Dollar Under Pressure Again as Stimulus Talks Remain Stalled

  • Curve steepening in the major fixed income markets continues; the dollar is back under pressure
  • Stimulus talks remain stalled; the stage is now set for the November US elections after Joe Biden picked Senator Kamala Harris as his Vice President
  • US data highlight today will be July CPI; US Treasury continues its record $112 bln quarterly refunding; July budget statement will hold plenty of interest
  • UK Q2 GDP plunged -20.4% q/q and -21.7% y/y, slightly less than expected; eurozone June IP rose 9.1% m/m vs. 10.0% expected
  • Japan reported weak July machine tool orders; RBNZ unexpectedly boosted asset purchases while keeping the target rate (OCR) at 0.25%; Westpac Australia confidence for August plunged

Curve steepening in the major fixed income markets continues. In the US, the 2- to 10-year curve has steepened about 10 bp over the last four sessions to 51 bp currently. The same thing has happened in the German and UK curves, though the moves have been less pronounced. Some of this seems to be driven by expectations of increased supply coming on line, but the rising inflation breakeven rates surely was a contributing factor.

The dollar is back under pressure. DXY set a marginal new high for this bounce yesterday but is down today and has given up a third of its recent bounce. Break below 93 is needed to set up a test of last week’s low near 92.52. The euro continues to find support just above the $1.17 area and a break above $1.1840 is needed to set up a test of last week’s high near $1.1915. Sterling has found support just above $1.30 and a break above $1.3120 would set up a test of last week’s high near $1.3185. Lastly, USD/JPY is the big mover after yesterday’s clean break above the 106 level. The pair is trading at the highest level since July 24 and is on track to test the July 20 high near 107.55 and then the July 1 high near 108.15.

AMERICAS

Stimulus talks remain stalled. Meanwhile, administration officials admitted that the enhanced unemployment benefits granted by executive order would only be for $300, not the $400 originally touted. Reports suggest the White House is looking into other measures that can be done via executive order, which would appear to signal that the near-term odds of a congressional deal are fading. This delay supports our view that the US economy faces growing headwinds in Q3, which in turn should underpin dollar underperformance near-term.

The stage is now set for the November US elections after Joe Biden picked Senator Kamala Harris as his Vice President. The former California prosecutor is the first African American woman running on a presidential ticket. President Trump’s prospects have improved since mid-July, but he is struggling to regain form. Implied odds and polling averages give him around a 45% chance of victory. Odds for Congress have been a lot more stable, consistently showing favorable odds of a Democratic sweep, with about an 80% chance of taking the majority in the House and 40% for the Senate.

US data highlight today will be July CPI. Headline is expected to rise a tick to 0.7% y/y and core expected to fall a tick to 1.1% y/y. Yesterday, PPI came in higher than expected, with headline at -0.4% y/y vs. -0.7% expected and core at 0.3% y/y vs. flat expected. The 5- and 10-year TIPS breakeven inflation rates have crept higher but remain below what they were in February. In other words, runaway inflation is not being priced in yet. The Fed’s Rosengren, Kaplan, and Daly all speak today.

The US Treasury continues its record $112 bln quarterly refunding. $38 bln of 10-year notes will be sold today, followed by $26 bln of 30-year bonds tomorrow. Yesterday, there was solid demand for the $48 bln of 3-year notes sold. It was priced to yield 0.179%, with the bid to cover ratio steady at 2.44. The refunding comes at a time of global curve steepening and so the costs of borrowing have risen this week. The current 10-year UST yield of 66 bp is the highest since mid-July.

The July budget statement will hold plenty of interest. It comes in the middle of the quarterly refunding process and is a reminder of the sharply higher supply that is coming down the pike. A deficit of -$137.5 bln expected. If so, the 12-month total would rise modestly to -$3 trln, which would still be a new record high.

EUROPE/MIDDLE EAST/AFRICA

UK Q2 GDP plunged -20.4% q/q and -21.7% y/y, slightly less than expected. Weakness was broad-based, with private consumption at -23.1% q/q, government spending at -14.0% q/q, GFCF at -25.5% q/q, and exports at -11.3% q/q. However dire, the figures are backwards looking and doesn’t yet fully reflect the re-opening bounce. Indeed, the June figures showed sequential improvement that suggests momentum should carry over into Q3. There were substantial increases in construction activity and services of 23.5% m/m and 7.7% m/m, respectively. IP (9.3% m/m) and manufacturing production (11.0% m/m) for June came in slightly above expectations. That said, we think that more accommodation from the BOE is likely later this year, as well as a potential extension of the government’s furlough program.

Eurozone June IP rose 9.1% m/m vs. 10.0% expected. The reading was slightly disappointing. After German IP rose 8.9% m/m, French IP rose 12.7% m/m, and Italian IP rose 8.2% m/m, we saw upside risks to the consensus. Note that May was revised down a tick to 12.3% m/m. Still, the momentum is strong going into Q3 and we underscore our view that Europe will see a rare period ahead of economic outperformance relative to the US.

ASIA

Japan reported weak July machine tool orders. At -31.1% y/y, orders showed little improvement of the -32.1% reading in June. Policymakers must be happy with recent weakness in the yen, as the Japanese economy continues to disappoint as Q3 data start trickling out. With Abe’s popularity plunging amidst the resurgent virus, we expect further fiscal stimulus later this year. For now, the BOJ is likely on hold.

The RBNZ unexpectedly boosted asset purchases while keeping the target rate (OCR) at 0.25%. The bank expanded its Large-Scale Asset Purchase Program to NZD100 bln from NZD60 bln previously and extended it until June 2022. Governor Orr said the bank wants to actively push bond yields lower, with Assistant Governor Hawkesby noting the bank can now buy up to 60% of new government bond issuance after the Finance Ministry agreed to raise the cap from 50%. The bank sees the cash rate remaining at 0.25% through Q1 202, which is consistent with previous forward guidance. Its projections show inflation dipping to 0.3% next year and remaining below the 1-3% target range until Q3 2022.

Separately, the RBNZ outlined a series of “tools” that can be deployed depending “on the outlook for inflation and employment.” They include (1) negative interest rates, (2) funding retail banks directly at the “near-OCR”, and (3) purchases of foreign assets. The last option would be meant to weaken the Kiwi. At the June 24 meeting, the RBNZ warned that recent NZD appreciation had placed further pressure on exports and damped the outlook for inflation. Since then, NZD has appreciated another 2.5% and so it remains a concern. NZD is underperforming on the day, down 0.4% against the dollar. Kiwi tends to weaken on RBNZ decision days, losing value on the last three and five of the last seven before today.

Westpac Australia confidence for August plunged. It fell to 79.5 from 87.9 in July, and largely reflects the recent virus outbreaks in the state of Victoria. The reading is the lowest since the April trough of 75.64 and continues a two-month slide from the June peak of 93.65. Australia reports July jobs data overnight. Employment is expected to rise 30k vs. 210.8k in June, but the unemployment rate is expected to rise to 7.8% from 7.4% in June. The RBA just left policy steady last week, noting that it stands ready to change if needed as it awaits more information on the potential impact of the widening lockdown in Victoria. Next policy meeting is September 1 and no change is expected then. However, the RBNZ’s move today should keep markets on alert for a dovish surprise from the RBA as well.