Dollar Weakness Resumes as Eventful Week Begins

  • Downward pressure on the dollar has resumed this week
  • There are no US data releases or Fed speakers today; the US House returns to Washington
  • The controversial UK Internal Markets Bill is back in Parliament for further debate; the ECB debate over the strong euro is by no means settled
  • Israel re-imposed a national lockdown due to rising infection and death numbers; Moody’s downgraded Turkey a notch to B2 and kept a negative outlook
  • Chief Cabinet Secretary Yoshihide Suga won the LDP’s leadership election; Philippine central bank agreed to increase lending to the government; India reports August CPI

Downward pressure on the dollar has resumed this week.  DXY traded last Wednesday at the highest level since August 12 but could not break above the key 94.00 area. It has since trickled lower and is back near 93.00 now.  A clean break below the 92.50 area is needed to set up a test of the September 1 low near 91.746. Similarly, the euro needs to break above the $1.1910 area to set up a test of its recent high near $1.2010. We remain negative on the dollar, as Powell’s dovish message from Jackson Hole is likely to be reiterated at the FOMC meeting this week.  Weaker US data this week should also fit into the weak dollar narrative.

 

AMERICAS

There are no US data releases or Fed speakers today. Markets may be marking time until Wednesday, when August retail sales and then the FOMC decision will be seen. These two events are likely to shape the dollar’s trajectory as we move into Q2 and the direction is likely to be further down. Why? Signs are already being seen of a loss in momentum for the US economy, and a weak sale reading would simply underscore this trend. And September sales are likely to be even worse, as the enhanced unemployment benefits done by executive order are starting to run out now.

The FOMC is likely to underscore its ultra-dovish position. Policy settings are expected to remain steady but markets will be looking for more clarity and detail regarding the Fed’s new “Statement on Longer-Run Goals and Monetary Policy Strategy.” Under this new framework, the Fed will have much more discretion to allow higher inflation and tighter labor markets.  Markets will want to know what will go into the Fed’s new reaction function but we don’t think policymakers know yet themselves. The forward guidance may be tweaked slightly to reflect this new approach, though the underlying message of “lower for longer rates” will remain intact.

Regarding the Fed’s efforts to boost inflation, the US bond market is saying “show me.” Last week’s sales of 10- and 30-year debt has been digested nicely, with yields now at the low end of last week’s range. After the initial knee-jerk rise to nearly 1.6% after Powell’s Jackson Hole speech, the 30-year yield has fallen to around 1.4% now. Thankfully, no one is still talking about negative rates here in the US, but the low rate/weak growth outlook is likely to continue weighing on the greenback.

The US House returns to Washington today. Optimists might hope for rekindled stimulus talks, but recent action in the Senate belies this. Recall the Republican-led Senate last week could not get the 60 votes needed to get a vote on its $500 bln “skinny” bill. Until that number is boosted significantly, it appears the Democratic caucus is standing united in opposition. Both sides are now playing chicken. Who will blink? It will take a big dose of fear to get talks going again. Fear of a sharply weaker economy, fear of a drop in public support, and ultimately fear of election losses. It’s worth noting that Democrats are widely expected to keep the House, while polls suggest the Republicans are in danger of losing the Senate. To be continued.

 

EUROPE/MIDDLE EAST/AFRICA

The controversial UK Internal Markets Bill is back in Parliament for further debate. However negative this story can be, we think the cards have already been dealt and there is no incremental new news to be traded on. Jonson’s rhetoric aside, it’s not even clear how far they really will take it. In any case, the noise level around the issue will remain high, both externally and internally. Several notable figures, including in the Tory Party, have spoken out against the bill. Even the US House Speaker, Nancy Pelosi, has chimed in against it. MPs should vote on its second reading today, and it’s widely expected to pass despite the rebellion. But there is lot more that must be done before the bill becomes law, including several potential amendments.

Eurozone reported July IP. It came in a tick weaker than expected, rising 4.1% m/m vs. a revised 9.5% (was 9.1%) in June. Weakness in German and France was largely offset by outsized gains in Italy and Spain. Still, IP contracted -7.7% y/y vs. a revised -12.0% y/y (was -12.3%).

The ECB debate over the strong euro is by no means settled. Over the weekend, Rehn and de Guindos weighed in with Lane and expressed concerns about the exchange rate.  Indeed, Lagarde also did a bit of a walk-back and said there would be no complacency about its price stability goal.  Despite the conflicting comments, we think markets will look to buy the euro and so we expect the recent high near $1.20 to be tested and broken.

Israel re-imposed a national lockdown due to rising infection and death numbers. This is the first such move for the pandemic’s “second wave,” but other governments have also been ramping up targeted restrictions. For example, Indonesia decided to put Jakarta back in a partial lockdown and the UK government has imposed limits of 6 for social gatherings. Still, we think Israel’s national lockdown will be an outliner. We expect other government to be more surgical with restrictive measures because the trade-offs between heath and the economy are vastly different this time around. Perhaps the most important variable is the relatively small death rate, even as the infection rates rise with larger testing efforts.

Moody’s downgraded Turkey a notch to B2 and kept a negative outlook. The agency noted that “Turkey’s external vulnerabilities are increasingly likely to crystallize in a balance-of-payments crisis.”  In some ways, such a crisis would simply be the symptom of deep-seated problems in the economy , couple with unorthodox policies that serve to drive foreign investors away. Our own sovereign ratings model has Turkey at B/B2/B and so we agree with the move. Turkey still faces significant downgrade risks to its ratings from S&P and Fitch of B+ and BB-, respectively.

 

ASIA

Chief Cabinet Secretary Yoshihide Suga won the LDP’s leadership election. This suggests continuity in Japan’s post-Abe politics. We see this as a (very) mild positive, but only as much as it reduces uncertainty. The continuity outcome was very much expected, so it shouldn’t mean much for asset prices given the simulative fiscal and monetary policy will remain intact. Suga should be confirmed on Wednesday, but the next risk event will be if the LDP calls for an early general election to legitimize the new Prime Minister.

The Philippine central bank agreed to increase lending to the government, in an Indonesia-like debt financing move. The limit of central bank lending to the government was increased from 20% to 30% of average revenue. The move will help with the government’s latest spending measures equivalent to $3.4 bln, which will probably be rolled into a three-month repo and will probably be extended like the one in March was. We layout out our views on the risks to EM Central Bank independence here, arguing that this is a dangerous game. For now, however, there has been little reaction in Philippines asset prices.

India reports August CPI.  Inflation is expected to rise 6.90% y/y vs. 6.93% in July.  If so, inflation would remain above the 2-6% target range.  Earlier today, WPI came in higher than expected, rising 0.16% y/y vs. -0.31% expected and -0.58% in July. It was the first y/y rise since March and suggests upside risks for the CPI reading. The Reserve Bank of India unexpectedly left rates steady at the last meeting August 6, when consensus saw a 25 bp cut.  Next policy meeting is October 1.  A lot can happen between now and then but a resumption of the easing cycle is unlikely if price pressures continue to rise.