Dollar Stabilizes as China Delivers a Warning

  • US-China tensions remain high after China responded by reportedly pausing agricultural imports from the US; the dollar has recovered from earlier losses as a result
  • ISM May manufacturing PMI will be the data highlight today
  • Brexit negotiations seem to be heading down the usual brinkmanship path; eurozone reported final manufacturing PMIs; Turkey is leaning on state banks for the next stage of the stimulus program
  • China’s Caixin manufacturing PMI surprised to the upside at 50.7; Korea reported weak May trade data; Hong Kong reported weak April retail sales data

The dollar is mostly weaker against the majors but off the day’s lows as US-China tensions continue to rise. Aussie and Loonie are outperforming, while Stockie and Swissie are underperforming. EM currencies are mostly firmer. KRW and PLN are outperforming, while TRY and CNY are underperforming. MSCI Asia Pacific was up 1.6% on the day, with the Nikkei rising 0.8%. MSCI EM is up 2.0% so far today, with the Shanghai Composite rising 2.2%. Euro Stoxx 600 is up 0.8% near midday, while US futures are pointing to a lower open. 10-year UST yield is flat at 0.66%, while the 3-month to 10-year spread is flat at +53 bp. Commodity prices are mostly higher, with Brent oil up 0.1%, WTI oil down 0.7%, copper up 0.4%, and gold up 0.3%.

US-China tensions remain high after China responded by reportedly pausing agricultural imports from the US. This has dented market sentiment a bit as the new week gets under way. Ahead of the import news, the lack of assertive action by the US administration against China and more favorable re-opening news had helped boost market sentiment despite the huge protests and riots in the US. Trump’s threats against China have so far been much ado about nothing, and risk assets bounced Friday after his press conference led to no significant measures by the US. Clearly, China’s move today is a shot across the bow.

The dollar has recovered from earlier losses as a result. DXY traded today at the lowest level since March 16 just below 98 before recovering on the Chinese import news. Just below that is the key 97.837 level, as a break below that would set up a test of the March 9 low near 94.65. The euro traded today at its highest level since March 30 before reversing lower. Sterling has held up relatively better and so EUR/GBP has moved back below the .90 area after trading Friday at the highest level since March 27. Lastly, USD/JPY remains stuck just below the 108 level.

AMERICAS

China policymakers have reportedly instructed major state-run agricultural companies to pause purchases of some American agricultural goods. Obviously, this puts the Phase One trade deal at risk. The pause reportedly includes soybeans and pork. State-owned traders Cofco and Sinograin were asked to suspend these purchases. We expected such action from China once the National People’s Congress ended. Halting agricultural goods imports is a particularly potent statement, as many of the goods affected are produced in so-called red states that President Trump must win in November. Trump is constrained by a political cycle. Xi isn’t and so he holds a much stronger hand at this juncture. How Xi chooses to play that hand will ultimately determine how markets perform in the coming months.

ISM May manufacturing PMI will be the data highlight today. It is expected to improve to 43.7 from 41.5 in April. There are some downside risks to ISM after Chicago PMI missed to the downside last week. ISM non- manufacturing PMI will be reported Wednesday, which is expected to improve to 44.5 from 41.8 in April. Other minor US data will be reported today, including April construction spending (-6.0% m/m expected) and final May Markit manufacturing PMI (40.0 expected). The media embargo for the June 10 FOMC meeting is in place and so there are no Fed speakers until Chair Powell gives his post-decision press conference that afternoon. Canada Markit May manufacturing PMI will be reported today.

EUROPE/MIDDLE EAST/AFRICA

Brexit remains a sideshow in the context of so many global events, but negotiations seem to be heading down the usual brinkmanship path. EU’s chief negotiator, Michel Barnier, said yesterday that the EU “will not accept — never accept — anything that makes the single market more fragile.” Talks resume tomorrow, and the two sides have until the end of the month to decide on an extension. Despite playing hardball, we think both have enough reasons to extending negotiations, and the coronavirus provides a perfect political cover to do so. Sterling is performing well today, but largely in line with broad dollar weakness across majors and EM and right in the middle of the $1.2150-1.2550 range seen over the last couple of months. On the year, the pound is 6.5% weaker against the dollar and 5.6% weaker against the euro. UK final May manufacturing PMI rose a tick from the preliminary to 40.7. Services and composite PMIs will be reported Wednesday, followed by construction PMI Thursday.

Eurozone final manufacturing PMIs were reported. Italy and Spain both improved from April to 45.4 and 38.3 vs. 36.8 and 37.8 expected, respectively. France improved three ticks from the preliminary to 40.6, but Germany fell a couple of ticks from the preliminary to 36.6 and that was enough to drag the eurozone reading down a tick to 39.4. The region faces a steep climb before reaching expansionary territory above 50. Services and composite PMIs will be reported Thursday, with Italy and Spain again seen improving sharply from April.

Turkey is leaning on state banks for the next stage of the stimulus program. A statement by the country’s three largest state-owned banks said they will start aggressively expanding credit through lower rates for mortgages, car loans and consumer credit. A 15-year mortgage could now come with a rate of 8%, compared with inflation running at 11%. Of course, this is a train wreck waiting to happen and we note that many of Turkey’s past economic crises have originated in the banking sector. Stay tuned.

ASIA

China’s Caixin manufacturing PMI surprised to the upside at 50.7. This compares to the 49.6 reading that was expected. This was the highest reading since January and is especially impressive in the context of weak external demand. Indeed, Caixin’s new export orders component is still deep in contractionary territory at 35.3. Over the weekend, the official PMI readings for May came out. Manufacturing fell a couple ticks to 50.6 while non-manufacturing improved a few ticks to 53.6, which left the composite steady at 53.4.

Korea reported weak May trade data. Exports contracted -23.7% y/y vs. -25.1% expected, while imports contracted -21.1% y/y vs. -20.6% expected. As the bellwether for the region, such weak readings would suggest that a recovery remains far off. Bank of Korea just cut rates 25 bp to 0.5%. Next policy meeting is July 16. While we cannot rule out further easing ahead, we suspect the bank will wait to see how the economy responds to fiscal stimulus that’s in the pipeline.

Hong Kong reported weak April retail sales data. In volume terms, sales contracted -37.5% y/y vs. -40.5% expected and a revised -44.0% (was -43.8%) in March. Some restrictions were lifted in May, but we suspect any significant improvement in the data won’t be seen until June, if at all. It remains to be seen whether the current round of protests will be sustained. If so, there are risks that consumption will remain depressed well into H2. Another risk comes from possible US sanctions. President Trump on Friday vowed “meaningful” action to strip Hong Kong of some of its trading privileges, but so far has released no details on what these actions will be. Yet HKD remains in the strong end of the trading band. This is unlikely to be sustained if US-China tensions remain high. Stay tuned.