Dollar Weakens Post-ECB

  • Downward pressure on the dollar has resumed; stimulus talks are going nowhere fast
  • Weekly jobless claims yesterday were worrisome; US 30-year auction went slightly better than the 10-year did
  • Main US data report today is August CPI; August budget statement today will be of interest
  • ECB delivered no surprises yesterday; the strong euro is not yet a concern. Or is it?
  • EU-UK tensions remain high; UK economy staged a solid bounce in July, but we see tougher times ahead
  • There are mixed signals about a consumption tax hike in Japan; Japan and the UK have agreed in principle to a free trade agreement; China’s credit figures for August indicate that the recovery is likely to continue at a strong pace

Downward pressure on the dollar has resumed.  DXY traded Wednesday at the highest level since August 12 but could not break above the key 94.00 area and is back near 93.00 now.  The euro found support below $1.18 but has so far been unable to challenge the high near $1.20 from last week. We remain negative on the dollar, as Powell’s dovish message from Jackson Hole is likely to be reiterated at the FOMC meeting next week. Global equity markets are stabilizing, with US futures pointing to a higher open. A return to risk-on trading would likely put some more downward pressure on the dollar.

It’s been a wild week for global equity markets with large moves and divergences. US has clearly underperformed the major markets but, when all said and done, the moves in aggregate indices weren’t all that dramatic with the S&P and Nasdaq futures down around 2% after taking into account the rebound during today’s London session. The UK’s FTSE 100 outperformed despite growing negative sentiment about the Withdrawal Agreement negotiations, but this was in part down to the weakness in sterling (see below).



Stimulus talks are going nowhere fast. As expected, the Senate vote on the Republican “skinny” bill failed the procedural vote with only 52 votes in favor, falling far short of the 60 needed to advance it to a full floor vote. The vote was basically split down party lines, with Senator Rand Paul of Kentucky the only Republican to vote against it. Both parties are now sounding quite pessimistic about another round of stimulus, something that the markets had priced in a while ago. Reports suggest the White House is exploring ways of adding stimulus via executive orders.

Weekly jobless claims yesterday were worrisome.  Even though regular initial claims have been stabilizing around 884k, PUA initial claims have risen four straight weeks to 889k, the highest since the week ending July 24. Adding regular and PUA initial claims shows nearly 2 mln are newly filing for unemployment and that’s not so good. Similarly, regular continuing claims have stabilized around 13 mln but PUA continuing claims have risen sharply to almost 15 mln, the highest ever. The total of the two is approaching 28 mln and also points to trouble. When all is said and done, the data suggest the labor market is now hemorrhaging, not healing. It’s worth noting that the enhanced unemployment benefits previously done by executive order in early August are running out soon.

The US 30-year auction went slightly better than the 10-year did. In the $23 bln sale, the bid to cover ratio rose to 2.31 from 2.14 last month, but the high yield still rose to 1.473% from 1.406% last month.  Indirect bidders were awarded 62.6% vs. 59.8% last month, suggesting foreign demand was stronger than it was for the 10-year. This required primary deals to take only 21.3% of the paper sold vs. 28.3% last month.

The main US data report today is August CPI. Headline expected to rise a couple ticks to 1.2% y/y and core is expected to remain steady at 1.6% y/y. Yesterday, August PPI came in slightly higher than expected, with headline at -0.2% y/y vs. -0.3% expected and core at 0.6% y/y vs. 0.3% y/y expected. As such, there are slight upside risks to today’s CPI readings.

The August budget statement today will be of interest. Consensus sees a deficit of -$235 bln. If so, this would push the 12-month total up to -$2.96 trln and just shy of the June record of -$2.982 trln. The Congressional Budget Office warned last week that the deficit will rise to a record -$3.3 trln in FY2020 ending this month. The CBO also said the debt to GDP ratio is likely to rise above 100% in FY2021 and will continue climbing to 109% in FY2030.



The European Central Bank delivered no surprises yesterday. All policy settings and forward guidance were left unchanged, as expected. New macro forecasts were released, with 2020 GDP at -8.0% vs. -8.7% previously, 2021 GDP at 5.0% vs. 5.2% previously, and 2022 GDP at 3.2% vs. 3.3% previously. These very small tweaks suggest that the ECB’s baseline scenario is unfolding, not the severe one (-12% this year) and that’s a good thing.

