Dollar Soft as Equity Markets Remain Under Pressure

  • The equity market has taken the focus off the bond market, at least for now
  • Lower US rates are helping to keep the dollar soft; US reports September CPI data
  • Markets are left wondering if an equity market correction will stay the Fed’s hand in December; the short answer is no
  • Fitch warned that it sees sizeable risks to Italy’s new fiscal targets
  • EU and UK officials warned that obstacles remain in getting a Brexit deal in place
  • Sweden reported higher than expected September CPI
  • Turkey August current account surplus was $2.56 bln, the first surplus since 2015; Peru central bank is expected to keep rates steady at 2.75%

The dollar is mostly softer against the majors as equity markets remain under pressure.  Stockie and Kiwi are outperforming, while sterling and yen are underperforming.  EM currencies are mixed.  TRY and ZAR are outperforming, while KRW and TWD are underperforming.  MSCI Asia Pacific was down nearly 3.5%, with the Nikkei falling nearly 4%.  MSCI EM is down over 3% so far today, with the Shanghai Composite falling over 5%.  Euro Stoxx 600 is down nearly 2% near midday, while US futures are pointing to a lower open.  The US 10-year yield is flat at 3.16%.  Commodity prices are mostly lower, with Brent oil down 1.5%, copper down 1.5%, and gold up 0.7%.

The equity market has taken the focus off the bond market, at least for now.  S&P 500 plunged over 3% yesterday, while the NASDAQ fell over 4% and the DAX fell over 2%.  Losses accelerated into the US close and so we are seeing some catchup selling today in Asia and Europe.  MSCI Asia Pacific was down nearly 3.5% today, with the Shanghai Composite down over 5%.  The DAX is tacking on another 1% loss near midday.  MSCI EM was down nearly 1% yesterday and has lost over 3% today.  It broke below the May 2017 low near 973 and then tested the April 2017 low near 951.  After that is the March 2017 low near 921.

Lower US rates are helping to keep the dollar soft.  The US 10-year yield is flat at 3.16%, while the 2-year yield is flat at 2.84%.  Both are down from the recent cycle highs after yesterday’s drop.  There are no Fed speakers today.

Markets are left wondering if an equity market correction will stay the Fed’s hand in December.  The short answer is no.  The long answer is that short of a plunge along the lines of 1987 or 2008, Fed policy will not be impacted.  Still, it’s worth noting that Bloomberg’s WIRP page shows the odds of a December hike falling to 73% today from 81% Tuesday.

Recall that the Fed has an official dual mandate of full employment and price stability.  The unofficial third mandate is financial stability.  This doesn’t mean it has to prop up the equity market.  What it does mean is that the Fed can and will act if financial stability is being threatened for whatever reason.  Recall that in 2008, it wasn’t just a precipitous plunge in equity markets, but a near-collapse of the global financial system.  Thankfully, we’re nowhere near that yet.

Of course, it’s very unhelpful for the President of the United States to say that the Fed “has gone crazy.”  The irony is thick, since hugely expansive fiscal policy under his administration is one of the major reasons the Fed is tightening.  We do not think jawboning will have any impact on Fed policy.  That said, continued criticism will likely keep markets nervous.

US reports September CPI data.  Headline CPI inflation is seen easing to 2.4% y/y from 2.7% in August, while core is seen accelerating to 2.3% y/y from 2.2% in August.  Yesterday, PPI data was benign.  Headline PPI inflation eased to 2.6% y/y vs. 2.7% consensus and 2.8% in August, while core accelerated as expected to 2.5% y/y from 2.3% in August.

Fitch warned that it sees sizeable risks to Italy’s new fiscal targets, particularly beyond 2019.  The agency sees the 2020 deficit closer to -2.6% of GDP rather than the target of -2.1%, due largely to less optimistic growth forecasts of 1.2% in 2019 and 0.9% in 2020 vs. budget forecasts of 1.5% and 1.6%, respectively.  Italy’s lower house will debate and vote on the government’s draft budget today.

We are in the process of updating our quarterly DM sovereign ratings model.  We just ran the updated numbers for Italy and its implied rating dropped two notches to BBB-.  This supports our view that the draft budget will lead to downgrades for Italy’s current ratings of BBB/Baa2/BBB.  Moody’s has its rating on review for possible downgrade.  Decision likely out at the end of October.

Italy bond yields are higher, as are spreads to Germany.  Today, the 10-year spread to Germany continues to move higher to a cycle high of 308 bp.  We believe Deputy Prime Minister Salvini will eventually regret drawing that 400 bp line in the sand.

The euro made new highs for this move today near $1.1570 before running out of steam.  This is due more to dollar weakness than euro strength, in our view.  With Italian spreads likely to continue widening amidst budget concerns, the euro should probably be weaker than it is right now.  We need to see a break above the $1.1625 area to suggest a larger move higher back to the September high near $1.1815.

EU and UK officials warned that obstacles remain in getting a Brexit deal in place.  UK press suggested late last night that an agreement had been reached, so officials are clearly pushing back a bit against undue optimism.  Earlier reports suggested intensive negotiations would continue with the aim of getting a provisional agreement by Monday.  We suspect it will go right down to the wire.

Sterling remains bid.  Recent break above $1.3155 sets up a test of the September 20 high near $1.33.  After that is the July high near $1.3365.  Given the opposing trajectories of sentiment in the UK and eurozone, we think EUR/GBP can continue to make new lows for this move as it did yesterday near 0.8723.  Indeed, we think the pair is on track to test the April low near 0.8621.

USD/JPY continues to drop but found some support near 112.  This is a key retracement objective from the September rally and a break below 112 would set up a test of the September low near 110.40.  Looking ahead, a break below 111.60 area would set up a test of the August low near 109.80.

Sweden reported higher than expected September CPI.  Headline rose 2.3% y/y vs. 2.2% expected, while underlying CPIF rose 2.5% vs. 2.3% expected.  Both measures accelerated from August.  If markets had been doubting the Riksbank’s resolve to hike in either December or February, the data should put those doubts to rest.  With the Norges Bank already hiking, Nokkie has been outperforming Stockie.  The NOK/SEK cross reversed today after yesterday breaking above the year’s high near 1.1040 and is back below 1.10.

Turkey August current account surplus was $2.56 bln, the first surplus since 2015.  This was close to consensus.  As the economy slows sharply, imports are collapsing and so the external accounts are improving.  On the other hand, real rates are negative again after the much higher than expected September CPI print.  Next policy meeting is October 25, and what happens then will depend in large part on the lira.  If it remains firm, then the bank will do nothing.

Peru central bank is expected to keep rates steady at 2.75%.  CPI rose 1.3% y/y.  While it remains within the 1-3% target range, inflation is creeping higher even as the economy picks up.  We believe that the central bank is likely to start the tightening cycle in Q1.