Dollar Soft Even as US Rates Rise and Trade Tensions Mount

  • US rates continue to march higher
  • Meanwhile, trade tensions continue to ratchet up
  • UK reported higher than expected August CPI
  • Yen weakness continues in the wake of the BOJ decision overnight
  • Bank of Thailand kept rates steady at 1.5%, as expected; Brazil COPOM is expected to keep rates steady at 6.5%

The dollar is mostly weaker against the majors as trade tensions mount.  The Antipodeans are outperforming, while Swissie and Nokkie are underperforming.  EM currencies are mostly firmer.  ZAR and TRY are outperforming, while MYR and IDR are underperforming.  MSCI Asia Pacific was up 1.1%, with the Nikkei rising 1.1% after the BOJ decision.  MSCI EM is up 0.7% so far today, with the Shanghai Composite rising 1.1%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year US yield is flat at 3.06%.  Commodity prices are mixed, with Brent oil down 0.2%, copper up 0.4%, and gold up 0.4%.

US rates continue to march higher.  The 10-year yield of 3.06% is the highest since May 23 and appears on track to test the May 18 high near 3.13.  Elsewhere, the 2-year yield hit a new cycle high of 2.80%, the highest since July 2008.

Meanwhile, trade tensions continue to ratchet up.  After the US announced 10% tariffs on another $200 bln of Chinese imports, China responded with their own tariffs on $60 bln of US goods that become effective on September 24.  No official word yet, but the US threatened to put tariffs on another $267 bln of Chinese imports if China were to retaliate.

Yet despite these dollar-positive drivers, the greenback remains on its back foot.  Granted, the dollar remains largely within recent ranges, the major exceptions being sterling and yen (see below).  For now, we view this current dollar softness as a correction within an ongoing uptrend.  As Fed tightening expectations adjust further upward, the dollar should get more traction.  With regards to EM FX, we do not think recent gains can be sustained given not only rising US rates, but also the downside risks to global trade.

It’s worth noting that China’s Premier Li promised today not to weaken the yuan to stimulate exports.  He added that a one-way devaluation will do more harm than good to China, and we concur.   The yuan firmed today, though we think it is more a function of the broad EM FX gains today rather than Li’s comments.

UK reported higher than expected August CPI.  Headline rose 2.7% y/y vs. 2.4% expected while CPIH rose 2.4% y/y v. 2.2% expected.  The data are unlikely to have much near-term impact on policy.  The BOE just left rates steady last week after it hiked rates in August.  However, markets are rethinking whether its gradual pace of tightening (one hike per year) can be maintained.

To wit, the yields on the near months of the short sterling contracts strip are little changed.  However, the far month yields have seen a jump of 3-4 bp today.  Market has now priced in the next hike by March 2019 and the hike after that to December 2019.  Next BOE meeting is November and no change is expected then.

Sterling remains bid and is well on its way to test the July high near $1.3365.  After that is the June high near $1.3470, whilst the 200-day moving average comes in near $1.3520.  Retail sales will be reported tomorrow and should help determine whether these near-term targets will be met.

Yen weakness continues in the wake of the BOJ decision overnight.  While no changes seen nor expected, the BOJ basically said that it is in “wait and see” mode with regards to previous policy tweaks.  Clearly, the BOJ has no intention of exiting QE anytime soon.  Given where USD/JPY is trading, we don’t think policymakers will want to rock the boat by giving any hint of hawkishness.

We got an outside up day for USD/JPY yesterday, which points to further gains.  Indeed, the pair is now trading at the highest level since July 20 and is on track to test the July 19 high near 113.15 and then the January high near 113.40.  Japan reported August trade data, with exports up 6.6% y/y and imports by 15.4% y/y, both slightly firmer than expected.

The other major central bank to watch this week is the SNB.  It meets tomorrow, and no change is expected.  However, it is grappling with a resurgent franc with EUR/CHF trading near levels not seen since last July.  Even though the economy is robust, we think the SNB will push back verbally on recent currency strength.

The US reports Q2 current account data and August housing starts and building permits.  Housing data have been running softer than expected in recent months.  Markets are looking for a bounce, but the housing outlook is tough given the rising rate environment in the US.

Bank of Thailand kept rates steady at 1.5%, as expected.  However, the committee vote was 5-2, with the dissenters in favor of a 25 bp hike to 1.75%, up from 1 dissent in June and August.  CPI rose 1.6% y/y in August.  While this is the highest since September 2014, inflation remains below the 2.5% target and in the bottom half of the 1-4% target range.  We do not see a tightening cycle until 2019.  Next meeting is November 14, no change is expected then.

Brazil COPOM is expected to keep rates steady at 6.5%.  The analysts are virtually unanimous in seeing no change (one sees a 25 bp hike).  However, the CDI market sees a slight chance of a hike but has more conviction for a 50 bp hike on October 31.  Mid-September IPCA inflation will be reported Friday, which is expected to rise 4.37% y/y vs. 4.30% in mid-August.