Dollar Remains Under Pressure as EU Delivers a Deal

  • Markets continue to fight a tug of war between improving economic data and worsening virus numbers; the dollar remains under pressure
  • Congress returns from recess today and the outlook for fiscal stimulus in the US remains uncertain; today is a light day for US data
  • The EU summit produced last minute deal; we will reassess our dollar call if and when the single currency reaches the $1.1820 area
  • Reports suggest the EU and the UK have hit a dead end in Brexit talks; markets are underestimating the chances of a hard Brexit
  • Japan reported disappointing June trade data; China left its loan rates steady, as expected; Taiwan reported firm June export orders

Markets continue to fight a tug of war between improving economic data and worsening virus numbers. Sentiment may be boosted early this week after the EU came up with a last minute deal on the recovery package. Hopes are high that the US can get a deal done before the August recess, and sentiment should remain positive as July preliminary PMI readings are expected to show further improvement. That said, record virus numbers in many US states will be difficult to overlook.

The dollar remains under pressure. It ended last week on a soft note, trading at the bottom of recent trading ranges. DXY is again trading just below the 96 level and a clean break would set up a test of the March low near 94.65. The euro is trading at a new high for this move near $1.1470 and is on track to test the March high near $1.15. Recent price action whereby markets sell into dollar strength rather than buy the dollar dip supports our view that the market bias for the dollar is further broad-based weakness ahead.

AMERICAS

Congress returns from recess today and the outlook for fiscal stimulus in the US remains uncertain. Lawmakers have only a small window to strike a deal before going back on recess in early August, and the two sides remain far apart. Republican lawmakers would like to cap this next package at $1 trln, while House Democrats last month passed a $3.5 trln plan that contains many provisions that are unlikely to pass in the Republican-held Senate. Of note, the extra $600 per week in jobless benefits expires at the end of the month and there is no agreement yet on any sort of extension. There is some talk about an extension at a significantly lower amount near $200, which would be a huge hit to household income.

Reports suggest President Trump said the next stimulus package “must” include a payroll tax cut. That is a non-starter for the Democrats and many Republicans. The reason? Bad optics, as the payroll tax funds Social Security and Medicare. Another reason? It would only benefit those that are still working and does nothing to help the 17 mln that are still unemployed. Other reports suggest the White House opposing new funding proposed for virus testing and contact tracing, as well as extra funding for the Centers for Disease Control and Prevention. Again, the optics are bad, and it remains to be seen whether Republican lawmakers will support these efforts ahead of November elections.

Today is a light day for US data. June Chicago Fed National Activity Index will be reported Monday and is expected at 4.00 vs. 2.61 in April. Due to the media embargo, there are no Fed speakers until Powell’s post-decision press conference.

EUROPE/MIDDLE EAST/AFRICA

The EU summit produced last minute deal. With the summit ending Saturday with no deal, talks continued Sunday in an effort to nail down the EUR750 bln recovery package. European Council President Michel floated another compromise, cutting the grant portion by EUR100 bln to EUR400 bln. The surplus nations led by the Netherlands and Austria wanted grants capped at EUR350 bln but both sides eventually compromised on a figure of EUR390 bln. For European politicians, this is about as good as it gets for quick and decisive action during times of crisis.

The euro is making a marginal new high for this move as a result. It is trading at the highest level since March 9 and is on track to test that day’s high near $1.15. Yet the lack of significant gains today will be disappointing to euro bulls, and suggests the EU deal was largely priced in. that said, we continue to believe that the eurozone economy will outperform the US in Q3 and so further euro gains are likely. The January 2019 high near $1.1570 is up next, followed by the September 2018 high near $1.1815.

Longer-term, we will reassess our dollar call if and when the single currency reaches the $1.1820 area. That level represents the 62% retracement objective of the big February 2018-March 2020 drop in the euro. Break above that would set up a test of the 2018 high near $1.2555. Whether we eventually get there will depend in large part how the US economy is faring.

Reports suggest the EU and the UK have hit a dead end in Brexit talks. The accelerated timeline of talks have not yielded any significant breakthrough yet from informal talks. Formal talks begin this week between Frost and Barnier with a dinner tonight and end Thursday lunchtime. A final negotiating round is scheduled for August 17, but nothing is on the books after that.

We continue to believe that markets are underestimating the chances of a hard Brexit. UK assets have underperformed this year, but recent price action speaks of greater optimism priced in. Sterling is now the second worst major currency at -5% YTD vs. the dollar. Yet we cannot help but recall the BOE’s worst case scenario for a hard Brexit that could lop off nearly 10% from sterling. That would suggest an exchange rate even weaker than the March lows near $1.14.

ASIA

Japan reported disappointing June trade data. Exports contracted -26.2% y/y vs. -24.7% expected and -28.3% in May, while imports contracted -14.4% y/y vs. -17.6% expected and -26.2% in May. While other countries in the region have seen their trade numbers improve, Japan has yet to see the benefit from the regional recovery led by China. Recall that the Bank of Japan has warned of downside risks due to a weaker than expected outlook for exports.

China left its loan rates steady, as expected. Rates are set on the 20th of each month and the 1-year and 5-year rates were kept steady for the third straight month at 3.85% and 4.65%, respectively. But make no mistake, recent loan data show that policymakers continue to rely on a credit-fueled expansion in order to recover from the pandemic. Recent real sector data suggest this is working, albeit modestly.

Taiwan reported firm June export orders. Orders rose 6.5% y/y vs. 1.2% expected and 0.4% in May. This is the strongest reading since August 2018 and suggests stronger exports over the next six months. June IP will be reported Thursday and is expected to rise 2.35% y/y vs. 1.51% in May. The economy seems to be benefiting from the recovery on the mainland, though the pace is clearly modest. However, the pace is modest and so we cannot rule out another rate cut at the central bank’s next quarterly meeting in September.