Tough Times for the US Dollar

The US dollar had an awful July, with the USD index dropping by around 5% over the month, its worst monthly performance in 10 years. A range of factors can be cited for USD weakness including an asset allocation shift to assets outside of the US, worsening news on US Covid cases over recent weeks, improved risk appetite, US election concerns, lower real yields and fiscal cliff worries, among other factors.  Gold has been a particularly strong beneficiary of the malaise in the USD and declining real yield yields.  The Fed’s pledge to keep on aggressively supporting the economy and likely strengthening of forward guidance in the months ahead suggest that any increase in US interest rates could be years off.

It is still difficult to see the recent weakness in the USD resulting in a deterioration in its dominant reserve currency status though the longer the factors noted above remain in place, the bigger the danger to longer term confidence in the USD. As a reminder of such risks Fitch ratings downgraded US AAA credit rating to a negative outlook.  I do not expect markets and the USD to be impacted by the move, but it does highlight a worsening in US fundamentals.  While other currencies are still a long away from displacing the USD dominance in FX reserves, financial flows, FX trading and trade, the longer term risks to the USD are clear.

That said, the USD caught a bid at the end of last week resulting in a sharp retreat in the euro (EUR) from heavily overbought technical levels.  It is unlikely to be a coincide that this occurred as US Covid cases showed signs of peaking while cases in many parts of Europe began to accelerate, resulting in delays to opening up or renewed tightening of social distancing measures there.  US stocks have also continued to perform well, despite much discussion of a rotation to value stocks.  Solid earnings from US tech heavyweights solidified their position as leaders of the pack.  It is too early to say that this is the beginning of a USD turnaround, but the currency is heavily oversold in terms of positioning and technicals, which point to room for some respite.

Turning to the week ahead attention will be on July global Purchasing Managers Indices (PMI) data beginning with China’s private sector Caixin PMI (consensus 51.1), and the US ISM survey (consensus 53.6) tomorrow.  Central bank decisions include the Reserve Bank of Australia (Tue), Bank of England (Thu), Reserve Bank of India (Thu) and Bank of Thailand (Wed).  No change is likely from the RBA, BoE and BoT, but expect a 25bp cut from RBI.  At the end of the week two pieces of data will take precedence; US July jobs data and China July trade data.  US-China tensions will come under further scrutiny after President Trump vowed to ban TikTok in the US while pouring cold water on a sale to a third party.

 

Nervousness Creeping Back – US dollar firmer

Last week ended on a sour note as concerns over second round virus cases intensified; Apple’s decision to close some US stores in states where cases are escalating added to such concerns. This overshadowed earlier news that China would maintain its commitment to buying US agricultural goods.  Although on the whole, equity markets had a positive week there is no doubt that nervousness is creeping back into the market psyche.  Indeed it is notable that the VIX equity volatility “fear gauge” ticked back up and is still at levels higher than seen over most of May.

Economic recovery is continuing, as reflected in less negative data globally, but hopes of a “V” shape recovery continue to look unrealistic.  In this respect the battle between fundamentals and liquidity continues to rage.  Economic data has clearly turned around, but the pace of improvement is proving gradual.  For example, last week’s US jobless claims data continued to trend lower, but at a slower pace than hoped for.  A second round of virus cases in several US states including Florida, Arizona and the Carolinas also suggest that while renewed lockdowns are unlikely, a return to normality will be a very slow process, with social distancing measures likely to remain in place.  Geopolitical tensions add another layer of tension for markets.  Whether its tensions between US/China, North/South Korea, India/China or the many other hot spots globally, geopolitical risks to markets are rising.

The USD has benefitted from increased market nervousness, and from US data outperformance, with US data surprises (according to the Citi economic surprise index) at around the highest on record.  JPY has bucked the trend amid higher risk aversion as it has regained some of its safe haven status. GBP was badly beaten last week selling off from technically overbought levels, amid fresh economic concerns and a dawning reality that a Brexit trade deal with the EU may be unreachable by year end.  EUR looks as though it is increasingly joining the club on its way down. Asian currencies with the highest sensitivities to USD gyrations such as KRW are most vulnerable to further USD upside in Asia.

Data highlights this week include the May US PCE Report (Fri) which is likely to reveal a bounce in personal spending, Eurozone flash June purchasing managers indices (PMIs) (Tue) which are likely to record broad increases, European Central Bank meeting minutes (Thu), which are likely to reflect a dovish stance, and several central bank decisions including Hungary (Tue), Turkey (Thu), New Zealand (Wed),  Thailand (Wed), Philippines (Thu).   The room for central banks to ease policy is reducing but Turkey, Philippines and Mexico are likely to cut policy rates this week.

 

 

Coronavirus – The Hit To China and Asia

Coronavirus fears have become the dominant the driver of markets, threatening Chinese and Asian growth and fueling a rise in market volatility.  Global equities have largely bounced back since the initial shock waves, but vulnerability remains as the virus continues to spread (latest count 40,514 confirmed, 910 deaths) and the number of cases continues to rise.  China helped sentiment by injecting substantial liquidity into its markets (CNY 150bn in liquidity via 7-day and 14-day reverse repos, while cutting the rate on both by 10bp) but the economic impact continues to deepen.

Today is important for China’s industry.  Many companies open up after a prolonged Lunar New Year holiday though many are likely to remain closed.  The Financial Times reports that many are extending further, with for example Alibaba and Meituan extending to Feb 16 at the earliest.  Foxconn is reportedly not going to resume iPhone production in Zhengzhou, while some regions have told employers in hard hit cities to extend by a week or two.  This suggests that the economic hit is going to be harder in Q1 and for the full year.