The strong euro is not yet a concern. Or is it? Madame Lagarde said the ECB discussed it but agreed that there is no need to overreact to its gains. She added that the bank does not target exchange rates but will “carefully assess” the impact on inflation. On the other hand, ECB Chief Economist Lane today repeated his warnings from last week that the strong euro has dampened the eurozone inflation outlook. He predicted that inflation will remain negative for the rest of the year, adding “It should be abundantly clear that there is no room for complacency.” In addition, Bank of France Governor Francois Villeroy de Galhau said that the exchange rate “does matter for inflation and monetary policy” and will have to be monitored.

Given these mixed signals, it’s clear that we must wait for more concrete signals about the path of ECB monetary policy, and whether more easing is warranted. While we think that more stimulus could be seen by year-end, the needle is gradually moving towards less need for more accommodation, hence a near-term tailwind for the euro. Spain July IP surged 9.3% m/m vs. 3.6% expected. Yesterday, France reported a 3.8% m/m gain vs. 5.0% expected and Italy reported a 7.4% m/m gain vs. 3.5% m/m expected, while Germany reported a weaker than expected 1.2% gain Monday.  Full eurozone IP will be reported September 14.  Germany and France are by far the largest economies in the eurozone and so we see some slight downside risks to the headline reading then.

EU-UK tensions remain high. The EU gave the UK until the end of this month to amend its so-called Internal Market Bill. The two sides held emergency talks in London yesterday even as the EU is considering legal action against the UK. The EU warned that “Violating the terms of the Withdrawal Agreement would break international law, undermine trust and put at risk the ongoing future relationship negotiations.”  However, Johnson’s government seems steadfast about keeping the bill as is even after the EU gave the UK a 3-month deadline to scrap the bill or face legal action.

While we still think much of this is typical brinkmanship, sterling continues to feel the pain. Cable traded today at the lowest level since July 24 near $1.2765 and the 200-day moving average near $1.2740 is coming up fast. That area coincides with the 62% retracement objective of the June-September rally and a break below would target the June 29 low near $1.2250. As we have previously noted, the technical outlook for short GBP/USD trades has been largely cleared after the prolonged period of dollar weakness. This has also led to a considerable divergence in the FTSE 100 with domestic stocks underperforming export-oriented ones by a wide margin. Elsewhere, the EUR/GBP cross is trading at the highest level since March and is on track to test the March 19 high near .95.

The UK economy staged a solid bounce in July, but we see tougher times ahead. Monthly GDP came in at 6.6% m/m, pretty much as expected, while IP rose 5.2% m/m vs. 4.1% expected. Construction output posted a big upside surprise by rising 17.6% m/m vs. 10.0% expected. The only downside surprise was services, which rose 6.1% m/m vs. 7.0% expected. Generous government stimulus programs are helping support the recovery and consumer spending, but their effect will start to wind down this fall. The same goes to bounce in the housing sector, which has been supported by temporary programs. Bank of England next meets September 17 and no change in policy is expected. The bank will release its updated macro forecasts at the November 5 meeting, which may provide the opportunity to set the table for another expansion of its QE program before year-end.



There are mixed signals about a consumption tax hike in Japan. Yoshihide Suga initially said a hike was inevitable, but later backtracked and said there was no need for one over the next ten years. Suga said “Abe once said the sales tax doesn’t need to be raised for about next 10 years. My thinking is the same.” There have been called to roll back the last increase from October, which was clearly ill-advised, but Suga has indicated this won’t happen. Suga is widely expected to become Prime Minister after the LDP leadership vote next week.

Japan and the UK have agreed in principle to a free trade agreement. The UK said that 99% of its exports to Japan will be tariff-free under the deal, boosting annual trade between the two by GBP15.2 bln. This is forecast to boost the UK economy by 0.07% per annum over the next 15 years. While this doesn’t sound like much, the deal itself is good news for the UK as it struggles to strike deals with the EU and the US.

China’s credit figures for August indicate that the recovery is likely to continue at a strong pace.  Aggregate financing grew by CNY3.58 trln, about double last month’s figure. The upside surprise came in part due to a large volume of government issuance (CNY 1.38 trln), on top of new loans at CNY1.28 trln. The main take away here is that the strong credit increase implies a diminished need for PBOC easing, though we wouldn’t yet rule it out.