Dollar Mixed, EM Risks in the Spotlight

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  • Fed released minutes yesterday that showed a majority of the regional Fed banks voted for a hike in the discount rate in July
  • Germany reported details of final Q2 GDP;
  • Norway reported June unemployment and released the results of its Q3 oil investment survey
  • South Africa reported July CPI; political risk is back as the Finance Minister comes under fire
  • Mexico reports mid-August CPI; S&P cut the outlook on its BBB+ rating from stable to positive

The dollar is mixed against the majors. Kiwi and the Norwegian krone are outperforming while the euro and the Swiss franc are underperforming. EM currencies are broadly weaker. MXN and THB are outperforming while KRW and ZAR are underperforming. MSCI Asia Pacific was flat, even with the Nikkei rising 0.6%. MSCI EM is down nearly 1%, with Chinese markets falling 0.4%. Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 1 bp at 1.55%. Commodity prices are mostly lower, with oil down 1-1.5%, copper down 0.4%, and gold flat.

Fed released minutes yesterday that showed a majority of the regional Fed banks voted for a hike in the discount rate in July. Dallas and Philadelphia joined the other six that already voted for a hike. It’s worth noting that the Fed Board of Governors must approve of any change in the discount rate, so it’s more symbolic than anything else. But coming ahead of Yellen’s speech, the symbolism is hard to ignore and is fitting in with the hawkish Fed storyline. Those of the eight regional banks asking for a discount rate hike that are also voting FOMC members this year total four: Boston, Cleveland, Kansas City, and St. Louis.

During the North American session, the US reports July existing home sales. Yesterday, July new homes sales came in much stronger than expected, rising 12.4% m/m vs. an expected -2.0% drop. Today, existing sales are seen falling -1.1% m/m.

Germany reported details of final Q2 GDP. Headline GDP growth was confirmed at 0.4% q/q. Private consumption rose 0.2% as expected, capital investment fell -1.5% vs. -1.3% expected, government spending rose 0.6% vs. 0.5% expected, and exports rose 1.2% vs. 0.7% expected. So it appears that Germany continues to rely in large part on external demand for growth.

Norway reported June unemployment and released the results of its Q3 oil investment survey. The unemployment rate rose to 4.8% vs. 4.7% expected and was the highest since at least 2004. Elsewhere, Norwegian oil and gas companies now expect investment of NOK163 bln this year, down from NOK166 bln forecast in May. For 2017, the forecast fell to NOK151 bln from NOK153 bln in May. The forecast cuts come despite a rebound in oil prices in August, and underscores further headwinds for the economy.

Overnight, New Zealand reported a larger than expected July trade gap of –NZD433 mln. Both exports and imports came in weaker than expected. Earlier this week, RBNZ Governor Wheeler said that while easing is still likely, he saw no need for rapid rate cuts. With two policy meetings left this year, this suggests no move on September 22 followed by a 25 bp rate cut on November 10. While the RBNZ doesn’t target the currency, Wheeler cannot be happy with ongoing Kiwi strength.

South Africa July CPI rose 6.0% y/y vs. 6.1% expected and 6.3% in June. SARB said inflation was still too high to ease policy. It has kept rates steady since March, when it last hiked rates 25 bp to 7.0%. Inflation has been above the 3-6% target range since January. Yet the weak economy argues against further tightening, with GDP contracting -0.2% y/y in Q1. The rand will likely be the deciding factor since any sustained currency weakness could feed into higher price pressures. The next policy meeting is September 22, and no action is seen then.

Meanwhile, political risk is back in South Africa. Local press reported yesterday that Finance Minister Gordhan received a “warning statement” from the Hawks police unit. Gordhan and four former tax agency officials have been asked to appear on Thursday. The story is obviously still developing but we think the basic takeaway is that Gordhan remains under fire and that he does not have Zuma’s support to enact the needed fiscal restraint.

Mexico reports mid-August CPI, which is expected to rise 2.82% y/y vs. 2.72% in mid-July. Core inflation is seen steady at 3% y/y. On Thursday, Banco de Mexico releases its minutes. Inflation is trending higher, and so we expect the minutes to sound hawkish. While the sluggish economy is likely to keep rates on hold for the time being, much will depend on the peso.

Yesterday, S&P cut the outlook on Mexico’s BBB+ rating from stable to positive. We very surprised by this. Our own sovereign ratings model has Mexico at BBB+/Baa1/BBB+ and we so think it’s correctly rated. We did agree with Moody’s recent move to a negative outlook, as its A3 (equal to A-) was too high. Once again, S&P is the most aggressively negative on EM.

Indeed, recent developments serve as a reminder that investing in EM comes with added risks. MSCI EM is down nearly 1% today, and has fallen in 5 of the past 7 days. The global liquidity outlook remains EM-supportive (for now), but recent comments from the Fed leadership have spooked EM investors. All in all, we recommend greater caution in the coming days, and to differentiate amongst EM.