Dollar Soft Ahead of ECB Decision

  • Risk sentiment was helped by a slight thaw in US-China trade tensions
  • The ECB decision is the main event today; the eurozone reported weak July IP
  • The US data highlight today is August CPI; higher US yields are helping the dollar
  • Oil prices remain heavy
  • Malaysia kept rates steady at 3.0%; Turkey is expected to cut rates 275 bp to 17.0%; Peru is expected to keep rates steady at 2.5%

The dollar is mostly softer against the majors ahead of the ECB decision.  The Antipodeans are outperforming, while yen and sterling are underperforming.  EM currencies are broadly firmer on signs of a US-China thaw.  RUB and TWD are outperforming, while MXN and PLN are underperforming.  MSCI Asia Pacific was up 0.5% on the day, with the Nikkei rising 0.8%.  MSCI EM is up 0.5% so far today, with the Shanghai Composite rising 0.8%.  Euro Stoxx 600 is down 0.1% near midday, while US futures are pointing to a higher open.  10-year UST yields are down 1 bp at 1.72%, while the 3-month to 10-year spread is unchanged at -20 bp.  Commodity prices are mostly higher, with Brent oil down 0.9%, copper up 1.6%, and gold up 0.4%.

Risk sentiment was helped by a slight thaw in US-China trade tensions.  The US will delay the October 1 round of tariffs for two weeks.  The rate will now be hiked on October 15 from 25% to 30% on $250 bln of Chinese goods.  President Trump called it a gesture of goodwill given China’s October 1 celebration of the founding of the People’s Republic of China.  In return, China said it would consider resuming its purchases of US agricultural goods. These are good signs, but a trade deal remains far away.

The ECB decision is the main event today.  See our preview for an in-depth look at the ECB.  The euro has seen a bounce since dropping briefly below $1.10 yesterday, likely due to some short-covering and profit-taking ahead of the ECB.  WIRP suggests 100% odds of a cut today, with 38% odds of a 20 bp move.

Over the past 13 ECB decision days dating back to the start of 2018, the euro has finished lower in 9 of them.  The last three meetings on April 10, June 6, and July 25 all saw the euro finish firmer, though the April and June gains were both less than 0.1%.  Looking at other asset classes, the behavior on ECB meeting days is much more mixed.  STOXX Europe 600 was down in 6 of the past 13 meetings, EURO STOXX Banks was down 6 of the past 13, MSCI EM was down in 5 of the past 13, and MSCI EM FX was down in 6 of the past 13.

With the ECB widely expected to deliver a dovish package, we may see some “sell the rumor, buy the fact” price action for the euro.  Yet Draghi is likely to push back against any euro strength at his press conference.  With the impact of more negative rates on the economy largely indeterminate, a weaker euro is the surest way to get some stimulus to the economy.

Before the decision, the eurozone reported July IP.  IP fell -0.4% m/m vs. -0.1% expected, with the y/y rate coming in at -2.0% vs. -1.4% expected.  The data have been coming in mostly weaker of late, driven especially by weakness in Germany.  A break below $1.0985 is needed to set up a test of the September 3 low near $1.0920.  After that, charts point to a test of the May 2017 low near $1.0840.

The US data highlight today is August CPI.  While inflation really isn’t on anyone’s radar screen right now, we note that core CPI was at the cycle high of 2.2% y/y in July and it is expected to tick higher to 2.3% in August.  Headline CPI is seen steady at 1.8% y/y.  Weekly jobless claims and August budget statement will also be reported.  Yesterday, August PPI came in higher than expected.  Headline rose 1.8% y/y vs. 1.7% expected, while core rose 2.3% y/y vs. 2.2% expected.

The selloff in global bond markets continues.  The yield on the US 10-year rose to 1.77% earlier today, the highest since August 8.  That’s a cumulative rise of 34 bp from the trough of 1.43% on September 3.   Similarly, the US 2-year yield rose to 1.70%, the highest since August 5.  The current US 3-month to 10-year curve inversion of -20 bp is the lowest since August 1.  These US rate moves all reflect a less pessimistic global outlook.

Higher US yields are helping the dollar.  We ran a correlation between JPY and US-Japan spreads.  The 2-year spread has a correlation of .7329 with JPY while the 10-year spread has a correlation of .7265.  Both are quite high and the similar readings likely reflect the flat Japan yield curve.  USD/JPY earlier traded at the highest level since August 1 near 108.15.  While the pair has since fallen back below 108, it is on track to test that day’s high near 109.30.  Japan reported July core machine orders fell -6.6% m/m vs. -8.0% expected.

Oil prices remain heavy.  IEA warned today that OPEC+ faces a “daunting” oil surplus in 2020.  Yesterday, press reported that President Trump wanted to ease sanctions on Iran whilst National Security Advisor Bolton objected.  Now that Bolton is gone, it’s possible that the US eases sanctions, allowing it to sell its oil and adding to the global supply glut.  However, signs of a US-China thaw have helped oil markets stabilize a bit.

Bank Negara kept rates steady at 3.0%, as expected.  A handful of analysts looked for a 25 bp cut.  It kept is growth forecast for this year steady at 4.3-4.8%, but warned it was “subject to further downside risks from worsening trade tensions” and other global factors.  Next policy meeting is November 5.

Turkey central bank is expected to cut rates 275 bp to 17.0%.  Market is all over the place, however, with analysts looking for cuts of 125, 175, 200, 225, 250, 275, 300, 325, 375, and 400 bp.  With the lira remaining surprisingly firm, we suspect the bank may deliver a dovish surprise.  However, we do not believe Erdogan’s professed plans for single digit interest rates and inflation will come to fruition anytime soon.

Peru central bank is expected to keep rates steady at 2.5%.  Most central banks in the region have started cutting rates.  At some point, Peru is likely to follow suit but we think it is too early now.