Dollar Soft as China News Calms Markets

  • The dollar is seeing a bit of a correction as markets reacted to calming signs out of China
  • The yuan was fixed stronger than expected overnight; China reported firm July trade data
  • The most important US data this week is July PPI today; US holds a 30-year auction
  • Saudi Arabia has contacted other major oil producers to discuss possible policy responses to lower oil prices
  • Philippines cut rates 25 bp to 4.25%, as expected; Peru central bank is expected to cut rates 25 bp to 2.5%
  • Brazil and Mexico report inflation data that may set up rate cuts in September

The dollar is broadly softer against the majors as China developments have calmed markets.  Aussie and Nokkie are outperforming, while Swissie and Loonie are underperforming.  EM currencies are mostly firmer.  PHP and KRW are outperforming, while ZAR and HKD are underperforming.  MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.4%.  MSCI EM is up 0.9% so far today, with the Shanghai Composite rising 0.9%.  Euro Stoxx 600 is up 1% near midday, while US futures are pointing to a higher open.  10-year UST yields are down 1 bp at 1.73%, while the 3-month to 10-year spread is unchanged and stands at -28 bp.  Commodity prices are mixed, with Brent oil up 1.6%, copper up 0.8%, and gold down 0.3%.

The dollar is seeing a bit of a correction as markets reacted to calming signs out of China.  Yet the age-old problem remains of finding a good alternative to the greenback. The eurozone economy remains challenged, which seems to be capping EUR upside near $1.1250 for now.  Hard Brexit fears are likewise weighing on sterling, which cannot seem to get any traction above $1.22.  Scandie or dollar bloc?  Too growth-sensitive.  EM?  Forget about EM until global trade tensions ease.  We remain dollar bulls in large part because the alternatives are even worse.

The yuan was fixed stronger than expected overnight.  While it was the highest fix for USD/CNY since 2008 at 7.0039, it was a bit surprising given EM FX weakness seen yesterday.  Recent moves support our view that China is not weaponizing the yuan.  Both CNY and CNH are firmer than the cycle lows seen earlier this week.

China reported firm July trade data.  Exports were expected to contract -1.0% y/y and imports by -9.0% y/y.  Instead, exports rose 3.3% y/y and imports fell -5.6% y/y.  We cannot get excited about these readings.  Until the trade war has been resolved and tariffs eliminated, global trade will remain soft.  Press reports quoted China officials as saying US tariffs will likely go into effect September 1 because China will stand firm.  They added that China will not buy US agricultural goods, and that they expect the 10% tariffs to eventually rise to 25%.

The most important US data this week is July PPI tomorrow.  Headline is expected to remain steady at 1.7% y/y while core is expected to rise a tick to 2.4% y/y.  This will set the table for July CPI, to be reported next Tuesday.  Powell said that this most recent rate cut was meant to help push inflation higher.  There are no Fed speakers scheduled today.

The US holds a 30-year auction today.  It will be closely watched after yesterday’s weak $27 bln 10-year auction that saw a 1.67% yield and a 1.7 bp tail (how much that yield exceeded market rates at the time).  It was the lowest yield awarded since August 2016.  Indirect bidder took 55.7% vs. 60.8% previously, while the bid-to-cover ratio was a rather low 2.2 vs. 2.41 previously.

These metrics indicate weaker demand, but it’s impossible to say whether this is due to low yields or concerns about the dollar.  Foreign investors may think twice about buying bonds from a country that is trying to intentionally weaken its currency.  Greater supply is also a concern that’s only going to get worse as issuance ramps up due to wider budget deficits.  $19 bln in 30-year bonds will be sold today, with results due at 1 PM ET.  At the last 30-year auction, the bid-to-cover was 2.13 and indirect bidders took 50%.

Press reports suggest Saudi Arabia has contacted other major oil producers to discuss possible policy responses to arrest this slide in prices.  Brent oil broke an important retracement objective this week near 59.75, which sets up a test of the December low near 49.95.  This news has helped oil stabilize today.  OPEC+ is scheduled to meet in Abu Dhabi the week of September 9.

Oil has weighed on the Loonie, with CAD coming up on an important retracement objective near 1.3355.  Break above would set up a test of the May 31 high near 1.3565.  The 200-day moving average comes in near 1.3305.  Similarly, NOK has come under pressure as EUR/NOK traded at a multi-year high this week near 10.10.  Next target is the all-time high near 10.16 from December 2008.

Philippines central bank cut rates 25 bp to 4.25%, as expected.  The bank noted that the current global environment provides room for further easing.  It also cut its inflation forecasts for this year and next to 2.6% and 2.9%, respectively.  The Philippines just reported July CPI at 2.4% y/y vs. 2.7% in June, the lowest since December 2016 and near the bottom of the 2-4% target range.  Q2 GDP was also reported, with growth slowing to 5.5% y/y vs. 5.9% expected.

Brazil July IPCA inflation is expected at 3.28% y/y vs. 3.37% in June.  If so, inflation would move closer to the bottom of the 2.75-5.75% target range and support another 50 bp rate cut at the next COPOM meeting September 18.  A cut then could be problematic if the real remains under pressure, but a lot can happen between now and then.

Mexico July CPI is expected to rise 3.78% y/y vs. 3.95% in June.  If so, inflation would move further within the 2-4% target range.  While this should allow the central bank to contemplate the start of an easing cycle, recent peso weakness is problematic.  Next policy meeting is August 15, and markets are split between no move and a 25 bp cut.  If the peso remains under pressure, we think the bank will stand pat.

Peru central bank is expected to cut rates 25 bp to 2.5%.  Expectations have swung more dovish as the data softens, but the market is basically split.  Of the 14 analysts polled by Bloomberg, 8 see a cut and 6 see no cut.  CPI rose 2.1% y/y in July, near the middle of the 1-3% target range.  However, the recent slide in copper prices will take a toll on the economy.