Dollar Soft Ahead of US Jobs Data

  • The dollar remains on the defensive ahead of the US jobs report; ISM manufacturing PMI will also be reported
  • UK reported October manufacturing PMI; Nigel Farage will align his Brexit Party with the Conservatives for the upcoming elections
  • Both Moody’s and Fitch are scheduled to rate South Africa
  • Efforts have begun in the US Congress to limit US government pension fund investment in China
  • China Caixin manufacturing PMI surprised on the upside; Korea reported weak trade data

The dollar is slightly weaker against the majors ahead of the US jobs data.  The Scandies are outperforming, while Swissie and euro are underperforming.  EM currencies are mixed.  MYR and RUB are outperforming, while TRY and KRW are underperforming.  MSCI Asia Pacific was up 0.3% on the day, with the Nikkei falling 0.3%.  MSCI EM is up 0.3% so far today, with the Shanghai Composite rising 1%.  Euro Stoxx 600 is up 0.4% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 1 bp at 1.70%, while the 3-month to 10-year spread has steepened 1 bp to +18 bp.  Commodity prices are mixed, with Brent oil up 0.1%, copper flat, and gold down 0.1%.

The dollar remains on the defensive as weak US data call into question the Fed’s intention to stand pat for the time being.  Concerns about a Phase One deal between the US and China is adding to the angst and US rates have fallen accordingly.  The 10-year yield has fallen from a high of 1.86% this week to 1.69% currently, while the 2-year yield has fallen from 1.67% to 1.53% currently.  Fortunately, the US 3-month to 10-year curve has maintained its positive slope, albeit flatter at 17 bp vs. the 24 bp peak Tuesday.

Yet the euro has been unable to break above the $1.12 area.  Same goes for sterling and the $1.30 area.  The major exception here is the yen, as USD/JPY fell back to test the 108 area after testing the 109.30 high from August 1.  DXY is testing this month’s lows near 97.14 and break below would set up a test of the June low near 95.843.  We maintain our strong dollar call but acknowledge that softer US data will likely lead to near-term losses.  Longer-term, we view any Q4 slowdown as transitory as trade tensions clear and the Fed’s three hikes work their way into the economy.

Sentiment has improved after recent headlines of China having doubts about a long-term trade agreement with the US.  We wouldn’t read much into these headlines.  As discussed in our latest report (A New Stage of the US-China Conflict), China has a stronger hand this time around, and it will try to use it.  Investors should expect a tougher stance, especially as they push for a reduction of existing tariffs.  In the past, a tougher stance would be countered by Trump tariff actions, but that is no longer the case.  We also think it is important to look out for anti-China actions coming from the US Congress, which could get caught up in process, adding another layer of complexity (see below).

 

AMERICAS

The October jobs report is the data highlight for the week.  Consensus is currently at 85k vs. 136k in September.  Average hourly earnings are expected to tick up to 3.0% y/y, while the unemployment rate is expected to tick up to 3.6%.  We note weekly initial jobless claims were only 212k for the survey week containing the twelfth of the month, while ADP private sector job gains came in at +125k vs. 110k expected.  Both suggest a solid but perhaps unspectacular NFP number today.

October ISM manufacturing will also be reported.  Consensus sees 48.9 vs. 47.8 in September.  However, the poor Chicago PMI reading yesterday of 43.2 vs. 48.0 expected argues for a potential downside surprise today.  Rounding things out will be October auto sales (17.0 mln expected) and September construction spending (0.2% m/m expected).  While we have remained upbeat on the US economic outlook, we acknowledge that Q4 is showing signs of weakness.

WIRP suggests 25% odds of a Fed cut December 11.  The media embargo has ended and so Fed officials are back to speaking engagements.  Kaplan, Clarida, Quarles, Daly, and Williams speak today and most are likely to echo Powell’s stance of steady rates for now.  That stance will be tested by the upcoming data.

 

EUROPE/MIDDLE EAST/AFRICA

UK began its PMI parade for October with manufacturing PMI. It was expected to fall a tick to 48.2 but instead rose to 49.6, the highest since April.  However, this was largely due to stockpiling ahead of the Brexit deadline. The underlying factors of the index continue to show a weak picture and that the UK economy is paying a high price for the prolonged period of uncertainty. Construction will be reported Monday (44.6 expected) and services and composite Tuesday (50.0 and 49.5 expected, respectively).  There is some risk that those readings come in on the firmer side, but the economy is likely to remain soft ahead of the extended Brexit deadline.  Until the actual form of Brexit becomes known, the BOE is expected to remain on hold.

On the UK political front, it appears that Nigel Farage will align his Brexit Party with the Conservatives for the upcoming elections after receiving a nudge in this direction by US President Trump.  Tories were concerned that the new party would siphon off votes, and so any sign of cooperation is positive.  Farage is expected to announce the number of seats the Brexit Party intends to challenge later today.  Note that early polling models suggest the Tories will win an outright majority.

Both Moody’s and Fitch are scheduled to rate South Africa.  The disastrous medium-term budget statement this week supports our call for an imminent downgrade to Moody’s Baa3 rating.  Consensus sees a move in its outlook from stable to negative, and so an actual downgrade would be unexpected and would likely cause severe dislocations in South African investments.  Our own ratings model has South Africa at BB-/Ba3/BB- and so Fitch’s BB+ rating is likely to be downgraded after it moved its outlook to negative earlier this year.  Even S&P’s BB rating seems too high.

While it’s unusual to downgrade with a stable outlook, it’s been done in the past when there has been a material change in the underlying situation.  This week’s medium-term budget statement would certainly qualify as that.  And even if the outlook is the only change, it would clearly set the stage for a downgrade to sub-investment grade in Q1 2020 since we highly doubt that Mboweni can pull anything out of his hat at his February budget presentation that will change the fiscal trajectory.

 

ASIA

Efforts have begun in the US Congress to limit US government pension fund investment in China.  Senator Marco Rubio (a Republican) is preparing legislation to block the decision by the board that administrates the Thrift Savings Plan (one of three parts of the Federal Employees Retirement System) to switch one of its benchmarks to the MSCI All Country World ex-US.  China has the third largest weight in this index, about 7.5%.  This debate has been going on for some time and is supposedly getting more traction from the China hawks inside the Trump administration.  We are less concerned about the direct market impact of this bill and more about the political noise going into the US-China trade negotiations.  Still, this is something that bears watching.

China Caixin manufacturing PMI surprised on the upside, the fourth consecutive increase. The index rose to 51.7 (51.0 expected) in October and compares to the low of 48.3 in January.  Of note, new orders increased by the quickest pace in over six years. The biggest discussion point is the contrast with the official manufacturing PMI readings (which is more weighted to larger companies), which has been ticking lower and still in contractionary sub-50 territory.  So while the Caixin print is good news, it’s only part of the story and likely a reflection the how Chinese policymakers are administering their targeted stimulus measures.

Korea reported October CPI and trade.  Inflation came in at 0.0% y/y vs. -0.3% expected.  However, this was offset reports of exports contracting -14.7% y/y and imports by -14.6% y/y, both weaker than expected and weaker than September.  This does not bode well for Korea nor for the other Asian exporters.  BOK just cut rates 25 bp to 1.25% this month.  Next policy meeting is November 28 and another 25 bp cut then is likely.