Dollar Trades Heavier, Key Events Awaited

Corrective Forces Dominate

– The US dollar is trading with a heavier bias today amid some last minute position squaring ahead of the key events that are stacked in the second half of the week

– The eurozone’s manufacturing PMI matched the flash reading and Germany’s unemployment rate fell to cyclical lows, but this should have little bearing on expectations for the ECB

– The RBA left rates unchanged as expected

– Elsewhere on the EM side, Brazil’s GDP came in even worse than the already bearish forecasts, the RBI kept the repo rate steady at 6.75%, and Korea posted a record trade surplus

Price action: The US dollar is trading with a heavier bias today amid some last minute position squaring ahead of the key events that are stacked in the second half of the week – the ECB meeting and US jobs data. The recent pattern for the euro has been for new lows to be greeted with a bit of profit-taking.  This pattern is holding.  New lows were made yesterday just below $1.0560, and short-covering lifted it to nearly $1.0620 in early Europe when sellers re-emerged.  There is a large option expiry (~2.1 bln) at $1.06 later today. Sterling is trading on both sides of $1.51. The New Zealand and the Australian dollars are outperforming at $0.6650 and $0.7280, respectively. The dollar is little changed against the yen at ¥123.0. EM currencies are mixed with ILS and TWD underperforming and TRY, MYR and ZAR outperforming. Asian equity indices were mostly higher with the Shanghai Comp up 0.3% and the Nikkei up 1.3%. EuroStoxx is marginally lower and US futures are up slightly.

 

The eurozone manufacturing PMI of 52.8 matched the flash reading, though the country breakdown seemed more favorable.  Germany’s flash reading of 52.6 was upgraded to 52.9.  This was blunted by France’s slippage to 50.6 from 50.8.  However, Italy’s manufacturing PMI came in at 54.9 from 54.1. The consensus was for 54.2.  Spain’s reading rose to 53.1 from 51.3, surpassing the consensus expectation for 54.2.  Separately, Germany reported a new cyclical low in unemployment (6.3%) and Italy reported its unemployment rate slipped to 11.5% from 11.8% (that was revised to 11.6%).  The first estimate of Italy’s Q3 GDP rose 0.2% as expected.  The year-over-year rate stands at 0.8% (rather than 0.9% the consensus forecast).

All this has very little bearing on expectations for Thursday’s ECB meeting.  A cut in the already negative deposit rate and an extension of the program into 2017 is widely expected.  Increasing the pace of the purchases and including a new asset classes into the program are possible but there appears to be somewhat less of a consensus.    With the German curve yielding less than minus 30 bp out to four years, a 10 bp cut in the deposit rate may not free up much more assets that can be purchased, suggesting something more is needed for the ECB to get ahead of the curve of expectations that Draghi’s dovish remarks fanned.  At the same time, many participants realize that more often than not Draghi has surprised the market with the extent of his dovishness, and are reluctant to get bitten by the same dog again.  

Sterling is also benefitting from the position adjustment taking place.  Sterling had briefly and narrowly traded below $1.50 yesterday.  Today it pushed to $1.5125, but the upticks were not sustained after the poor manufacturing PMI.  It fell to 52.7 from 55.2 (revised from 55.5). The consensus was for 53.6.  However, this should be kept in perspective.  Note that the Q2 and Q3 average reading was 51.7 and 51.8 respectively. The euro bounced to GBP0.7080 in the middle of last week where it was greeted with new sales that have pushed it back to almost GBP0.7000 today, where it is catching a bid.  The 20-day moving average comes in near GBP0.7050.  The euro has not traded above that average since mid-October and offers a near-term cap.

