Dollar Vulnerable as US Economic Outlook Worsens for Q4

  • Virus-related headlines continue to worsen, at least in terms of infection rates; the dollar has been unable to break any new ground
  • President Trump called off stimulus talks with House Speaker Pelosi until after the election; the decision will have wide-ranging implications; US House published a series of proposals to curb the power of big tech
  • FOMC minutes will be released; this is another quiet day in terms of US data; Canada reports September Ivey PMI; Peru is expected to keep rates steady at 0.25%. 
  • Industrial data from Germany and Spain for August came in decidedly downbeat; Poland is expected to keep rates steady at 0.10%
  • China foreign reserves came in at $3.143 trln in September; Taiwan reported September trade data

Virus-related headlines continue to worsen, at least in terms of infection rates. In the US, the outbreak in the White House continues to spread and hospitalization rates in Texas are picking up again, now at a 3-week high (+2.3%). In Europe, Germany imposed new restrictions on bar and restaurants, similar to actions taken in the UK, France, and Spain. The good news is that the pattern of comparatively lower death rates during the second wave remains in place.

There has been a notable development in the volatility space in recent sessions: the fixed income MOVE index is gaining upside momentum.  This is happening against the backdrop of relatively small moves in implied volatility measures in other asset classes. The fixed income move is probably a side effect of the curve steepening trade that’s been picking up steam due to increasing chances of a Democratic sweep and a resulting fiscal expansion that pressures yields higher. Indeed, the 30-year Treasury yield is up 11 bp since the start of the month and the 10-year is up 8 bp.

The dollar remains vulnerable. The dollar spiked higher late yesterday afternoon as risk-off sentiment rose after the collapse in stimulus talks (see below). Yet the bounce in DXY ran out of steam ahead of the 94 area and is treading water today. When all is said and done, the lack of any fiscal stimulus until after the election means that US growth in Q4 will come in much weaker than anticipated. This continued economic underperformance is likely to drive continued dollar underperformance. The euro found support just above $1.17 and should eventually test the September 21 high near $1.1870.

 

AMERICAS

President Trump called off stimulus talks with House Speaker Pelosi until after the election. He accused Pelosi of negotiating in bad faith but comes just days after he exhorted Congress to “GET IT DONE.” Talks were already on life support but now they are officially dead. We really don’t understand why a sitting president who is way behind in the polls isn’t pushing his party in Congress to open up the checkbook. And that’s in normal times. With a pandemic raging, Powell and Lagarde are right to push for more fiscal stimulus as monetary policy is close to its limits.

The decision will have wide-ranging implications, all negative. Households will not get another $1200 stimulus check, tens of millions of unemployed workers will not get enhanced benefits, and the airlines will have no choice but to furlough and lay off more workers in the absence of an aid package for the industry. And then there’s state and local governments, which will have to lay off more workers as a result of not getting any aid. What’s most puzzling is that Trump has set himself up to take all the blame for this failure to pass stimulus.

The US House published a series of proposals to curb the power of big tech. There is nothing new here, but this push for anti-trust legislation seems like a bad omen for this sector under a Biden presidency and especially a Democratic sweep. However, it’s important to keep some perspective on what the sector has done so far this year, with most of the larger companies posting gains well above the broad market index. The risk of new regulation in the sector has done little damage to these stocks so far, but it’s certainly an issue that needs to be watched closely if odds of a Democratic sweep continue to rise.

FOMC minutes will be released. The Fed delivered no surprises at its September meeting but updated the forward guidance to reflect its new policy framework, pledging to keep rates near zero until “inflation has risen to 2% and is on track to moderately exceed 2% for some time.” The phrases “moderately exceed” for “some time” are suitably vague and so it’s not a mechanical Taylor Rule by any stretch.  That gives the Fed maximum flexibility while underscoring that rates will stay lower for longer. Minutes should hopefully give more insight into the new framework.

This is another quiet day in terms of US data. August consumer credit is the only report and an increase of $14.0 bln expected. In terms of Fed appearances, Rosengren, Bostic, Kashkari, Williams, and Evans all speak. Yesterday, Chair Powell warned of a weak recovery without more fiscal support. While nothing new, his comments took on even more poignance after President Trump later pulled the plug on stimulus talks.   We expect Fed officials to continue pushing for fiscal support, but to no avail so far.

Canada reports September Ivey PMI. Markit manufacturing PMI came in at 56.0 vs. 55.1 in August. However, the Ivey PMI covers all sections of the Canadian economy and its reading of 67.8 in August was still near the 68.5 peak the previous month. While Q3 has seen a strong recovery, a second wave of virus infections is hitting the province of Ontario, leading to expanded restrictions in the large urban areas of Ottawa, Toronto, and Peel. This will surely weigh on the economy in Q4 and bears watching.

Peru central bank is expected to keep rates steady at 0.25%.  CPI rose 2.26% y/y in September, the highest since June 2019 and in the upper half of the 1-3% target range.  At its last meeting September 10, the bank said it sees inflation below target this year and next, and pledged to keep policy “strongly expansive” for a prolonged period.  As such, we do not think it will be concerned by the recent uptick in price pressures.

 

EUROPE/MIDDLE EAST/AFRICA

Industrial data from Germany and Spain for August came in decidedly downbeat. German IP unexpectedly contracted -0.2% m/m vs . +1.5% expected, with the y/y rate coming in at -9.6%. Capital and consumer goods dragged down the reading. Still, alternative data points from Germany (factory orders, for instance) suggest a respectable recovery into Q4, though it will likely start to face headwinds with the impact of the virus’ second wave. Spain’s industrial output figures also disappointed at -5.7% y/y, though still better than the July print of -6.4%. Elsewhere, Italy reported strong retail sales, up 8.2% m/m vs. 3.8% expected.

National Bank of Poland is expected to keep rates steady at 0.10%.  The bank has kept rates on hold at 0.10% since its last 40 bp cut in May.  It has signaled rates will remain low for the foreseeable future.  Minutes will be released Friday.  September CPI rose 3.0% y/y and remains in the upper half of the 1.5-3.5% target range.

 

ASIA

China foreign reserves came in at $3.143 trln in September. That’s down from the recent peak of $3.165 trln in August and the lowest since June. We would not read too much into this drop, as it was likely due mostly to valuation effects. The dollar gained significantly against the majors last month, which would tend to depress the dollar value of any non-dollar reserve holdings. Chinese markets remain closed until Friday. The data deluge for September begins next week, followed by Q3 GDP the week after that. GDP is expected to grow 3.3% q/q and 5.3% y/y.

Taiwan reported September trade data. Exports rose 9.4% y/y vs. 9.6% expected and 8.3% in August, while imports fell -5.4% y/y vs. 2.3% expected and 8.5% in August. Exports have now risen y/y for three straight months, boosted by the regional recovery led by the mainland. Export orders have risen six straight months and suggest robust exports through at least the first quarter of 2021. USD/TWD traded this week at the lowest level since 2011, suggesting there has been little impact on export competitiveness. The central bank has recently taken a more hands-off approach to the exchange rate.