Dollar Steadies as Global Equity Markets Calm

  • Markets have gotten excessively pessimistic about the US economic outlook
  • In terms of Fed speakers, this is the busiest day of the week
  • US won a landmark WTO case against Europe, potentially igniting another front on the trade war
  • Eurozone and UK reported weak services and composite PMIs
  • There have been some tentative positive signals towards Johnson’s new Brexit plan
  • Turkey reported September CPI; Brazil pension reform bill has gotten watered down

The dollar is mostly firmer against the majors.  The Antipodeans are outperforming, while Stockie and Swissie are underperforming.  EM currencies are mostly firmer.  ZAR and THB are outperforming, while CZK and RON are underperforming.  MSCI Asia Pacific was down 0.8% on the day, with the Nikkei falling 2%.  MSCI EM is up 0.1% so far today, with China markets closed until October 8 due to the National Day holiday.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open.  10-year UST yields are down 2 bp at 1.58%, while the 3-month to 10-year spread has inverted 1 bp and stands at -15 bp.  Commodity prices are mostly lower, with Brent oil down 0.4%, copper down 0.9%, and gold flat.

The dollar came under increasing pressure as the day progressed yesterday.  Some reports attributed the weakness to political uncertainty, but we believe it was due more to concerns about the US economy.  The greenback has stabilized today against the majors, though the dollar bloc is posting some small gains.  Global equity markets have calmed today after yesterday’s sell-off.

Markets have gotten excessively pessimistic about the US economic outlook.  We do not put a huge amount of weight on the ISM number, given that it was affected by the GM strike. The ISM non-manufacturing PMI report today will be closely watched and consensus sees 55.0 vs. 56.4 in August.  During the North American session, the US also reports August factory orders, September Challenger job cuts, weekly jobless claims, and final Markit services and composite September PMIs.

In terms of Fed speakers, this is the busiest day of the week.  Evans, Quarles, Mester, Kaplan, and Clarida all speak today.  WIRP now suggests 73% odds of a cut October 30, nearly double the 40% seen at the beginning of the week.

US won a landmark WTO case against Europe, potentially igniting another front on the trade war.  This was the biggest WTO case ever, worth the right to impose a potential $7.5 bln in tariffs.  The US will start with a 10% tariff on imported European aircrafts and a 25% on selected consumption items such as whiskey and cheese. The reaction from the EU side was subdued, with the bock’s trade chief saying they will wait until the WTO ruling against Boeing (expected early next year) to respond in kind.

We are heartened by the fact that the matter was addressed by the WTO and not by unilateral action.  The risk of more tariffs couldn’t have come at a worse time.  However, the result demonstrates that the WTO process works.  Markets seem to be fading the move so far, and that’s probably the right posture until we see how President Trump will play this new card in his electoral campaign deck.  Here are some possibilities: (1) escalate and fight a double-front trade war against both China and the EU; (2) use the awarded tariffs to bolster his electoral base (farmers, for example); or (3) use this opportunity to pivot the trade war away from (the more economically damaging) China front towards a greater focus on the EU.

Final eurozone services PMI readings and August retail sales were reported.  Headline services and composite came in at 51.6 and 50.1 vs, 52.0 and 50.4 expected, respectively.  Manufacturing fell below the 50 boom/bust level back in February.  Now, the wider economy is on the cusp of doing so as well.  Germany and France composite PMIs both worsened from the flash readings to 48.5 and 50.8, respectively.  Spain composite fell to 51.7, while Italy rose slightly to 50.6.  We see continued downside risks to the eurozone data, which should continue to weigh on the euro.

There have been some tentative positive signals from Tory Brexit hardliners and the Northern Irish government ally DUP towards Johnson’s new Brexit plan.  The EU didn’t outright reject it and so there is hope, but we are far from reaching any significant milestone of progress.  Johnson’s path to solving the Irish border dispute is to impose a regulatory border across the Irish Sea (which former PM May was staunchly against) and have some form of customs frontier in Ireland.  The Northern Ireland assembly must give its consent towards the agreement every four years, but it’s not clear what happens if they decide against it.  All said, another extension to the Brexit deadline still seems likely but the odds of a deal have increased over the last 24 hours.

Weak UK services and composite PMIs were reported.  They came in at 49.5 and 49.3 vs. 50.3 and 50.0 expected, respectively.  Manufacturing fell below the 50 boom/bust level back in May.  Now, the wider economy has followed suit.  Recent comments from BOE officials suggest they are finally rethinking the need to hike rates since inflation remains below target and the economy is soft.  It will all ultimately fall on which form Brexit takes.  Next BOE meeting is November 7 and WIRP suggests 25% odds of a cut.

Turkey September CPI rose 9.26% y/y vs. 9.70 expected.  This is the lowest level since early 2017, and a huge decline from the peak readings near 26% from late 2018.  Officials will probably feel vindicated and likely to deliver another large cut at the next meeting October 24, perhaps on the magnitude of 400 bp from the current 16.5% rate.  There was no meaningful reaction in TRY, which has been largely rangebound around USD/TRY 5.70 since early September.

Brazil pension reform bill has gotten watered down.  The Senate approved the bill 56-19 but then went to work on the amendments.  One that passed maintains an annual bonus to low-income workers that will cost the government an estimated BRL70 bln over the next ten years.  Along with other changes, the estimated savings of the entire bill have fallen to around BRL800 bln over the next ten years from over BRL1 trln initially proposed.  USD/BRL should resume its march upwards.