Dollar Soft as Markets Begin the Week in Risk-On Mode

  • The virus news stream is negative, but equity markets got a boost from China; the dollar remains stuck in narrow ranges as markets contend with conflicting drivers
  • Last week’s jobs reports has likely set expectations high for the rest of the June data; US highlight this week is likely to be ISM non-manufacturing PMI today
  • UK Chancellor Sunak had a busy weekend; we are growing more concerned about the risk of a more meaningful retaliation on the UK by China
  • Eurozone data was mixed; Israel is expected to keep rates steady at 0.10%
  • Chinese equity markets are on a tear; the controversy about Bank Indonesia’s fiscal financing continues to deepen

The virus news stream is negative, but equity markets got a boost from China. Infection rates are still rising fast but deaths and hospitalizations are not looking as bad. More importantly, in our view, re-lockdowns are happening in a surgical manner (such as in Australia and the UK), with very little discussions about backtracking on a national level. In any case, markets still prefer to focus on the macro recovery, which is certainly doing better than most (including ourselves) had predicted a month ago. China has added some fuel to the equity rally with some cheerleading from local press (see below).

The dollar remains stuck in narrow ranges as markets contend with conflicting drivers. On the one hand, better than expected economic data and continued stimulus has tended to boost market sentiment, but the virus news stream has gotten worse for many countries, including the US. DXY is back below 97 today but remains near the middle of the 96-98 range seen since late May. Similarly, the euro is no testing the $1.13 area that is smack in the middle of the $1.12-1.14 range since early June. We look for continued dollar weakness this week as risk-on sentiment seems to be persisting for the time being.

AMERICAS

Four major epicenters are being seen in the US. The Los Angeles area, Texas, Florida, and Arizona. But it’s not just these four; new cases are rising in nearly 40 states, with only one (New Hampshire) showing a decline. The rolling 7-day average for new daily cases in the US has risen for 27 straight days, with local officials warning of shortages of hospital beds developing. Fed Chair

Powell has tried to hammer home this point, which bears repeating: there can be no significant economic recovery until the health care crisis has been contained. We concur.
Last week’s jobs reports has likely set expectations high for the rest of the June data. Yet we continue to caution investors against getting too optimistic. Jobs data is collected in the week that contains the 12th of every month. Since mid-June, many states have reversed or paused their reopening and that has led some workers that were recently rehired to be let go again. We really need to watch the virus numbers but at this rate, Q3 is likely to start off slowly as July is spent trying to control the virus again. How the rest of Q3 develops will depend on whether those problem states can bend the curve down enough to permit reopening.

The data highlight this week is likely to be ISM non-manufacturing PMI today. It is expected to improve to 50.0 from 45.4 in May. Given that services account for nearly 70% of the US economy, this is arguably more important than the manufacturing (around 11% of GDP) reading. Markit’s final services and composite PMI readings will also be reported today. Consensus sees a slight improvement from the preliminary readings of 46.7 and 46.8, respectively. There are no Fed speakers today. Elsewhere, the results for the Bank of Canada’s Q2 business outlook survey will be released today.

EUROPE/MIDDLE EAST/AFRICA

UK Chancellor Sunak had a busy weekend. First,, he announced a GBP1.6 bln plan to support theaters, museums, and music venues, with much of it in the form of grants. Later, the Treasury announced that it would spend $1 bln on hiring at job centers in an effort to help alleviate stresses in the labor market. Sunak will address UK Parliament Wednesday, and it seems likely that he will use the opportunity to outline further stimulus measures. Prime Minister Johnson’s so-called New Deal for infrastructure spending was deemed insufficient and so UK business interests are urging Sunak to be more aggressive.

We are growing more concerned about the risk of a more meaningful retaliation on the UK by China. The latest headlines claim that Prime Minister Johnson is looking “very closely” at the participation of Chinese telecom giant Huawei in the UK. This follows the government’s announcement of a “bespoke” immigration deal for some 3 mln Hong Kong residents. To be clear, the UK is not the only country reacting to the new Hong Kong security laws approved by China (Australia, for example, may also offer safe haven visas for residents). Still, the immigration deal plus the Huawei story might make the UK a good target for the Chinese government to set an example against provocations in the geopolitical arena. So far, China has limited itself to issuing an ominous warning that there will be “consequences.”

Eurozone data was mixed. Germany May factory orders rose 10.4% m/m vs. 15.4% expected and a revised -26.2% (was -25.8%) in April. The y/y WDA rate improved to –29.3% vs. -24.0% expected and a revised -36.9% (was from -36.6%) in April. Elsewhere, eurozone May retail sales rose 17.8% m/m vs. 15.0% expected and a revised -12.1% (was -11.7%) in April, which led the y/y rate to improve to -5.1% vs. -6.5% expected and -19.6% in April. Overall, the data suggest the regional recovery got under way in May and continued in June, with further improvement expected in Q3. Final eurozone June services and composite PMI readings both improved a full point from the preliminary readings to 48.3 and 48.5, respectively.

Bank of Israel is expected to keep rates steady at 0.10%. CPI fell -1.6% y/y in May, well below the 1-3% target range. The bank left policy steady at its last meeting May 25 and upgraded its outlook slightly. However, it warned that the strong shekel poses risks to the recovery and could prevent inflation from returning to the target range. Since that meeting, the shekel has appreciated nearly 2.5% and so stronger pushback may be seen this week. The bulk of any stimulus going forward is likely to come from the fiscal side, but the bank may have to support this by expanding its current QE program in H2.

ASIA

Chinese equity markets are on a tear. The Shanghai Composite rose 5.7%, the biggest one-day gain since 2015 and is up 9.4% on the year. The pace is noteworthy, with a 13.6% gain seen just in the past week. The mania has been fueled in part by several local media articles cheerleading the rally, which would seem to imply an official stamp of approval. However, the underlying drivers still make sense. The virus outbreak is under control, liquidity and fiscal stimulus is abundant, external demand will probably pick up soon, and the US-China trade war looks contained for now.

The controversy about Bank Indonesia’s fiscal financing continues to deepen. A panel of lawmakers in Indonesia is said to be looking into the government’s new plan and will hold a hearing on the topic soon. Recall that last week we heard that the BI was looking to purchase some $40 bln from the government, equivalent to about 60% of its the post-virus spending increase. Purchases would happen at zero rates, or below market prices. Like several other EMs, BI has already been buying bonds, but not at this scale and not pre-announced in this fashion. There has been little reaction to the news so far with Indonesia’s CDS trading at 120 bp, well below that of some of the riskier EMs such as Brazil, Mexico, or South Africa.