.1% so far today, with China markets closed until October 8 due to the National Day holiday.  Euro Stoxx 600 is flat near midday, while US futures are pointing to a lower open.  10-year UST yields are down 1 bp at 1.53%, while the 3-month to 10-year spread is unchanged and stands at -16 bp.  Commodity prices are mixed, with Brent oil up 0.8%, copper down 0.4%, and gold up 0.3%.

It took only two pieces of data this week to chop the legs off this dollar rally.  For now, at least.  As our faithful readers know, we have remained more upbeat on the US economy than most.  We have always acknowledged recession risks stemming from the trade war with China.  It does appear that weakness in manufacturing has spread to the wider economy, but we remain far from recession.  That said, it will likely take more than a strong jobs report today to turn the dollar around.

The movement in US rates markets is noteworthy.  Looking at the Fed Funds futures strip, the implied yield on the January 2020 contract is now 1.44% and nearing the cycle low of 1.41% in mid-August.  Implied yield on the January 2021 contract is now 0.95%, the lowest since the cycle low of 0.85% on September 4.  That means the market has almost fully priced in four more cuts by the Fed in this cycle.  That would not be a “mid-cycle adjustment” by any stretch and seems to overstate the case for Fed easing.

We want to point out the obvious that if the US is slowing, the rest of the world is even worse off.  Yes, the knee-jerk trade is to sell dollars but where does a dollar bear go?  EM?  Not when global trade is at risk and the world’s biggest consumer nation is slowing.  EUR?  Not when its biggest economy is already in recession.  GBP?  Not with Brexit still hanging over and the economy also sliding into recession.  It may take some time for this current bout of selling to run its course, but we believe the dollar should eventually rebound.

US September jobs data today will be the data highlight of the week.  Consensus sees 145k jobs added vs. 130k in August, unemployment steady at 3.7%, and average hourly earnings steady at 3.2% y/y.  Weekly claims for the September survey week were low, suggesting a solid if unspectacular jobs number.  August trade data will also be reported today.  Rosengren, Bostic, and Powell speak.  Clarida sounded mixed on the rates outlook yesterday.  On one hand he cited powerful deflationary forces, while on the other noting that the US economy is in “a good place.”  WIRP suggests 84% odds of a cut October 30, up from 40% at the start of the week.

The US economy remains solid.  The Atlanta Fed’s GDPNow model is tracking 1.8% SAAR growth in Q3, down from 2.1% previously, which is still near trend (~2%) with little drop-off from 2.0% in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 2.1% SAAR growth in Q3, down from 2.2% previously.  Its forecast for Q4 growth is now 1.8% SAAR, down from 2.0% previously.  We expect downward revisions from both models today after the weak ISM data.

The reception to Johnson’s latest Brexit plan remains mixed.  There have been some supportive comments from UK MPs but not so much from the EU.  Indeed, the EU has given the Johnson government until October 11 to “fundamentally amend its position” in order for more concrete discussions to take place.  It will be a tough sell.  This is starting to be reflected in FX markets, though more in the volatility space than in spot.  Implied vol for cable has been ticking higher, especially the 1-week reading (now at nearly 10%).  The 3-month GBP implied vol reading remains well above that of the G7 and many EM currencies.

It’s early days but Japan officials are downplaying the impact of the consumption tax hike that went into effect this month.  Finance Minister Aso sees no major trouble related to the hike and so sees no immediate need to act.  We agree.  Yet WIRP suggests 92% odds of a cut then.  USD/JPY saw support near the 106.50 area yesterday, which is the 50% retracement objective of the August-September rally.  Break below the 62% level near 106 would signal deeper losses towards the August low near 104.45.

Philippines September CPI rose 0.9% y/y vs. 1.1% expected.  Inflation is the lowest since May 2016 and moves further below the 2-4% target range.  Next policy meeting is November 14 and another 25 bp cut to 3.75% is expected then.  That is unlikely to be the last in this cycle and would continue the trend of lower rates in EM.  Whilst positive for growth, policymakers must take care not to cut too much for fear of pushing the perceived risk premium for holding riskier assets too low.

Reserve Bank of India cut rates 25 bp, as expected.  One of the six on the MPC voted for a more aggressive cut of 40 bps.  WIRP suggests 60% odds of another cut at the December 5 meeting.  That said, monetary policy is not likely to be the main story in India going forward and we highlight other major areas of focus for investors.  First, the geopolitical situation in Kashmir remains a medium-term negative tail risk.  Second, the overall policymaking outlook has become increasingly volatile.  For example, the government unexpectedly cut the corporate tax in late September, leading to a massive rally in the Sensex.  Before that, it reversed the surcharge on foreign portfolio investment imposed earlier in the year.  Lastly, there have been too many scandals in the banking system.  Despite comforting statements from regulators, they undermine India’s fundamental story.  The rupee has been trading with a stronger tone after the sharp depreciation in early August from the Pakistan conflict, but the overall investment outlook will remain challenging.