Dollar Softer as Calm Returns to the Markets

Gear Abstract Background marc (2)

  • A measure of calm has returned to global financial markets
  • The Bank of England allotted GBP3.1 bln in a special ILTR liquidity operation
  • The Brexit result has added to the fog surrounding Fed policy 
  • S&P cut its UK rating to AA with a negative outlook; Fitch did the same
  • Brazil’s central bank releases its quarterly inflation report; EM remains vulnerable

The dollar is mostly softer against the majors as a measure of calm returns to global financial markets. The Norwegian krone and the Antipodeans are outperforming while the yen and Swiss franc are underperforming. EM currencies are mostly firmer. ZAR and PLN are outperforming while CNY and INR are underperforming. MSCI Asia Pacific was flat, with the Nikkei rising 0.1%. MSCI EM is up 0.9%, with Chinese markets rising around 0.5%. Euro Stoxx 600 is up 2.4% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 4 bp at 1.48%. Commodity prices are mostly higher, with oil up 3% and copper up 2%. Gold is down over 1%. 

A measure of calm has returned to global financial markets. Yet as long as the terms and timing of Brexit are unknown, these markets remain vulnerable to renewed selling. Sterling has felt the most heat, with cable weakening nearly 4% Monday to go on top of the 8% loss on Friday. Today, however, cable is up nearly 1%.

The Bank of England allotted GBP3.1 bln in a special ILTR liquidity operation. Banks bid for GBP6.3 bln. It was the third long-term repo operation held since the Brexit referendum, as the BOE attempts to keep UK markets functioning. Demand for funding has risen, as the BOE allotted only GBP370 mln last week. BOE Governor Carney chairs a meeting today of the Financial Policy Committee, and surely he will discuss what needs to be done to maintain the safety and integrity of the UK financial system. UK bank stocks have been hit particularly hard since the referendum, though they are up nearly 5% today.

Meanwhile, Labour leader Corbyn faces a vote of confidence today within his own party, as the UK political outlook remains muddied on all sides. Betting markets suggest that Theresa May is the new favorite to become the next Tory leader.

While it will take some time to gauge the economic impact of Brexit on the UK economy, the data had already been softening ahead of the vote. Today, CBI reported softer retail sales volumes in June. Orders placed improved slightly, but remains in negative territory. What’s more important will be the Q3 data in the coming months. As it is, the short sterling market is already pricing in BOE easing this year.

The Brexit result has added to the fog surrounding Fed policy. Most had expected the Brexit vote to fail, allowing the Fed to resume hiking rates at the July 27 FOMC meeting. Instead, markets have now adjusted Fed expectations the other way, with the August Fed funds futures contract pricing in chances (albeit rather low chances) of a cut in July rather than a hike. Tonight, the Fed’s Powell speaks, and it will be hard for him not to address the Brexit vote.

S&P cut its UK rating by a full rung to AA with a negative outlook. This shouldn’t be a total surprise, but the move seems a bit aggressive given that we don’t yet know the real impact of Brexit. So, the UK has now lost its last AAA rating. Moody’s first moved it to Aa1 back in February 2013 while Fitch moved it to AA+ back in April 2013. Fitch then cut its rating by a notch to AA with negative outlook late Monday afternoon. A Moody’s downgrade seems like a lock, since its last move to Aa1 was made back in early 2013. Things now look worse, don’t they?

Brazil’s central bank releases its quarterly inflation report. This will be the first one prepared under Goldfajn, and will be very important in setting the tone for H2. We think rising price pressures and a weaker BRL could prevent a cut at the next COPOM meeting July 20. Indeed, Brazil reports June IGP-M wholesale inflation Wednesday, which is expected to accelerate to 12% y/y from 11.1% in May. Yet the real is been pretty resilient in recent days.

There’s not much we can say about EM beyond highlighting the obvious dent to risk sentiment. With UK Article 50 talks likely to stretch out for a while, this points to a protracted period of risk aversion that will likely prevent EM from getting much traction. But rather than seeing sharp violent moves in EM FX, we think we see a protracted slow bleed. Furthermore, we think that the downside risks to global growth will likely keep EM central banks in dovish mode.