Dollar Struggles; More Losses Likely Before Better Demand is Found

Dollar Soft as Risk Sentiment Stoked Ahead of US Retail Sales

  • US-China relations appear to be thawing
  • Trading was volatile after the ECB decision; we are still dollar bulls
  • EM has benefitted from the shift in the global backdrop this week
  • The US data highlight is August retail sales
  • Vietnam cut rates 25 bp to 6.0%; Turkey reported July current account and IP

The dollar is mostly softer against the majors ahead of the US retail sales data.  Sterling and Swissie are outperforming, while Kiwi and Loonie are underperforming.  EM currencies are broadly firmer on continued signs of a US-China thaw.  RUB and HUF are outperforming, while TRY and PHP are underperforming.  MSCI Asia Pacific was up 0.7% on the day, with the Nikkei rising 1.1%.  MSCI EM is up 0.6% so far today, with China markets on holiday.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open.  10-year UST yields are up 3 bp at 1.80%, while the 3-month to 10-year spread steepened 5 bp to stand at -13 bp.  Commodity prices are mostly higher, with Brent oil down 0.1%, copper up 0.7%, and gold up 0.5%.

US-China relations appear to be thawing.  China is encouraging purchases of US agricultural goods and added soybeans and pork to the list of items to be exempted from US tariffs.  This adds on to a list of exempted items released by China earlier this week.  The news comes after the US announced a delay to the latest round of tariffs from October 1 to October 15.

Despite conflicting reports, the signs suggest the two sides are moving towards a possible interim trade deal.  Initial reports yesterday were initially denied, but President Trump later acknowledged that it was a possibility, “something we would consider.”  Trump is worried about re-election, while China would like to calm the waters ahead of the upcoming October 1 anniversary of the founding of the People’s Republic of China.  While cooler heads have prevailed for now, we believe a true deal that leads to the elimination of tariffs remains far away.

Trading was volatile after the ECB decision.  The euro initially strengthened, then weakened, then strengthened again beyond pre-ECB levels.  We think the market has acknowledged our initial take on the ECB.  That is, we didn’t get to see the bazooka.  The ECB delivered a little bit of everything but when all is said and done, they were all pretty timid.

It was later reported that Draghi faced pushback against QE from core Europe.  Central bankers from France, Germany, and the Netherlands all opposed the resumption of QE, and were joined by Austria and Estonia.  This suggests that Draghi’s successor Lagarde will face strong opposition to future easing.

Yet we are still dollar bulls.  Because the ECB was so timid, it’s pretty clear to us that this is not the last we’ve seen of ECB easing.  It will be a tough sell for Lagarde, but more easing will have to be done.  On the other hand, we still think markets are overestimating the Fed’s capacity to ease.  This is especially true now that global trade tensions are easing.

EM has benefitted from the shift in the global backdrop this week.  However, the best we can say is that things are not getting worse.  We note that most tariffs remain in place, and so the situation really won’t get better until these are removed.  That may eventually happen, but we do not think it will happen anytime soon.  ECB easing is positive for EM at the margin, but markets are already repricing Fed easing prospects.  And as we have seen before, the liquidity story is not enough to sustain an EM rally if the global growth story is missing.

We saw a big reversal higher in US rates yesterday.  Maybe markets finally got around to looking at the US August CPI data.  Or maybe it was the weak 30-year auction.  Either way, 10-year yield is now trading above 1.80% and the 2-year is trading near 1.75%, both highs for this move and the highest since early August.  The 3-month to 10-year US curve traded as low as -10 bp today, the least inverted since July 31.

US core CPI continued to march higher in August.  At 2.4% y/y, this is the high for the cycle and the highest since July 2018.  This comes after stronger than expected PPI data earlier this week.  The August inflation data certainly complicates the Fed’s job next week.

The US data highlight is August retail sales today.  Headline is expected to rise 0.2% m/m vs. 0.7% in July, while ex-autos is expected to rise 0.1% m/m vs. 1.0% in July.  Lastly, the so-called control group used for GDP calculations is expected to rise 0.3% m/m vs. 1.0% in July.  Headline jobs data was disappointing, but the stronger than expected 3.2% y/y gain in average hourly earnings should continue to support consumption.

This retail sales report is a big piece of the US rates puzzle.  If we get a strong read, how can the Fed justify a cut next week, much less the many cuts priced in already?  Fed Funds futures have already started to adjust.  Only two cuts are priced in for the rest of this year, followed by a little more than one cut next year.  At the start of this month, the market was pricing in 2-3 cuts for both.  If we get a strong print today, the adjustment in the US rates outlook should continue.

Vietnam cut rates 25 bp to 6.0%.  This was the first cut in over two years, and the central bank cited “unfavorable” global economic developments as the major reason.  The cut is noteworthy, as Vietnam has been one of the beneficiaries of the US-China trade war as some production was shifted there.  Today’s move suggests that no one is immune from the global chill.

Turkey reported July current account and IP.  The former remains in surplus, while the latter is showing signs of improvement.  Yesterday, the central bank delivered a dovish surprise, as we expected.  Rather than the consensus 275 bp, the bank cut rates by 325 bp to 16.50%.  The next policy meeting is October 24.  If the lira continues to hold up relatively well, another large cut is likely then.  However, we do not believe Erdogan’s professed plans for single digit interest rates and inflation will come to fruition anytime soon.