Dollar Softens as Market Sentiment Improves

  • The dollar bounce is running out of steam; Trump is still hoping for a stimulus deal; we think more stimulus is coming but on the other side of the election
  • The main event is September US retail sales; BOC announced some changes to its financial market support programs; it is coming under criticism from the opposition Conservatives
  • With the EU summit wrapping up with no Brexit breakthrough, we await the UK decision on whether to walk away or not; corporate credit risk in Europe has ticked higher this week but remains very subdued overall
  • New Zealand holds general elections Saturday; the RBNZ just delivered a dovish hold and appears to be setting the table for negative rates

The dollar bounce is running out of steam.  DXY traded yesterday at the highest level since October 2 but is softer today after being unable to breach the 94 area. Indeed, past bouts of risk-off gains have also tended to hit a brick wall around that level.  With the US economic outlook softening, we feel this level will remain very tough to break and look for dollar weakness to resume.  Market sentiment is improving, with European equity markets trading higher and US equity futures turning positive. The euro continues to find support near $1.17, while sterling continues to see some support just below the $1.29 area as its continues to be buffeted by Brexit-related headlines.  USD/JPY continues to see support near 105 but any extended bout of risk-off trading could see this pair break below that level.

 

AMERICAS

President Trump is still hoping for a stimulus deal. Treasury Secretary Mnuchin reportedly told House Speaker Pelosi that President Trump will personally lobby reluctant Senate Republicans to support any deal that is reached. With Trump pushing for concessions to go over $1.8 trln and the Democrats currently at $2.2 trln, a deal would likely have a 2-handle. This is a number that Senate Majority Leader McConnell is nowhere close to accepting, as the Senate prepares to vote on an even skinnier bill next week from the $500 bln already passed. It’s up to Trump and Mnuchin to persuade Republicans to go for it, which remains a very unlikely prospect in our view.

In the end, we think more stimulus is coming but on the other side of the election. If so, longer-dated yields should remain under pressure. The 10-year yield has been pushing up against the top of its 6-month range of roughly 0.6-0.8%. We think it’s really a matter of time until it does, especially in a Democratic sweep scenario. Either way, the spread between US Treasuries and European yields should continue to widen between greater borrowing in the US and the impact of the virus second wave in Europe. We don’t think, however, that this widening will translate into medium-term dollar strength, unless it comes through genuine economic growth outperformance.

The main event is September US retail sales. Headline sales are expected to rise 0.8% m/m vs. 0.6% in August, while ex-autos are expected to rise 0.4% m/m vs. 0.7% in August. The so-called control group used for GDP calculations is expected to rise 0.3% m/m vs. -0.1% in August. All in all, the data are likely to show continued restraint in consumption as the labor market remains under stress and a resumption of enhanced unemployment benefits nowhere to be seen. We see weaker than expected consumption turning out to be a considerable drag on the US economy in Q4.

Fed manufacturing surveys for October are mixed so far.  Empire survey came in at 10.5 vs. 14.0 expected and 17.0 in September, while Philly Fed business outlook came in at 32.3 vs. 14.8 expected and 15.0 in September.  September IP will be reported today and is expected to rise 0.5% m/m vs. 0.4% in August. August business inventories (0.4% m/m expected), TIC data, and preliminary October University of Michigan consumer sentiment (80.5 expected) will also be reported today. The Fed’s Bullard and Williams speak today.

Yesterday, initial claims came in at 898k vs. 825k expected and 840k the previous week. This was the highest reading since August. However, we don’t want to make too much of the claims data, as we know California is still working out its distortions for another week or two. That said, the lack of another stimulus deal pretty much guarantees that the claims data will move higher and the labor market will get worse. Next week’s initial claims data will be for the BLS survey week containing the 12th of the month, but even a bad number shouldn’t be over-processed. While there’s no consensus yet for the October jobs report November 6, we expect downside risks.

Bank of Canada announced some changes to its financial market support programs. It will discontinue its bankers acceptance facility as well as its mortgage bond purchase program. The bank will also reduce the frequency of its term repo operations to bi-weekly and will also narrow the range of securities eligible to take part.   When all is said and done, we don’t take this as being hawkish by any stretch. These are emergency programs meant to keep markets functioning normally during the height of the crisis. We are not back to normal, but markets are functioning close to normally and so these programs can be pared back. BOC would not hesitate to reinstate them if market conditions were to deteriorate.

Meanwhile, the BOC is coming under criticism from the opposition Conservatives. Chief Conservative spokesperson on finance Pierre Poilievre said the bank “should not be an ATM for Trudeau’s insatiable spending appetites” and raised concerns about the long-term impact of the bank’s easy money policies while urging Governor Macklem to steer clear of “ideological” debates. We think this criticism is unfair and that Poilievre is the one injecting ideology into the debate. BOC is doing what virtually every central bank is doing, regardless of which party happens to be in power.

 

EUROPE/MIDDLE EAST/AFRICA

With the EU summit wrapping up today, markets await UK Prime Minister Johnson’s decision on whether to walk away or not. With limited progress but no breakthrough yet in Brexit talks, we are assuming that he will take UK chief negotiator Frost’s recommendation to extend talks for two weeks. It’s hardly worth going through the cacophony of comments, but net outcome seems to be that France is still sticking to its tough line on fisheries, UK negotiators are playing the classic brinkmanship game, and the EU is willing to continue negotiations. We still see a substantial chance of a “skinny deal” with minor concessions and face saving on both sides, which would probably give a small boost to the pound.

Corporate credit risk in Europe has ticked higher this week but remains very subdued in the pandemic’s second wave. None of the Itraxx’s subcomponents are reflecting much concern on the part of credit investors. For example, the high yield index (a.k.a. cross over), is trading around 330 bp, well under half the level seen in March. The sub-financial and IG indices haven’t done much either. We share the optimism here. The ECB remains a credible backstop for the market and, despite some speedbumps, the EU’s recovery fund will soon kick in.

ECB President Lagarde said the bank will carefully assess all incoming data, including the exchange rate. Adding the bit about FX clearly reflects the concern within the ECB as reflected in the account of the September ECB meeting. Then, Lagarde didn’t seem concerned about the strong euro at her post-decision press conference. However, other officials pushed back hard and so now it appears that she includes it in her official statements. That said, not much that jawboning can do to impact the exchange rate in a significant way. What could is more easing by the ECB, which we think is coming at the December meeting.

 

ASIA

New Zealand holds general elections Saturday. The latest poll shows Prime Minister Ardern’s Labour Party with 46% support compared to 31% for the opposition National Party. With 6% support seen for its coalition partner Green Party, Labour should easily form a majority in parliament. It’s clear that Ardern his being rewarded for her success in controlling the virus, and this would mean continuity in pandemic policy as well as in fiscal policy. Ardern has pledged massive infrastructure spending, though to be fair, so has opposition leader Collins.

On the monetary side, the RBNZ just delivered a dovish hold and appears to be setting the table for negative rates. Next policy meeting is November 11 and the bank is set to release new details of its term lending scheme for commercial banks. This is widely seen as a precursor to negative rats and so it would be at that November meeting that the RBNZ sets out a clearer timetable for negative rates in 2021. Currently, markets are pricing in the possibility of negative rates at the February 24 meeting and fully by the April 14 meeting. New Zealand has been one of the most successful countries in controlling the virus and this gives the economy a leg up in reopening even as policy settings shift more expansive.