Dollar Remains Soft as Risk On Sentiment Continues

  • The dollar is struggling to get some traction
  • China confirmed that officials will travel to Washington early next month for the next round of trade talks
  • The US reports ADP, non-manufacturing PMI, and July factory orders; Fed Beige Book report was balanced
  • The drop in perceived hard Brexit risks has helped sterling get some traction
  • Germany reported very weak July factory orders; Riksbank kept rates steady at -0.25%, as expected
  • Philippines August CPI rose 1.7% y/y; Russia August CPI is expected to rise 4.4% y/y

The dollar is mostly weaker against the majors as risk on sentiment continues.  Sterling and the Scandies are outperforming, while yen and Swissie are underperforming.  EM currencies are mostly firmer.  KRW and MYR are outperforming, while PHP and TRY are underperforming.  MSCI Asia Pacific was up 1.1%, with the Nikkei rising 2.1%.  MSCI EM is up 0.9% so far today, with the Shanghai Composite rising 1%.  Euro Stoxx 600 is up 0.6% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 5 bp at 1.52%, while the 3-month to 10-year spread has steepened 5 bp to stand at -43 bp.  Commodity prices are mostly higher, with Brent oil up 0.4%, copper up 0.4%, and gold down 0.8%.

The dollar is struggling to get some traction.  Some signs of easing political risks in the UK and Hong Kong have helped market sentiment improve.  We do not think this optimism will prevail for very long.  While tensions have undoubtedly eased, neither have fully addressed the underlying causes and so we believe we are simply in the eye of the storm.  This correction could continue for some time yet, but we retain our bullish dollar call.

China confirmed that officials will travel to Washington early next month for the next round of trade talks.  In the meantime, lower level talks will continue “serious” discussions as preparation for next month’s talks.  While this is welcome news, all signs still point to a protracted trade war that will likely extend well into next year.  The next rounds of tariffs are likely to still go into effect in Q4 and that’s not good.

Because of the US holiday Monday, ADP August jobs data will be reported today along with July factory orders.  ADP is expected at 148k, while orders are expected to rise 1.0% m/m.  Weekly jobless claims and final Markit services and composite PMIs will also be reported.

US August ISM non-manufacturing PMI will also be reported, and it is expected at 54.0.  This reading will be closely watched after the weaker than expected manufacturing PMI reading of 49.1.  Looking back, it’s worth noting ISM manufacturing PMI fell below 50 back in October 2015 and stayed below until March 2016.  The low was 48.0 in January 2016 and the US never went into recession.  During that period, our favorite indicator CFNAI-3MA got as low as -0.42 in April 2016 vs. -0.7 recession threshold.

US August auto sales and July trade were reported yesterday.  Vehicle sales were stronger than expected, nearing a 17 mln annualized pace vs. 16.8 expected.   On the other hand, the trade deficit was larger than expected.  As a result, the Atlanta Fed’s GDPNow model is tracking 1.5% SAAR growth in Q3, down from 1.7% previously.  This is below trend (~2%) and down from the revised 2.0% SAAR in Q2.  The NY Fed’s Nowcast model is tracking 1.8% SAAR growth in Q3.  It is updated every Friday and we expect it will follow the Atlanta Fed lower.

The Fed Beige Book report was balanced.  It said businesses were still optimistic even as trade uncertainty continues.  The Fed noted that the economy grew at a modest pace through the end of August, adding that employment growth was also modest.  The report noted mixed impact of the tariffs on pricing, adding that the impact may be delayed.  As expected, some manufacturing weakness was noted.

We think a balanced approach was prudent, as it leaves the Fed with some flexibility either way.  Now, let’s see how the August data come between now and the September 18 FOMC meeting.  Powell’s speech tomorrow is the last Fed speaking appearance before the media embargo kicks in.   We do not expect him to tip his hand, but rather should follow the same balanced approach as the Beige Book did.

UK Parliament vote 327-299 to ask for another Brexit Extension if no deal can be reached ahead of the October 31 deadline.  To add insult to injury, Parliament rejected Johnson’s call for early elections.  Even though the vote was 298-56 in favor. Labour abstained from the vote and effectively killed it since 434 votes were needed.  Johnson will make a direct appeal today to the public for fresh elections.

The drop in perceived hard Brexit risks has helped sterling get some traction.  The next target is the August 27 high near $1.2310.  Break above that level is needed to set up a test of the July 24 high near $1.2520.   Yet we cannot get very bullish on sterling until Brexit uncertainty has been removed.  For now, it appears that the can has been kicked down the road again.

Germany reported very weak July factory orders.  Orders were expected to fall -1.4% m/m, but instead plunged -2.7%.  This dragged the y/y rate down to -5.6% from a revised -3.5% (was -3.6%) in June.  Weak data come even as some ECB officials are pushing back against more stimulus.  WIRP suggests 100% odds of a rate cut September 12, with 48% odds of a larger 20 bp move.

Swedish Riksbank kept rates steady at -0.25%, as expected.  However, it kept its forward guidance for the next hike toward end-2019 or early 2020.  The bank lowered its rate path forecast.  The new path implies only one hike (vs. two previously) by Q3 2020 followed by one more hike by Q3 2021 that would take the policy rate to 0.25%.

The krona jumped after the decision, as many expected a shift to a more neutral stance.  That said, we suspect the Riksbank is being too hawkish now and may have to dial back its rate hike plans further as the global economy weakens.  The bank cut its 2019 and 2020 growth forecasts to 1.5% in both years vs. 1.8% and 1.6%, respectively.  Next policy meetings are October 24 and December 19.

Philippines August CPI rose 1.7% y/y vs. 1.8% expected and 2.4% in July.  Inflation is the lowest since September 2016 and now below the bottom of the 2-4% target range.  The central bank cut rates in May and August.  Next policy meeting is September 26 and another 25 bp cut is expected.

Russia August CPI is expected to rise 4.4% y/y vs. 4.6% in July.  If so, inflation would be the lowest since December 2018 and nearing the 4% target.  The central bank then meets Friday and is expected to cut rates 25 bp to 7.0%.