Dollar Soft as Optimism on Trade Talks Runs High

  • Markets continue to digest a lot of back and forth headlines on the two major issues of the day
  • Two-day talks between the US and China begin; UK PM Johnson will meet Irish PM Leo Varadkar
  • FOMC minutes released yesterday can be characterized as dovish; US reports September CPI
  • A leaked document once again laid bare the divisions within the ECB
  • Eurozone finance ministers agreed on the major elements of a common budget
  • BOT announced rule changes that are meant to ease appreciation pressures on the baht

The dollar is broadly weaker against the majors as optimism runs high for a partial US-China trade deal.  The Scandies and Antipodeans are outperforming, while yen and Loonie are underperforming.  EM currencies are mostly firmer.  The CEE currencies are outperforming, while TRY and KRW are underperforming.  MSCI Asia Pacific was up 0.2% on the day, with the Nikkei rising 0.5%.  MSCI EM is up 0.1% so far today, with the Shanghai Composite rising 0.8%.  Euro Stoxx 600 is flat near midday, while US futures are pointing to a flat open.  10-year UST yields are up 1 bp at 1.59%, while the 3-month to 10-year spread has steepened 2 bp and stands at -7 bp.  Commodity prices are mixed, with Brent oil down 0.3%%, copper up 1.3%, and gold up 0.1%.

Markets continue to digest a lot of back and forth headlines on the two major issues of the day: the trade war and Brexit.  When all is said and done, we don’t think we’re any closer to a resolution for either.  Delays and extensions seem to be the most likely outcomes near-term.  While pushing out negative tail risk may lead to a relief rally, we just don’t think delays to these two key issues will have much lasting positive impact on the markets.  To us, the obvious investment punchline is to fade this bounce in risk appetite.

Two-day talks between the US and China begin today.  Ahead of the talks, markets have been buffeted by conflicting headlines.  Initially, China press reported talks would end early due to lack of progress, but this was later denied with reports that the Chinese team would stay through Friday as planned.  Later, it was reported that China would agree to a “currency pact” that had been discussed earlier this year as part of a partial trade deal.  We don’t think China is offering enough at this point, as the US is clearly playing hardball on structural issues.  As such, it’s unclear whether the US will be willing to roll back the upcoming tariffs, which seems to be a pre-condition for China in terms of a partials deal.

On the Brexit front, UK PM Johnson will meet the Irish PM Leo Varadkar today in what should be one of the last attempts to reach an agreement. We remain skeptical.  Our base case is for an extension, despite Jonson’s vows to avoid it, then probably general elections.  Polls show that the Conservative Party has managed to hold on its recent popularity gains with voting intentions hovering round 35% compared to 25% for Labour and 20% for the Liberal Democrats.



FOMC minutes released yesterday should be characterized as dovish.  “Participants generally judged that downside risks to the outlook for economic activity had increased somewhat since their July meeting, particularly those stemming from trade policy uncertainty and conditions abroad.”  We’d go further and add that those downside risks have grown since the September 18 meeting.  Many Fed officials cited low inflation in justifying the September cut, while some officials saw downside inflation risks going forward.

Given this apparent focus on inflation and downside risks to justify the cut last month, the odds are rising for an October cut.  This is especially true if September CPI misses on the downside today.  WIRP suggests 82% odds of a cut this month, up from 40% at the start of last week.  While we have pushed back against an October cut in the past, we think recent data coupled with the dovish minutes makes a cut very likely now.

US reports September CPI.  Headline is expected to rise a tick to 1.8% y/y while core is expected to remain steady at 2.4% y/y.  However, given the downside miss for PPI Tuesday, the risks are tilted for a similar miss for CPI today.  Weekly jobless claims will be also reported (218k expected).  Claims have remained low, but next week’s reading will be important as it will be for the BLS survey week that includes the twelfth of the month.  Mester and Bostic speak.

Peru central bank is expected to cut rates 25 bp to 2.25%.  The market is almost evenly split between no cut and a 25 bp cut.  CPI rose 1.9% y/y in September, in the bottom half of the 1-3% target range.  For now, we think the central bank is on hold but low price pressures will allow it to cut rates later this year if the economy slows significantly.



A leaked document once again laid bare the divisions within the ECB.  Reports claim that the ECB’s monetary policy committee wrote a letter to Mario Draghi advising against resuming QE.  Going against the committee is unusual, but not unheard of.  The FT points out that the Governing Council has ignored the committee’s advice at least four times in recent years.  The more worrying part of this event is the damage to the institution caused by leaking a confidential document, especially ahead of leadership transition.

So, what does this mean for the policy outlook?  We now know that the ECB’s monetary policy committee is on the side of the dissenting hawks, but this does not necessarily translate into higher odds of a hawkish policy shift.  In fact, it may mean the opposite.  It might force Lagarde into adopting a firmer stance to assert her control over the institution for fear of being perceived as weak.

ECB releases its account of its September meeting later today.  Of course, markets will be looking for more evidence of a split now.  Markets are pricing in nearly a 40% chance of a rate cut in December, and that has been pretty steady since the start of the month.  Those odds rise as we move into 2020, approaching nearly 70% by April 30.

Eurozone finance ministers agreed on the major elements of a common budget.  Pessimists will point to the measly size €20 bln, whilst optimists will point to the ground-breaking move towards greater fiscal union.  While there was a commitment to increase the budget if needed, the matter of financing it is yet to be determined.  The outcome will surely be unsatisfying to those calling for more fiscal stimulus out of the region but we take the view that any agreement, however small, is a victory.  It provides a stepping stone to build upon and shows that the direction is towards greater integration.

Turkish assets continue to suffer the consequences of the military action in Northern Syria.  The US Senate is now pushing for sanctions against Turkey through a bipartisan initiative spearheaded by Republican Senator Lindsey Graham. The bill requires the Trump administration to certify to Congress every 90 days that Turkey is not operating in Syrian territory, otherwise sanctions would take effect. Since the start of the week, the lira has depreciated some 3%, the 1-month swap rate jumped from around 14% to 16%, and the local stock market is down 4%.  It’s a very difficult comparison to make but recall the dramatic moves seen in late 2018, when Turkish assets crashed after the US imposed sanctions against the country over the dispute surrounding a detained evangelic pastor.  The price action so far is nowhere near that magnitude.

UK data continue to show the effects of Brexit uncertainty. Industrial production and manufacturing production for Augusts came in at -0.6% m/m and -1.7% m/m, both well below consensus expectations, with ten out of 13 manufacturing sectors posting declines.  However, the economy may be able to avoid a near-term recession. GDP contracted -0.1% m/m in August, down from a +0.4% reading in July, propped up by a small increase from the construction sector.  Sterling is appreciating slightly on the day, but in line with broad dollar weakness.



The Bank of Thailand announced rule changes that are meant to ease appreciation pressures on the baht.  The changes will make it easier to invest funds abroad and to permit exporters to keep more money offshore.  The move is not surprising after BOT minutes earlier this week showed growing concerns about the impact of a stronger baht on the economy.  THB stands out for appreciating within a broadbased EM sell-off, up 7% YTD and behind only RUB at 7.7% YTD.  USD/THB is trading at the lowest level since 2013 and is on track to test the April 2013 low near 28.56.