Dollar Steadies as Market Sentiment Sours

  • Market sentiment has soured today; the dollar has steadied but the outlook remains one of weakness
  • The Fed delivered a dovish hold with no surprises; extension of the Fed’s USD liquidity lines is a small positive for EM
  • We get the first look at US Q2 GDP; weekly jobless claims will also be reported
  • German data today has been mixed; eurozone July economic confidence index improved to 82.3 vs. 81.4 expected
  • Japan officials are planning to tighten restriction to help limit the current spike in infections; Japan reported strong June retail sales; the strong yen is raising official concerns

Market sentiment has soured. It’s all about earnings, it seems, as more than 60 of the EuroStoxx 600 companies are reporting today. These will be followed by tech giants in the US – Apple, Amazon, Alphabet, and Facebook. In Asia, Samsung beat estimates and came out with a somewhat optimistic outlook on the back of rising demand for chips. Still, that didn’t help the regional bourses, with MSCI Asia Pacific down modestly today. European shares have gotten hit harder, while US futures are pointing to a lower open.

The dollar has steadied but the outlook remains one of weakness. With its dovish message, the Fed gave dollar bears no reason to change their strategy. DXY traded yesterday at new lows for this move before steadying, and we believe it remains on track to test the September 2018 low near 93.814. The euro has been unable to make a clean break above $1.18, above which the September 2018 high near $1.1815 beckons. Likewise, sterling has so far been unable to break above $1.30. Above that, the next target is the March high near $1.32.

AMERICAS

The Fed delivered a dovish hold with no surprises. All policy settings were left unchanged and a sober outlook was presented. The bank warned the pandemic still poses considerable risks, noting that there are signs that the recent rise in the virus numbers is weighing on the economy. Chair Powell said the path forward is extraordinarily uncertain, with a full recovery unlikely until people feel safe. He said the Fed has ways to further support the economy, emphasizing again that the Fed is “not even thinking about thinking about raising rates.”

Of note, Powell said the Fed is wrapping up its framework review in the near future. Perhaps it will be unveiled at the next meeting September 16, at the same time that new staff forecasts and Dot Plots will be released. If the Fed is preparing to introduce some sort of target-based forward guidance, it would make sense to do it at a time when its macro forecasts are updated. Many expect the centerpiece of this review to be an average inflation target, allowing the Fed to overshoot the 2.0% level to make up for below target periods.

The extension of the Fed’s USD liquidity lines is a small positive for EM. Its central bank repo and swap lines through March of next year. Not that we think the Fed would let EM get squeezed if dollar liquidity were to dry up, but it’s nice to see officials acting pre-emptively to keep the safety net in place through the turn of the year. Our base case remains that of all problems facing the financial system and global economy, dollar shortages is not one to be concerned about.

Senator Lisa Murkowski said she is still undecided on whether to support Judy Shelton’s nomination to the Fed’s Board of Governors. Two other Republicans, Collins and Romney, have said no. This appears to be a trial balloon from Murkowski. If any Republican Senator takes the bait and opposes Shelton, we suspect Murkowski will join them to sink Shelton’s nomination. Stay tuned.

We get the first look at US Q2 GDP. Consensus sees a contraction of -34.5% SAAR vs. -5.0% in Q1. The Atlanta Fed’s GDPNow model estimates Q2 at -32.1% SAAR, while the New York Fed’s Nowcast model estimates Q2 at -14.3% SAAR. We suspect the truth is somewhere in between. The Nowcast model looks ahead to Q3 and sees growth of +13.3% SAAR, while Bloomberg consensus is currently at 18.0% SAAR. Again, we suspect the truth is somewhere in between but probably closer to the bottom of that range.

Weekly jobless claims will be reported. Initial claims are expected at 1.445 mln vs. 1.416 mln last week, while continuing claims are expected at 16.2 mln vs. 16.197 mln last week. in other words, no improvement is expected. Despite the strong jobs report for June, the fact that initial claims are still coming in at nearly 1.5 mln every week suggests the labor market is still under some stress. Last week’s claims were the highest since the week ending June 20 and rose for the first time since the week ending March 28. They were also for the BLS survey week containing the 12th of the month. Consensus for July jobs has worsened and is currently at 1.875 mln vs. 4.8 mln in June, while unemployment is expected to fall to 10.5% from 11.1% in June.

EUROPE/MIDDLE EAST/AFRICA

German data today has been mixed. Preliminary Q2 GDP came in weak, with the readings of -11.7% y/y and -10.1% q/q both a full percentage point worse than expected. A rebound is coming, but it will be an uneven one. Weak global demand will continue to dampen exports and industrial industry, even though government stimulus and lower VAT will help the services side. We still believe Germany will very likely come out better than many of the other large EU economies. Indeed, July unemployment fell -18k and was the first drop since February. A gain of 41k was expected. Preliminary July CPI will be out shortly, with headline inflation expected to slow sharply to 0.1% y/y (0.3% y/y EU harmonized). State data already reported today suggest downside risks to the national reading.

Eurozone July economic confidence index improved to 82.3 vs. 81.4 expected. June was revised a tick higher to 75.8. The index continues to improve from the low of 64.8 in April but is still well off the 103.4 level seen before the pandemic. Service confidence is still contracting the most (-26.1), compared to industrial (-16.2) and Consumer (-15.0). The region’s unemployment rate came in at 7.8% in June, a tick higher than expected and up from 7.4% in May.

ASIA

Japan officials are planning to tighten restriction to help limit the current spike in infections. Hours for bars, restaurants, and karaoke in Tokyo will be shortened in August. However, infections have spread outside of Tokyo and reports also suggest the federal government is considering a limit on the number of people that can dine out together as part of a three-stage process that would allow local governments to gradually increase restrictions before declaring a state of emergency.

Japan reported strong June retail sales. Sales rose 13.1% m/m vs. 8.0% expected, dragging the y/y rate up to -1.2% y/y vs. -5.5% expected and a revised -12.5% (was -12.3%) in May. While welcome news, the improvement in consumption may be short-lived now that parts of the country are starting to impose restrictions again. Indeed, the recovery in Japan has been uneven and certainly lagging much of DM, with the exception of the US, and this is likely to continue in Q3.

The strong yen is raising official concerns. Ministry of Finance official said today that stability in the currency market is important and so the it will be watched with a sense of urgency. The official added that various policy tools will be considered as a response. We do not think there is much that can be done beyond increased intervention, as cutting rates is not a workable option at this point. USD/JPY traded yesterday at the lowest level since March 13 near 104.75 but has since recovered back to around 105. This week’s break below the 105.20 level is key, as it represents the 62% retracement of the March rise and sets up a test of the March 9 low near 101.20.