- We expect markets to remain volatile but as long as sentiment remains on the upswing, the dollar is vulnerable
- The situation remains fluid but it appears that a hard Brexit will be avoided
- We are beginning to become more constructive on EM
- Canada holds national elections today; Asian trade data points to continued weakness in Q4
The dollar is broadly weaker against the majors as a new week begins. Kiwi and Nokkie are outperforming, while yen and sterling are underperforming. EM currencies are mostly firmer. KRW and IDR are outperforming, while TRY and RON are underperforming. MSCI Asia Pacific was up 0.3% on the day, with the Nikkei rising 0.3%. MSCI EM is up 0.3% so far today, with the Shanghai Composite rising 0.1%. Euro Stoxx 600 is up 0.3% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 2 bp at 1.77%, while the 3-month to 10-year spread has risen 2 bp to stand at +12 bp. Commodity prices are mixed, with Brent oil down 1%, copper up 0.2%, and gold up 0.1%.
We expect markets to remain volatile but as long as sentiment remains on the upswing, the dollar is vulnerable. DXY broke a major retracement objective and its 200-day moving average last week, setting up a test of the June low near 95.843. Much of the DXY move has been driven by GBP, which is already nearing its May high near $1.3185. EUR is lagging a bit and is just coming up on a test of its 62% retracement objective of the June-October drop near $1.1210. The 200-day moving average lies there also and a break above would set up a test of the June high near $1.1410.
The situation remains fluid but it appears that a hard Brexit will be avoided. Prime Minister Johnson will try to bring his deal to a vote again either today or tomorrow, but he remains steadfast in his position not to negotiate an extension despite a legal requirement that he do so. While the odds of a deal now are much higher than just a week ago, the vote will be very tight and unpredictable at this point. The two near-term risks for the process are for House Speaker Bercow to refuse Johnson’s request for another vote on his deal (as he did for Theresa May earlier this year) and for more amendments to muddy the deal even further. We think sterling would have trouble breaking above $1.3185 on another Brexit extension. However, passage of a deal could send sterling up past the March high near $1.3380 and eventually towards the $1.40 area.
We are beginning to become more constructive on EM. The main trigger for some optimism is the shifting US-China dynamic. In our view, the partial trade deal reveals weakness on the part of the US. Reports suggest China will begin pushing for all existing tariffs to be dropped as part of Phase 2, which would be very positive for EM. That is still likely months away but this shifting dynamic bears watching. We will be putting out a longer MarketView piece on this topic this week.
The media embargo ahead of the October 30 FOMC has gone into effect and so there are no Fed speakers this week. WIRP suggests 88% odds of a cut then, the high for the cycle. We are not entirely convinced it will cut again but if it does, the Fed will then likely remain on hold until stronger evidence of a significant slowdown emerges. There are no US data reports today, but it’s clear that retreating global tail risks is a major factor behind the steepening of the US yield curve, signaling lower recession risk.
Canada holds national elections today. Please see our recent piece “Canada Election Preview: Trudeau Weathers Brownface Scandal” for an in-depth look. Polls suggest a close race between the Conservatives and the Liberals. While likely falling short of winning an absolute majority, the Liberals appear to have the best chance of forming the next government. Firmer oil prices and firm data should keep CAD as an outperformer. For USD/CAD, the July low near 1.3015 is the next big target.
Switzerland held elections and the Greens became the fourth-largest party. Together with the Green Liberal Party, they will control about a quarter of the seats in parliament. Of note, the anti-immigration SVP lost 12 seats (of the 200-member lower house) but still had 26% of support. Even if the two environmental parties cannot secure a seat in the executive government (the seven members of the Federal Council), it shows that political landscape is changing and the country will have to adjust to it. There was little market reaction, however.
Japan reported weak September trade data. Exports contracted -5.2% y/y vs. -3.7% expected, while imports contracted -1.5 y/y vs. -2.8% expected. Local press reports the BOJ may cut its current inflation forecasts for FY19/20 at its upcoming October 31 meeting. WIRP now shows only 38% odds of a cut then, down from nearly 100% earlier this month.
Korea reported weak trade data for the first twenty days of October. Exports contacted -19.5% y/y and imports by -20.1% y/y, suggesting no near-term relief for the region. Elsewhere, Taiwan September export orders contacted -4.9% y/y vs. -4.6% expected and -8.3% in August.
The PBOC kept its new benchmark policy rate, the one-year Loan Prime Rate (LPR), unchanged at 4.20% vs. expectations for a 5 bp cut. The 5-year rates also remained unchanged at 4.85%. Recall that the PBOC replaced the lending rated with the LPR as the pricing benchmark for commercial lenders, and its calculated as the average price submitted by 18 banks. The reaction came mostly in equity markets with financial sector stocks gaining 1%, outperforming most other sectors as a higher lending rate boosts lenders’ margin. The yuan is little changed. PBOC Governor Yi said that the yuan is at an “appropriate level” and noted that cross-border capital flows have been balanced since it weakened past 7 per dollar back in August. On the trade front, we continue to get positive signals from China about the progress of stage one of the deal. All told, officials are signaling steady as she goes.