The extent of economic damage is clearly not easy to gauge at this stage. What we know is that the quarantine measures, travel restrictions and business shutdowns have been extensive and while these may limit the spread of the virus, the immediate economic impact may be significant. While transport and retail sectors have fared badly, output/production is increasingly being affected. This may result in a more severe impact than SARS, at least in the current quarter (potentially dropping to around 4-4.5% y/y or lower, from 6% y/y in Q4 2019).

China’s economy is far larger and more integrated into global supply chains than it was during SARS in 2003, suggesting that the global impact could be deeper this time, especially if the economic damage widens from services to production within China. Worryingly, China’s economy is also in a more fragile state than it was in 2003, with growth already on track to slow this year (as compared to 10% GDP growth in 2003 and acceleration in the years after).

This does not bode well for Asia.  Asia will be impacted via supply chains, tourism and oil prices.   The first will be particularly negative for manufacturers in the region, that are exposed to China’s supply chains, with Korea, Japan and Taiwan relatively more exposed. Weakness in tourism will likely  be more negative  for Hong Kong, Thailand and Singapore.  Growth worries have pressured oil prices lower and this may be a silver lining, especially for big oil importers such as India.

China Data Fuels A Good Start To The Week

Better than expected outcomes for China’s manufacturing purchasing managers indices (PMIs) in November, with the official PMI moving back above 50 into expansion territory and the Caixin PMI also surprising on the upside gave markets some fuel for a positive start to the week.   The data suggest that China’s manufacturing sector has found some respite, but the bounce may have been due to temporary factors, rather than a sustainable improvement in manufacturing conditions.  Indeed much going forward will depend on the outcome of US-China trade talks, initially on whether a phase 1 deal can be agreed upon any time soon.

News on the trade war front shows little sign of improvement at this stage, with reports that a US-China trade deal is now “stalled” due to the Hong Kong legislation passed by President Trump last week as well as reports that China wants a roll back in previous tariffs before any deal can be signed.  Nonetheless, while a ‘Phase 1’ trade deal by year end is increasingly moving out of the picture, markets appear to be sanguine about it, with risk assets shrugging off trade doubts for now.  Whether the good mood can continue will depend on a slate of data releases over the days ahead.

Following China’s PMIs, the US November ISM manufacturing survey will be released later today.  US manufacturing sentiment has come under growing pressure even as other sectors of the economy have shown resilience.  Another below 50 (contractionary) outcome is likely.  The other key release in the US this week is the November jobs report, for which the consensus is looking for a 188k increase in jobs, unemployment rate remaining at 3.6% and average earnings rising by 0.3% m/m. Such an outcome will be greeted positively by markets, likely extending the positive drum beat for equities and risk assets into next week.

There are also several central bank decisions worth highlighting this week including in Australia, Canada and India.  Both the Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are likely to keep monetary policy unchanged, while the Reserve Bank of India (RBI) is likely to cut its policy rate by 25bps to combat a worsening growth outlook.  Indeed, Q3 GDP data released last week revealed the sixth sequential weakening in India’s growth rate, with growth coming in at a relatively weak 4.5% y/y. Despite a recent food price induced spike in inflation the RBI is likely to focus on the weaker growth trajectory in cutting rates.

A Host Of Global Risks

Last week was a tumultuous one to say the least.  It’s been a long time since so many risk factors have come together at the same time.  The list is a long one and includes the escalation of the US-China trade war, which last week saw President Trump announce further tariffs on the remaining $300bn of Chinese exports to the US that do not already have tariffs levied on them, a break of USDCNY 7.00 and the US officially naming China as a currency manipulator.

The list of risk factors afflicting sentiment also includes intensifying Japan-Korea trade tensions, growing potential for a no-deal Brexit, demonstrations in Hong Kong, risks of a fresh election in Italy, growing fears of another Argentina default, ongoing tensions with Iran and escalating tensions between India and Pakistan over Kashmir.

All of this is taking place against the background of weakening global growth, with officials globally cutting their growth forecasts and sharply lower yields in G10 bond markets.  The latest country to miss its growth estimates is Singapore, a highly trade driven economy and bellwether of global trade, which today slashed its GDP forecasts.

Central banks are reacting by easing policy.  Last week, the New Zealand’s RBNZ, cut its policy rate by a bigger than expected 50 basis points, India cut its policy rate by a bigger than expected 35 basis points and Thailand surprisingly cutting by 25 basis points.  More rate cuts/policy easing is in the pipeline globally in the weeks and months ahead, with all eyes on the next moves by the Fed.  Moving into focus in this respect will be the Jackson Hole central bankers’ symposium on 22/23 August and Fed FOMC minutes on 21 August.

After the abrupt and sharp depreciation in China’s currency CNY, last week and break of USDCNY 7.00 there is evidence that China wants to control/slow the pace of depreciation to avoid a repeat, even as the overall path of the currency remains a weaker one. Firstly, CNY fixings have been generally stronger than expected over recent days and secondly, the spread between CNY and CNH has widened sharply, with the former stronger than the latter by a wider margin than usual.  Thirdly, comments from Chinese officials suggest that they are no keen on sharp pace of depreciation.

Markets will remain on tenterhooks given all the factors above and it finally seems that equity markets are succumbing to pressure, with stocks broadly lower over the last month, even as gains for the year remain relatively healthy.  The US dollar has remained a beneficiary of higher risk aversion though safe havens including Japanese yen and Swiss Franc are the main gainers in line with the move into safe assets globally.  Unfortunately there is little chance of any turnaround anytime soon given the potential for any one or more of the above risk factors to worsen.

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