Greenback Remains on the Defensive

  • Corrective forces continue to weigh on the US dollar
  • The news stream is light and largely limited to EMU money supply and lending figures
  • The ramifications of the deal announced by the US and Mexico yesterday remains the main talking point
  • Tensions in Italy are flaring up again
  • The US reports the advanced goods trade balance (small deterioration is expected)
  • Renewed lira weakness comes as no surprise

The dollar is mostly weaker against the majors as markets await fresh drivers.  Swissie and Nokkie are outperforming, while Stockie and Aussie are underperforming.  EM currencies are mostly firmer.  KRW and PHP are outperforming, while TRY and IDR are underperforming.  MSCI Asia Pacific was up 0.4%, with the Nikkei rising 0.1%.  MSCI EM is up 0.4% so far today, with the Shanghai Composite falling 0.1%.  Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a higher open.  The 10-year US yield is flat at 2.85%.  Commodity prices are mostly higher, with Brent oil up 0.7%, copper up 1.0%, and gold up 0.2%.

Corrective forces continue to weigh on the US dollar.  Sometimes the narratives drive the price action and sometimes the price action drives the narratives.  Currently the latter appears to hold sway.

The dollar’s downside correction began around the middle of the month, well before Powell’s August 24 Jackson Hole speech.  The Fed funds futures do not reflect the dovish spin many wanted to see in Powell to explain the dollar’s slide.  In fact, the odds of a September and December rate hike have edged higher over the last few sessions.

Emerging market currencies are mixed.  The yuan is slightly firmer, as is the South African rand.  The Turkish lira is under a modicum of pressure within yesterday’s ranges.  The Mexican peso is in the middle of yesterday’s range.  The MSCI Emerging Markets Index is up about 0.4%.  It is the third consecutive advance and seventh advance in the past eight sessions.

The news stream is light and largely limited to EMU money supply and lending figures.  Little to see there.  Money supply (M3) growth slowed more than expected (4.0% from 4.5% and Dow Jones survey median expectation of 4.3%).  Lending to non-financial businesses rose 4.1% in July, the same as June, which is the best since May 2009.  Lending to households was also steady at 3.0%.

The ramifications of the deal announced by the US and Mexico yesterday remains the main talking point.  President Trump made it clear that with a new North American deal in hand, or nearly so, he is not in the mood to accept China’s offer to negotiate, suggesting no relaxation in tensions anytime soon.  It also suggests that the next round of tariffs (the US puts 25% tax on $200 bln of Chinese goods and China has indicated a sliding tariff on $60 bln of US goods).

Canada has been dealt a fait accompli.  It either joins the US-Mexico agreement or trade with its largest partner returns to the CUSFTA that predates the NAFTA deal.  The new rules of origin (to 75% from 62.5%) and that 40-45% of the production must pay labor at least $16 an hour favors the US and Canada over Mexico.  Much of the US-Mexico agreement tends to incorporate the rules that had been negotiated under the Trans-Pacific Partnership that the US withdrew from in early 2017.

Canada will face pressure in some areas, including increasing the de minimis shipment order from the current $25.  Mexico agreed to $100.  Canada may have its own view of the modified sunset provision that makes it a 16-year agreement with a formal review after six years.  Canada may also not be in favor of the intellectual property rights for which Mexico agreed to more stringent rules than the TPP included.

Canada may seek assurances that it will no longer be subject to the steel and aluminum tariffs, and perhaps all future action that may be taken on national security grounds.  And in the US, there is a small window for the lame duck Congress to approve it after the mid-term elections, but now even the slightest delays mean it could fall to the next Congress.  Regardless, it will likely be grueling and all the more so if Canada is not included.

What does it mean, though, that if Canada does not agree in the coming days, that the US will levy a tariff on its autos?  Canada to does not have a domestic auto industry. Primarily US car companies that produce components in Canada.  Canada’s sells around 2 mln vehicles a year.  The US market is at least eight times larger.  Starting several years ago, a number of economists began questioning the value of this offshore production and the US traditional foreign direct investment strategy (rather than export-oriented, like Germany, China, and several East Asian and Northern European countries).  They emphasized the tax arbitrage account games that are often played. This created fertile soil for such confusion as taxing Canadian cars.  There is no such thing.  Those are primarily US parts and vehicles, and the tariff will be borne by US households.

The euro’s recovery from testing $1.13 on August 15 was extended today to $1.1700.  There is a 900 mln euro option struck there that expires today.  The trendline drawn off the high on June 14 (ECB meeting) through the July 9 and 31 comes in near $1.1690 today.  A similar trendline in the Dollar Index is found near 94.70.  The next technical targets we identify are near $1.1780 for the euro and 94.00 for the Dollar Index.

Tensions in Italy are flaring up again.  M5S leader and deputy Prime Minister Di Maio warned that Italy’s budget deficit may exceed EU targets and the country will come to market in a couple days trying to raise around 3.75 bln euros in new debt offerings.  Italian stocks and bonds are underperforming today, and the Italian ban share index is off more than 2%.  This month, the bank share index has risen in four sessions, and two of them were last week.

The Dow Jones Stoxx 600 is up fractionally (less than 0.2%) as it tries to extend the advance for a third session, which would be the longest rally in a month.  Peripheral bond yields are a little higher, while core bond yields are slightly softer.  The main exception to this generalization in Europe is the UK, where the 10-year Gilt yield is up with the periphery.  Prime Minister May’s comment that the Brexit without an agreement “is not the end of the world,” was not particularly helpful.

However, sterling is firm in the softer US dollar environment.  Cable is looking to test the recent high near $1.2935.  A move above $1.2950 targets $1.30 and a little more.  Meanwhile, sterling is at its lowest level against the euro since last September.  The euro reached a high then a little above GBP0.9300, which is the next significant technical level.

Against the yen, the dollar is consolidating the recovery from the dip below JPY110 in the middle of last week to the high at the end of the week near JPY111.50.  The dollar has been confined to about a third of a yen range today.  There are nearly $1 bln in options at JPY110.90 and JPY110.95 that are rolling-off today.

The US reports the advanced goods trade balance (small deterioration is expected).  More imports and softer consumption may translate into a rise in inventories.  House prices, Conference Board’s measure of consumer confidence, and the Richmond Fed manufacturing survey will also be reported but do not typically move the markets.  There are no Fed officials scheduled to speak.  Nor is there any Canadian economic data on tap.

While Turkish markets were closed last week, USD/TRY largely traded within a narrow 6.0-6.2 range.  With markets reopening, the pair is pushing above 6.20 to trade at the highest level since August 17.  The major retracement objectives from the August 13-16 drop come in near 6.2850, 6.4665, and 6.6480.  No one should be surprised by renewed TRY weakness.  Nothing has fundamentally changed there and so we expect USD/TRY to move higher.