Mnuchin Talks Down the Dollar

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  • The dollar remains under pressure from comments from US Treasury Secretary Mnuchin
  • Japan reported its December trade balance; Eurozone reported flash manufacturing PMI at 59.6 vs. 60.3 expected
  • UK reported December strong labor market data
  • Mexico mid-January CPI is expected to rise 5.62% y/y; Brazil court rules on Lula

The dollar is broadly weaker against the majors after US comments welcoming a weaker dollar.  Aussie and yen are outperforming, while the euro and Nokkie are underperforming.  EM currencies are broadly firmer.  THB and PLN are outperforming, while RUB and TWD are underperforming.  MSCI Asia Pacific was up 0.2%, with the Nikkei falling 0.8%.  MSCI EM is flat on the day, with the Shanghai Composite rising 0.4%.  Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year US yield is up 1 bp at 2.63%.  Commodity prices are mostly higher, with WTI oil up 0.1%, copper up 1.5%, and gold up 0.7%.

The dollar remains under pressure, with this latest wave of selling brought on by comments from US Treasury Secretary Mnuchin.  Whilst in Davos, he noted that “Obviously a weaker dollar is good for us as it relates to trade and opportunities.”  While Mnuchin was only stating the obvious, Treasury Secretaries since Robert Rubin have never deviated from the strong dollar mantra.  That mantra has never really meant much, but to deviate from it suggests that US policymakers desire a weaker dollar.  Rubin started this “policy” after his predecessor Lloyd Bentsen used the exchange rate to pressure Japan into opening its markets.  Mnuchin’s comments pack an even bigger punch coming after the US trade actions announced this week.

The market responded by taking the greenback to new multi-year lows against the euro and sterling while pushing it below the JPY110 level for the first time since last September.  The comments came on the heels of US trade actions yesterday, and this has become latest element of the narrative the seeks to explain the dollar’s slide and the decoupling of the greenback from interest rates.  The euro reached a high near $1.2355 and sterling reached nearly $1.4120.  The dollar eased to almost JPY109.50.

The price action brings new option strikes into view.  There is a little more than $500 mln on a JPY109.20 strike that will be cut in NY today and another $400 mln near JPY110.80.  Tomorrow, there is roughly $2.4 bln of options struck at JPY110.00-JPY110.05 that expire.  Today, there is also an option struck at $1.23 for 640 mln euros and 1 bln euros of options struck between $1.2250 and $1.2275 that expire.

There are two broad explanatory models of currency movement that seem to be prevalent among investors.  The first focuses on the relative price of capital (interest rate differentials) and the trajectory of monetary policy.  The second focuses on external imbalances (trade and current account).  The seeming decoupling of the US dollar from the movement of interest rates has seen greater emphasis placed on the latter.  The tariffs the US has imposed on solar panels and washing machines draws attention to the deterioration of the US trade balance.

We too have noted that despite the striking improvement of the US energy trade balance, there has been notable deterioration of the non-oil balance.  Yet, it seemed that the capital flows were sufficient to offset it, and the broader current account deficit as a percentage of GDP has been fairly steady over the last few years near 2.4% of GDP.  This is less than half the size of the pre-crisis levels.

The incentives provided in the recent tax bill for companies to repatriate overseas earnings likely heralds a dramatic improvement in the US current account balance.  The lion’s share of the earnings that have been retained abroad is already in dollar-denominated investments, according to various accounts and reports.  However, when it is brought back into the US, it is picked up in the current account measure of investment income and will offset part of the trade deficit.

The sanctions that the US imposed on solar panels were slightly less than those sought by the US-based International Trade Commission.  And both the solar panel and washing machine actions were seen as narrow and limited rather than broad and disruptive.  There are other issues pending – steel, aluminum and intellectual property.  China’s response is still awaited.  It has complained, of course, but in 2011, the last time US imposed tariffs on solar panels, China retaliated against importing US-sourced polysilicon that is used to make the panels.  It is not clear if or how China will respond.

Japan reported its December trade balance earlier today.  Seasonal factors make the December surplus almost always larger than the November balance and last year was no exception.  The unadjusted trade surplus was a little more than three times the November surplus (JPY359 bln vs. JPY113.4 bln), but exports were weaker than expect and imports stronger.

Oil prices are little change as the market turns cautious ahead of the EIA report today.  Yesterday, the US API estimated that oil inventories rose 4.76 mln barrels, the first increase in 10-weeks.  The median forecast in the Bloomberg survey is for the EIA measure to fall by two million barrels.  The concern is that the higher prices, and yesterday the WTI contract for March delivery closed at its highest level since December 2014, will spur a faster increase in US output.

Eurozone reported flash manufacturing PMI at 59.6 vs. 60.3 expected.  However, the services PMI was stronger than expected at 57.6, pulling the eurozone composite reading up to 58.6 from 58.1 in December.  Germany and France both reported weaker manufacturing and stronger service PMIs, and their national composite readings came in at 58.8 and 59.7, respectively.

UK reported December strong labor market data.  The 4.3% unemployment came in at consensus, but the employment rose 102k vs. -12k expected.  Weekly earnings ex-bonuses rose 2.4% vs. 2.3% expected.  Despite the firm data, markets are not expecting the BOE to move again anytime soon.  The next policy meeting is February 8, no change is expected then.

During the North American session, the US reports December existing home sales.  Sales are expected to fall -1.9% m/m.  Markit also publishes its flash US PMI.  Manufacturing is expected at a tick lower to 55.0, while services is expected to rise to 54.3 from 53.7 in December.  Late yesterday, the US Senate voted on Powell and appointed him the next Fed chair.  There are no Fed speakers today.

Mexico mid-January CPI is expected to rise 5.62% y/y vs. 6.69% in mid-December.  The drop is due mostly to base effects from last January.  As such, we believe the central bank will remain in hawkish mode.  Next policy meeting is February 8 and another 25 bp hike to 7.5% seems likely.  Mexico then reports December trade Friday.

A Brazilian high court will rule today whether to uphold form President Lula’s 9 ½ year prison sentence.  In turn, this will determine whether Lula can run in this October’s presidential election.  The decision should be handed down before markets close tomorrow.  Note that the Bovespa and BM&F are closed Thursday for Sao Paulo’s anniversary.