The Reserve Bank of Australia was the first of the three major central banks to meet this week. As widely anticipated it left rates on hold. Governor Stevens does not appear to be in any hurry to cut rates again, despite the shockingly weak capex report last week. Today’s data was considerably more constructive. The PMI hit at two-year high of 52.5 and building permits rose 3.9% on the month (the consensus was for a 2.5% decline). And while the current account deficit was larger than expected (A$18.1 bln vs A$16.5 bln), exports rose more than expected (1.5% vs 1.0%).   Q3 GDP figures are out tomorrow. The consensus expects that the economy expanded by 0.8% after a 0.2% expansion in Q2. The Australian dollar made new highs for the move, nearing $0.7300 before the momentum stalled. The Aussie is the best performing major currency over the past month, rising 2% against the US dollar. This has taken place even with iron ore prices falling to new multi-year lows.

China’s data was not particularly inspiring. The official manufacturing PMI was a bit softer than expected at 49.6 from 49.8, though the non-manufacturing reading improved to 53.6 from 53.1. The Caixin manufacturing PMI edged higher to 48.6 from 48.2. There are two observations to share. First, the general pattern is what one would expect if China was transitioning from investment/manufacturing to consumption/services growth. Second, like many other central banks, the PBOC still needs to ease monetary policy.

China’s PMI data was not particularly inspiring; there has been little market response to the IMF’s SDR decision

There has been little market response to the IMF’s SDR decision. The official reference rate (fix) was set at CNY6.3973 today from CNY6.3962 yesterday. While we had thought that expectations for a 14-16% weight were exaggerated, the 10.92% weighting was a bit more than we anticipated. The fact that room for the yuan largely came at the expense of Europe (euro and sterling) is consistent with our emphasis on the shifting of the center of the world economy from the Atlantic to the Pacific.

Although some anticipate that now in SDR, China will back away from support the yuan and allow it to fall. We are not convinced. The yuan trended gently lower throughout November.   We do not believe China is seeking a large devaluation. However, we recognize that the same divergence that is underpinning the dollar in general is also at work against the yuan. We expect mild weakness in the yuan against the dollar, but anticipate that it will still be firm to higher on a trade-weighted basis.

Brazil’s GDP came in even worse than the already bearish forecasts. The country’s economy contracted 4.5% y/y in Q3, compared with 4.2% expected and a contraction of 3.0% in Q2. The agricultural sector contracted 2.0% and industry 6.7%, with manufacturing down a whopping 11.3%, all in y/y basis.

Reserve Bank of India kept the repo rate steady at 6.75%, as expected. The central bank cut rates at its last meeting in September by a larger than expected 50 bp. According the Governor Rajan, “The Reserve Bank will use the space for further accommodation, when available,” and he expects inflation to come down to 5 percent by March 2017.” The RBI has so far kept to its pattern of cutting rates at every other meeting in 2015. However, CPI inflation is rising again and may keep the bank on hold in early 2016. CPI rose 5% y/y in October, and is moving closer to the top of the 2-6% target range.

Korea reported its November trade data today. Exports surprised on the strong side, contracting just 4.7% compared with -8.9% y/y and a -15.9% print in the previous month. Imports, however, were considerably worse than expected at -17.6% vs. -14.7% expected. This brought the trade surplus to a record $10.4 bln. Inflation is well below the 2.5-3.5% target range, but the BOK has been on hold since the last 25 bp cut to 1.5% back in June. The next policy meeting is December 10. October current account data will be reported Wednesday.

Indonesia’s November CPI came in near expectations at 4.89% y/y, down from 6.25% in October, and the lowest since November 2014. Inflation is still above the 3-5% target range, but is moving towards it enough to have Bank Indonesia cut reserve requirements at its last meeting. The next policy meeting is December 17. Outright cuts in the policy rate are likely in 2016 if the inflation trajectory continues.

Mexico reports November PMI Tuesday. Domestic consumption has been firm recently, helping to offset the drag from lower oil prices. However, price pressures remain low and we see no need for the central bank to hike rates December 17, no matter what the Fed does the day before.

The North American session features the Bank of Canada meeting. It is on hold, but the statement could be on the dovish side of neutral. The US reports the manufacturing ISM and construction spending. November auto sales will also be reported and the second consecutive month above 18 mln units (annualized pace) is anticipated. Although they may not rise much, if at all, on a sequential basis, which means the impact on retail sales may be minimum, the high absolute level reflects well on the overall level of consumption.