Dollar Firm as Investors Await Fresh Directional Cues

new world

  • The US confirmed North Korea’s claims that its tested an intercontinental ballistic missile  
  • Caixin reported China’s service and composite PMI 
  • The service and composite PMI release is the main economic data from Europe today 
  • The slightly disappointing UK service PMI rounds out the three PMI reports and each was reported below expectations 
  • Most inflation readings out of EM recently have been on the soft side
  • National Bank of Poland is expected to keep rates steady at 1.5%; Colombia June CPI is expected to rise 4.08% y/y vs. 4.37% in May

The dollar is broadly firmer against the majors as the holiday-shortened week resumes for the US. Stockie and sterling are outperforming, while Nokkie and Kiwi are underperforming. EM currencies are broadly weaker. TWD and KRW are outperforming, while TRY and RUB are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.3%. MSCI EM is up 0.2%, with the Shanghai Composite rising 0.8%. Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open. The 10-year US yield is flat at 2.35%. Commodity prices are mostly lower, with oil down 1.4%, copper down 1.4%, and gold down 0.4%.

The US dollar is enjoying a firm tone today. Yesterday’s two weakest major currencies, the Australian dollar and Swedish krona, are the strongest currencies today little changed on the session. After a strong rebound in the greenback to start the week, it mostly consolidated yesterday.

The euro was sold briefly through $1.1320 before finding a bid, while sterling and yen are extending this week’s declines. Global equities are mixed, with modest gains in Asia and small losses in Europe. Bond yields are mostly firmer.

The US confirmed North Korea’s claims that it’s tested an intercontinental ballistic missile. The US and South Korea almost immediately announced a new joint military exercise.

The UN Security Council will meet today to discuss. Besides tightening the isolation of North Korea, it is not clear what other options are really available. Although the US has indicated that all options are on the table, there does not appear to be support for military options by South Korea, Japan, Russia, or China.

The South Korean won was little changed and the Kospi gained 0.3% to recover most of yesterday’s decline and is off slightly on the week. More broadly, the MSCI Asia Pacific Index snapped a three-day fall and rose 0.2%.

Japanese shares initially fell to near two-week lows before recovering. The Topix and Nikkei closed on session highs, almost 0.6% and 0.3% higher respectively. Japan reported a stronger service PMI (53.3 in June from 53.0 in May). The composite reading slipped to 52.9 from 53.4. Still, it average 53.0 in Q2 after 52.5 in Q1 and 52.0 in Q4 16.

The dollar is at its best level against the Japanese yen since the middle of May, as it tries to get a handhold above JPY113.50. Chart resistance is seen in the JPY113.80-JPY114.00 area. The dollar edged higher against the yen for the past two weeks. It is up a little more than 1% this week after a gain of a similar magnitude last week.

Caixin reported China’s service and composite PMI. The service reading eased to 51.6 from 52.8. The composite slipped to 51.1 from 51.5, which is the lowest since last June. The composite averaged 51.3 in Q2 after 52.3 in Q1 and 53.1 in Q4. It averaged 51.4 last year. The Shanghai Composite gained 0.75% to move above 3200 for the first time since mid-April.

Note that China’s bond-connect program went operational yesterday. Turnover was a little more than CNY6 bln yesterday. The bond-connect program complements the stock connect initiative, and improves international investors’ access to China’s financial markets.

The service and composite PMI release is the main economic data from Europe today. The eurozone service PMI was revised from the flash estimate of 54.7 to 55.4 from it is still off the May reading of 56.3, and is off for the second month. The composite PMI was also revised higher from the 55.7 flash estimate to 56.3. It was 56.8 in May. It averaged 56.6 in Q2 after 55.6 in Q1 and underpins expectations that the regional economy may have accelerated.

In terms of the country breakdown, German and French flash service reports were revised higher. Note that the French and German composite readings did slip from May. Italy’s service PMI eased to 53.6 from 55.1 and was weaker than the 54.6 median estimate in the Bloomberg survey. Still, the Q2 average composite was 55.5 after 53.9 in Q1 and 52.5 in Q4 16. Spain accelerated. The services PMI jumped to 58.3 from 57.3 and the composite rose to 57.7 from 57.2.

