Dollar Bounces to Start H2

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The beleaguered US dollar is enjoying a respite from the selling pressure that pushed it lower against all the major currencies in the first six months of 2017.   A measure of the dollar on a trade-weighted basis fell about 5% in the first half after appreciating nearly 8% in Q4 16.  

Paradoxically, the dollar’s recovery today has not been sparked by a new fundamental development but seems to be a reflection of sentiment and a cautiousness about the proximity of key chart points.  In fact, the economic data that has been reported today, which includes Caixin manufacturing PMI for China, Japan’s Tankan Survey and the eurozone’s manufacturing PMI all came in stronger than expected.   The UK manufacturing PMI was an exception and as it fell more than expected.  However, overall, the fact that the dollar is broadly higher suggests that the market may have already discounted the strengthening global macro picture.  

For the record, China’s Caixin manufacturing PMI rose to 50.4 from 49.6.  It is the strongest reading since March.  Output rose to 50.6 from 50.2.  The improvement seen in the official measure speaks to the larger businesses and exporters.  The Caixin measure says that the economic strength is also being seen in the domestic economy among smaller businesses as well.  

Japan’s Tankan Survey showed improvement across the board:  large and small manufacturers and non-manufacturers.  Of particular interest, capex plans jumped dramatically.  Large businesses intend to boost capital spending by 8% after a 0.6% increase was planned in Q1.  The median expected a 7.2% gain.  Separately, the LDP was trounced in the Tokyo election.  It may take a little time for the results to impact policy.  A cabinet reshuffle and prospects for a supplemental budget, a typical response may be forthcoming.  Finance Minister Aso is consolidating his power among LDP factions, and it is out of Aso’s faction that a rival to Abe may emerge.  

In the eurozone, the final manufacturing PMI  ticked up to 57.4 from a flash reading of 57.3 and a May reading of 57.0.  It is the highest level since April 2011.  Forward-looking new orders to 58.7 from 57.8, which is the highest since February 2011.  The country breakdown as a bit disappointing, however.  

Germany, where the flash reading had shown a decline, bounced back.  It rose to 59.6 from a 59.3 flash report and 59.5 in May.  France was revised down from its 55.0 flash report to 54.8.  In May, it stood at 53.8.  Italy eked out the slightest of gains, rising to 55.2 from 55.1, while Spain slipped to 54.7 from 55.4

The Scandi’s showed improvement.  Sweden’s manufacturing PMI jumped to 62.4 from 58.8.  The Riksbank meets on Tuesday and today’s report underscores expectations that it will adopt less dovish forward guidance like the ECB.  Norway’s manufacturing PMI rose to 55.1 from 54.2.  

It UK where the disappointment is more significant.  First, the May series was revised to 56.3 from 56.7.  Second, the June manufacturing PMI fell to 54.3.  It is the second consecutive decline and suggests that the early bounce back from Q1 weakness quickly faded as the quarter progressed.  While the service sector PMI covers much larger part of the UK economy and is due out later this week, the fact that price pressures moderated is an important reminder of why BOE policymakers ought not to be in a hurry to remove more accommodation.  Input manufacturing prices fell to their lowest level in 12 months, while output prices eased to nine-month lows.  

Although most Asia equity markets advance, the basket that makes up the MSCI Asia Pacific Index edged 0.15% lower, after shedding nearly 0.7% before the weekend.  European shares are faring better, and the Dow Jones Stoxx 600 is about 2/3 a percentage point higher, led by energy, materials, and financials.  Oil prices are trying to extend last week’s recovery.  Gains today would be the eighth consecutive session, during which the price of oil has risen almost 9% after falling more than 20%.

Asia-Pacific bonds were under pressures after the pre-weekend sell-off in the US and Europe. The BOJ did buy bonds today, but the 10-year yield edged less than half a basis point higher.  Benchmark 10-year yields are lower in Europe, especially in the periphery.   UK Gilts are an exception, and the 10-year yield is up a little more than a basis point.  US 10-year Treasury yields are also firmer, after finishing last week near 2.30%.  

US markets close early today ahead of tomorrow’s holiday.  There are several readings on the US economy that will be reported in today’s abbreviated session.  The manufacturing ISM is first.  The price and employment components may be just as important as the forward look new orders. Construction spending is expected to have recovered after a steep 1.4% drop in May.  

Perhaps the most important reading may come from the auto industry, where June sales figures will be reported.  Auto sales appear to be gradually slowing.  Auto sales have fallen in four of the first five months of the year.  Auto sales averaged 17.44 mln vehicles a month (SAAR) in 2016 and had averaged 16.97 mln over the first five months of 2017.  June auto sales are expected to slip to 16.5 mln, which would be the slowest since February 2015.  

We would not want to exaggerate the significance of the dollar’s better tone today.  The market was over-extended, and the bounce has not taken out important chart points.  The bounce was not sparked by fresh fundamental positive developments for the US.  We do think the market got ahead of itself in thinking that Draghi or Carney was signaling a near-term change in rates at last week’s ECB conference.  Sentiment is a key driver, even if not always fully appreciated, and we suspect that it will take more than a modest bounce to persuade many that the dollar’s H1 losses were too much.