Rally Stalls as Dollar Consolidates Recent Gains

  • US-China tensions are still rising; we retain our strong dollar call
  • FOMC minutes will be released; Canada reports March retail sales
  • Brexit headlines came roaring back yesterday; we remain bearish on sterling
  • Japan exports contracted for the fifth straight month; Korea is getting more concerned about the weak won
  • South Africa reported softer than expected April CPI; SARB on hold tomorrow

The dollar is mostly softer against the majors in consolidative trade. The Scandies are outperforming, while sterling and Kiwi are underperforming. EM currencies are mixed. RUB and ZAR are outperforming, while IDR and TRY are underperforming. MSCI Asia Pacific was up 0.1%, with the Nikkei rising 0.1%. MSCI 6EM is up 0.3% so far today, with the Shanghai Composite falling 0.5%. Euro Stoxx 600 is up 0.1% near midday, while US futures are pointing to a flat open. 10-year UST yields are flat at 2.43%, while the 3-month to 10-year spread is steady at 6 bp. Commodity prices are mostly lower, with Brent oil down 0.3%, copper down 0.6%, and gold down 0.1%.

US-China tensions are still rising. Press reports suggest the US may add several more Chinese companies to the so-called Entities List that would cut off their access to US technology. This would further inflame tensions and make a near-term trade deal even more unlikely. President Xi is talking about a new Long March, while President Trump is readying a new round of aid for US farmers hurt by China tariffs. Everyone is digging in for a long fight.

In this current environment, we retain our strong dollar call. While MSCI EM FX is stabilizing a bit, it should come under greater pressure as global trade and growth suffers. DXY continues to edge higher and traded yesterday at levels not seen since April 26, when it posted a cycle high near 98.33. With virtually every major central bank tilting more dovish, relatively high US rates should continue to boost the dollar.

FOMC minutes will be released. The Fed delivered a dovish statement at the May 1 meeting but was followed up by a much less dovish Powell press conference. As such, these minutes will take on added significance as markets try to figure out the Fed’s true message. Bullard, Williams, and Bostic speak today.

During the North American session, Canada reports March retail sales. Headline sales are expected to rise 1.2% m/m, while ex-autos are expected to rise 0.9% m/m. Data have been coming in soft lately. Even though the BOC moved to a neutral bias, markets are tilting dovish. WIRP shows low odds of a near-term cut but rising as we move into Q4. Next policy meeting is June 19, no change is expected then.

Brexit headlines came roaring back yesterday. Headlines touted a second Brexit referendum and sterling was initially bid. Yet the negative response was quick, with SNP’s Sturgeon and Labour’s Corbyn immediately making it clear that they wouldn’t support May’s latest bid. So too did the euroskeptic ERG parliamentary group.

Given that all eyes were on her and this last-ditch attempt to salvage her plan, shouldn’t May have gauged likely support? It seems amateurish, but that’s really been par for the course. She is now under even greater pressure to resign. With Boris Johnson waiting in the wings and the Brexit Party poised to win big in the European Parliamentary elections, we think May’s bungling has increased the chances of a hard Brexit.

We remain bearish on sterling.   It’s now down nine straight days against the dollar and twelve of the past thirteen to trade at levels not seen since January 4. The January 3 low near $1.2440 remains within sight. Against the euro, sterling is now down thirteen straight days to trade at levels not seen since February. After breaking above the 200-day moving average today, EUR/GBP now needs to break the .8865 area to set up a test of the January high near .9108.

UK reported softer than expected April CPI. Headline inflation was seen picking up to 2.2% y/y from 1.9% in March but instead rose 2.1%, while CPIH was seen rising 2.1% y/y vs. 1.8% in March but instead rose 2.0%. Implied yields on the short sterling strip continue to fall. The next hike has been pushed out to mid-2021 and the one after that to end-2023.

Japan exports contracted for the fifth straight month. Instead of contracting the consensus -1.6% y/y, exports instead fell -2.4%. Imports rose a stronger than expected 6.4% y/y, and so the adjusted deficit came in at -JPY111 bln. Core machine orders rose a stronger than expected 3.8% m/m. USD/JPY continues to grind higher and levels to look out for are 110.70 and 111.10.

Korean policymakers are getting more concerned about the weak won. BOK warned traders that the won has dropped too rapidly, and reports suggest officials will meet soon to discuss the “distorted” FX market. Any potential measures to support the won are likely to be mild. Rate hikes are highly unlikely give the soft economy, but some FX intervention to smooth the move is possible. For USD/KRW, the December 2016 high near 1212 is nearing and after that is the March 2016 high near 1245.

South Africa reported softer than expected April CPI. It was expected to remain steady at 4.5% y/y but instead rose 4.4%. Inflation is now below the center of the 3-6% target range. The central bank meets tomorrow and is expected to keep rates steady at 6.75%. With the economy weak, the bank would probably like to cut rates, but the vulnerable rand is likely to prevent that for now.