The inability of the euro to rally on what seems to be good news appears to be a break from the recent price action where nearly any excuse was sufficient to lift the single currency. It is consistent with our sense that the market has discounted a favorable news stream for Europe and may have gotten ahead of itself. Initial support is seen in the $1.1320 has been tested, and a break would set up a test on $1.1280. The US two-year premium over Germany has widened about six basis points this week and the 10-year premium is about three basis points wider this week.

The slightly disappointing UK service PMI rounds out the three PMI reports and each was reported below expectations. The miss was not large but the direction is notable. The services PMI eased to 53.4 from 53.8 and the composite reading eased to 53.8 from 54.3. In fairness, the Q2 composite average of 54.8 is above the 54.6 average of Q1 and last year’s average of 53.5.

This suggest that growth may not have deteriorated from the 0.2% quarter-over-quarter pace recorded in Q1. However, the quarter appears to have ended on a weak note. In June, the employment sub-index was the strongest in a little more than a year. Price data was mixed, with input prices rising and prices charged easing, warning of the risk of a profit squeeze.

Sterling has snapped an eight-day advance with a three-day fall this week. Today’s losses were marginal and may have exhausted themselves in the European morning a little below $1.29. Initial resistance is seen in the $1.2940 area.

The final US May durable goods orders and factory orders are unlikely to capture the market’s imagination. The FOMC minutes may be more interesting. Participants are looking for insight into two things. First, even though the Fed hiked, how cautious are Fed officials in the wake of disappointing economic data and the four-month softening of measured inflation. Second, observers are looking for more details about when the balance sheet operations will begin.

We see more observers coming to our view that an announcement to start not recycling the maturing issues fully will be made at the September FOMC meeting (for October start). This would likely be followed by what would be the third rate hike of the year more likely to be delivered in December (data permitting). In terms of data, this week’s employment report is the highlight and improvement is expected in the June report.

The Reserve Bank of Australia did not completely remove the downside potential, but more banks appear to be giving up the idea that it will cut rates again this year. The Australian dollar bounced from dipping below $0.7600 yesterday to a little more than $0.7630 today before running out of steam. A break of $0.7590 would target $0.7530-$0.7540 initially.

The market appears to have discounted a Bank of Canada rate hike next week. It would be more destabilizing if a rate hike at this juncture was not delivered. The US dollar is finding support against the Canadian dollar, but it needs to rise above CAD1.3020 to be anything significant.

Philippines June CPI rose 2.8% y/y vs. 3.0% expected and 3.1% in May. This is back below the 3% target for the first time since January but is still within the 2-4% target range. The central bank next meets August 10 and is expected to keep rates steady at 3.0%.

Taiwan June CPI rose 1.0% y/y vs. 0.9% expected and 0.6% in May. The central bank does not have an explicit inflation target. However, low price pressures should allow it to keep rates steady at its next quarterly policy meeting in September.

Indeed, most inflation readings out of EM recently have been on the soft side. This suggests no need to hike rates even as DM rates are rising. If the interest rate differentials continue to narrow, this would be negative for EM FX. Today, the Bank of Thailand kept rates steady at 1.5%, as expected, and lowered its inflation forecasts for 2017 and 2018.

National Bank of Poland is expected to keep rates steady at 1.5%. June CPI came in lower than expected at 1.5% y/y. This was the lowest since December, and is very close to the bottom of the 1.5-3.5% target range. Central bank officials continue to say no hikes until 2018, and the data for now supports this.

Colombia June CPI is expected to rise 4.08% y/y vs. 4.37% in May. If so, that would be the lowest since January 2015 and would be very close to the 2-4% target range. The central bank just cut rates 50 bp to 5.75% on Friday. It next meets July 21 and is expected to cut rates by another 50 bp to 5.25%.