US Dollar Recovery Extended

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  • The US dollar recovery that began in North American yesterday continued to in Asia and Europe
  • There is more talk that the strength of the euro could prompt a dovish tapering from the ECB next week
  • US data includes the ADP private sector employment estimate; Canada reports Q2 current account
  • South Africa reports July budget, money, and loan data; Brazil reports July consolidated government budget data

The dollar is mostly firmer against the majors, extending yesterday’s late recovery. Sterling and Aussie are outperforming, while the euro and Stockie are underperforming. EM currencies are softer. RUB and INR are outperforming, while ZAR and PLN are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.7%. MSCI EM is up 0.5%, with the Shanghai Composite falling 0.1%. Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is flat at 2.13%. Commodity prices are mixed, with Brent oil down 0.9%, copper down 0.2%, and gold up 0.1%.

The US dollar recovery that began in North American yesterday continued to in Asia and Europe. The geopolitical anxiety sparked by North Korea’s missile over Japan subsided. The US response was seen as measured and tempered. North Korea indicated that the missile test was done to protest the annual military exercises of the US, South Korea and other allies in the region. During the military exercises last year, North Korea also protested with a missile launch.

Geopolitical tensions often seem to spur a short-lived but sharp reaction in the capital markets. However, recall that the dollar was already selling off before the latest developments on the Korean peninsula. The geopolitical developments accelerated the move, and then the profit-taking was triggered. The Australian dollar was among the weakest of the major currencies yesterday, and today it is the only major not weakening against the dollar.

The Dollar Index reached 91.62 yesterday, the lowest level since early 2015. The 91.20 area corresponds to the 50% retracement of the big rally since the middle of 2014. Our constructive strategic outlook for the dollar was fundamentally anchored by the divergence theme, which we think is still intact (balance sheet and policy rates have not reached peak divergence). Our more tactical bearish stance on the dollar was, in part, based on the understanding that the dollar’s down move this year is a correction to the rally since 2014. A break of the 91.20 area would suggest the risk of a new leg down to the 6.18% retracement, which is found near 88.25.

The long dollar position was crowded at the end of the year. But now, formal surveys, some speculative positioning in the futures, anecdotal stories, and the way implied vol moves in the options market all point to the short dollar position as being overcrowded. In terms of time, we have anticipated a better fourth quarter for the dollar, but we are concerned that the looming US debt ceiling and spending authorization deadlines can weigh on the dollar first.

There is more talk that the strength of the euro could prompt a dovish tapering from the ECB next week. Tomorrow the EMU’s preliminary August CPI will be reported. Today the Spanish and German reports warn of upside risks. Spain’s CPI rose 0.2% in August for a 2.0% year-over-year pace. It was 1.7% in July, after peaking at 3.0% in February. The German states have reported firmer inflation figures, and the risk is on the upside for the national report due shortly, where the year-over-year rate is likely to rise from July’s 1.5%. It peaked at 2.2% in February.

The euro closed last week at $1.1924, according to Bloomberg. It has dipped briefly below $1.1940 today after reaching $1.2070 yesterday. The 50% retracement of its decline since 2014 is found just below $1.2170. The consensus narrative of the euro’s rally this year emphasizes the disappointment with progress on Trump’s legislative agenda and the softer US inflation data. However, the one factor that does not get its fair due, in our view, is the changed the political climate in Europe. Specifically, what signaled the euro’s move higher was the gap opening on April 24 when it became clear that the populist-nationalist wave was going to be turned back in France.

Last year, foreign investors sold roughly $100 bln of European equities. This year, European equities have been a market favorite, and roughly $30 bln has returned. Yet the equity performance has been disappointing. The Dow Jones Stoxx 600 is up about 2.4% year-to-date. The real return for foreign investors comes from the dollar’s slide. For dollar-based investors, the Dow Jones Stoxx 600 has returned 16.3% this year, compared with a 9.3% return for the S&P 500.

The Dow Jones Stoxx 600 is up about 0.4% in late morning turnover in Europe. It has recovered about half of what it lost yesterday. Real estate and industrials are leading the market higher. The utility sector is the only one lower on the day. Asian markets mostly moved higher. The regional leader was Hong Kong’s Hang Seng. It was already up 26.5% for the year before today, where it tacked on another 1.2%. Korea’s Kospi, which recovered smartly yesterday and closed near its highs, recovered another 0.3% today, though foreign investors were small net sellers.

Japan reported a 1.1% rise in July retail sales, well above the 0.3% median forecast. The Japanese consumer has recovered in recent months, and this is clearly helping to support the economy. Auto purchases have been particularly robust and rose for the 12th consecutive month on a year-over-year basis. The dollar staged a big potential key reversal against the yen. It fell sharply to the recent lows and recovered to close above the previous day’s highs. Follow-through buying lifted the greenback to nearly JPY110.20 before running out of steam. Support is seen in the JPY109.40-JPY109.50 area. There are large options expiring today struck at JPY109.50 ($825 mln) and JPY110 ($360 mln).

Sterling reached almost $1.2980 yesterday before reversing lower and settled on its lows near $1.2915. Selling brought it briefly below $1.29 in early European activity. It has since rebounded toward session highs near $1.2940. Part of the overcrowded euro trade was expressed against sterling, and sterling is recovering a bit on the cross after the poked through GBP0.9300 yesterday. Initial support is seen near GBP0.9230. There is a GBP225 mln option struck at $1.29 that expires today.

US data includes the ADP private sector employment estimate. A small increase from 178k in July is expected. Such a reading would not help fine tune expectation for the national report due out at the end of the week, but it would remove some downside risks. The US will also report an updated estimate for Q2 GDP. It may have ticked up to 2.7% from 2.6%, helped by a consumer sector that is aided by the continued improvement in jobs and wages. The US reports the Fed’s preferred inflation measure (core PCE deflator) tomorrow. The y/y rate may have slowed from 1.5% to 1.4%, which would be the lowest since the end of 2015. Such a report could weigh on the dollar through the interest rate channel.

Canada reports its Q2 current account position. The deficit likely grew. Tomorrow, Canada reports Q2 GDP. It is expected to have matched the first quarter pace of 3.7% annualized, and will likely reinforce expectations for the Bank of Canada to hike rates in October.

South Africa reported July money and loan data. M3 growth picked up to 6.8% y/y, while private sector credit growth slowed to 5.7% y/y. With the economy still sluggish, we expect SARB to continue easing. The next policy meeting is September 21, and another 25 bp cut to 6.5% seems likely then. The November 23 meeting should also see a 25 bp cut. July budget data will be released later today.

Brazil reports July consolidated government budget data, where a deficit of -BRL16.9 bln deficit is expected. The central government deficit was larger than expected at -BRL20.2 bln, which suggests upside risks to the consolidated reading. The government recently raised its 2017 and 2018 deficit targets to -BRL159 bln for both years vs. -BRL139 bln and -BRL129 bln, respectively.