Yen and Dollar Firm, Risk Off Continues

Stacks of dollar bills propped up to form a financial maze marc

  • The risk off sentiment continues
  • The UK political backdrop remains unclear
  • Sweden’s Riksbank left policy steady, as expected
  • EM is back under pressure

The dollar is firmer against the majors as risk off sentiment intensifies. The yen is outperforming while sterling is underperforming. EM currencies are mostly weaker. MYR and CNY are outperforming while KRW and ZAR are underperforming. MSCI Asia Pacific was down 1%, with the Nikkei falling nearly 2%. MSCI EM is down 1.3%, despite Chinese markets being marginally higher. Euro Stoxx 600 is down 1.2% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is down 4 bp at 1.33%. Commodity prices are mostly lower, with oil down 0.5%, copper down nearly 2%, and gold up over 1% to a new cycle high.

The risk off sentiment continues.  Sterling took another leg lower after the break of $1.30, trading just below $1.28 before bouncing a bit.  The euro is softening but continues to outperform sterling.  As such, the EUR/GBP cross is moving higher, breaking .8600 before falling back a bit.

The yen is bid, with dollar/yen making a new low for this move near 100.40.  The post-Brexit low from last week near 99 is drawing close.  Yet despite the gains in the yen, there did not appear to be any verbal intervention by Japanese officials.  On the margins, this may be emboldening some participants, but there can be no doubt that officials are frustrated by the yen’s strength.

There’s not much new news.  However, the aftershocks of the Brexit vote continue to be felt.  Markets were spooked by news this week of pressures in the UK property market, as several asset managers froze withdrawals from property funds after a spike in redemptions was seen.  Another asset manager today said it halted plans to lease new offices in London due to the Brexit vote, as it appears that stress on the UK property market is just beginning.

The UK political backdrop remains unclear.  However, there was one small step towards clarity Tuesday.  In the first round vote for Tory leadership, Theresa May won handily with 165 votes.  She was followed by Andrea Leadsom with 66, Michael Gove with 44, Stephen Crabb with 34, and Liam Fox with 16.  Under the rule, Fox has now been eliminated.  The second round of voting takes place Thursday and continues until there are only two candidates to be presented to Tory party members for a final vote.

The UK statistics office said July inflation data to be published on August 16 will be the first to truly reflect the impact of the Brexit vote.  It noted that earlier data points will cover some weeks in June, which would largely capture the pre-referendum period.  BOE Governor Carney didn’t waste any time in acting this week, though the BOE is not due to release updated growth and inflation forecasts until August 4.

Germany reported May factory orders, which were flat vs. 1.0% m/m expected.  Elsewhere, Spain reported May IP at -0.5% m/m vs. flat expected.  ECB President Draghi spoke earlier in Frankfurt, and will be followed later today by Nouy.  The ECB next meets on July 21.  Despite growing notions that the ECB will have to add more stimulus because of Brexit, this meeting is simply too soon.  However, Draghi could start laying out the case for an eventual move in Q4.

Sweden’s Riksbank left policy steady, as expected.  However, it did push back plans to hike rates, pushing the expected timing out to H2 2017 from mid-2017 previously.  It also expects rates to remain negative through mid-2018.  The central bank said the impact on Sweden from Brexit was difficult to assess, but added that it should be “relatively limited.”  Lastly, the Riksbank lowered its 2017 growth and inflation forecasts.      

During the North American session, the US reports weekly mortgage applications, May trade, and ISM non-manufacturing PMI.  The Fed also releases minutes from its June 15 meeting.  These have been rendered moot by the Brexit developments, but could shed some more light on just how much it might impact Fed policy going forward.  Canada reports May trade as well.

The FOMC minutes tend to obscure the signal that emanates from the Fed’s leadership with a cacophony of voices.  Dudley’s comments yesterday underscore the cautiousness of the Fed.  The heightened sense of risk reinforces the idea that Fed is on hold.  Governor Tarullo speaks today before the FOMC minutes on regulation and monetary policy.

EM is back under pressure.  We have remained consistently negative on EM in the wake of the Brexit vote.  Uncertainty is running high, and when investors see uncertainty, they dump risk.  The worst EM performers since June 23 are PLN, HUF, MXN, ARS, and ZAR.  BRL has held up surprisingly well, but it has been unable to escape the generalized EM selling.

Banxico hiked by a larger than expected 50 bp and MXN is still taking it on the chin.  What next?  We don’t think another rate hike will be seen intra-meeting, with the next meeting scheduled for August 11.  Between fiscal and monetary tightening already seen, we think it would be hard to justify more tightening now.  An extraordinary FX intervention is likely to be the next line of defense, though we may not see this within the current generalized risk off trading environment.  Again, we question why Banxico opened up what seems to be a Pandora’s Box in its interest rate defense of the peso.

National Bank of Poland kept rates steady at 1.5%, as expected.  The central bank has been on hold at 1.50% since its last 50 bp cut in March 2015.  With new central bank chief Glapinski at the helm, we think the bank will ease in H2 if the outlook worsens.  Indeed, some MPC members are already starting to talk of easing after coming aboard spouting hawkish views.