Dollar Rally Continues as Risk-Off Sentiment Intensifies

August 19, 2021

FOMC minutes are worth discussing; regional Fed manufacturing surveys for August will continue to roll out; weekly jobless claims data will be very important
Norges Bank kept rates steady at 0.0%, as expected
Australia reported firm July jobs data; Indonesia kept its 7-day reverse repo rate on hold at 3.50% as expected

EM assets are following the broad downdraft in risk appetite with the MSC Asia index falling below the lows of the year. As of yesterday’s, close, the MSCI Asia Pacific index was down nearly 3.5% for the year (and down further during the overnight sessions). This compares to -1.9% for the LatAm index and a whopping +17% for the Eastern Europe index. Weakness in all the regions has dragged the wider MSCI EM index to new lows for this move. At around 1237, it is the lowest since early December and break below 1234 would set up a test of the October 30 low near 1100.

The dollar is building on its recent gains as risk-off sentiment intensifies. DXY is trading at new highs for this move near 93.50. Next targets are the November 2020 high near 94.302 and the September 2020 high near 94.742. EUR has broken below $1.17 and is on track to test the November 2020 low near $1.16. Sterling is finally playing catch-up and the clean break below $1.3730 sets up a test of the July 20 low near $1.3570. Of note, AUD is trading at new lows for this cycle around .7145 and is on track to test the November 2020 low near .6990. AUD is typically the canary in a coal mine for a drop in risk appetite and so it bears watching. The growing risk-off sentiment led USD/JPY to reverse and the pair is trading back below 110.

AMERICAS

FOMC minutes are worth discussing. Minutes show that “Various participants commented that economic and financial conditions would likely warrant a reduction in coming months. Some said it was prudent to prepare for tapering “relatively soon” while a few others saw the possibility that there would be no tapering “for some time.” Furthermore, “Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year.” Several said they would change their views if the impact of the delta variant was worse than expected. We think this variety of views was pretty much expected but the dollar initially sold off as if the minutes were uber-dovish. We believe the ranks of the hawks have and will continue to grow, raising the odds of another hawkish shift in the September Dot Plots to show median lift-off expectations moving up to 2022.

Indeed, Bullard remains hawkish. Yesterday, he warned that he sees core PEC inflation remaining above 2.5% next year, and that he prefers tapering to be completed in Q1 2022. He added that Q4 2022 is “the logical place” for rate lift-off. We think Bullard's view is getting more mainstream at the FOMC. Now, it seems like it's just a matter of months separating the hawks from the doves, in terms of starting the tapering process.

Regional Fed manufacturing surveys for August will continue to roll out. Philly Fed is expected at 24.0 vs. 21.9 in July. Empire survey kicked things off Monday and came in at 18.3 vs. 28.5 expected and 43.0 in July. Overall, the U.S. manufacturing sector remains strong as virtually all the survey and PMI readings are at or near record highs. Some moderation is to be expected but that does not mean the economy is slowing sharply. IP came in strong in July, up 0.9% m/m vs. 0.5% expected and driven by continued strength in manufacturing production (1.4% m/m vs. 0.7% expected).

Weekly jobless claims data will be very important. That is because the initial claims data will be for the BLS survey week containing the 12th of the month. Continuing claims data are reported with a one-week lag and so next week’s reading will be more important. Initial claims are expected at 364k vs. 375k the previous week, while continuing claims are expected at 2.80 mln vs. 2.866 mln the previous week. Last week’s readings were both cycle lows for the pandemic and so further improvement this week would support our view that the labor market continues to heal. Of note, JOLTS job openings rose to a record 10.1 mln in June, which shows continued strength in labor demand. As such, it’s no surprise that average hourly earnings continue to move higher, hitting 4.0% y/y in July. July leading index (0.7% m/m expected) will also be reported.

EUROPE/MIDDLE EAST/AFRICA

Norges Bank kept rates steady at 0.0%, as expected. The bank noted that “The reopening of society has driven a marked rise in activity, and unemployment has fallen further. Increased activity in the Norwegian economy suggests that inflation will pick up further out.” As such, the bank affirmed its forward guidance from the June 17 meeting that it would “most likely” hike rates in September. New forecasts and an updated rate path will be released then. The June rate path saw the policy rate at 0.1% at end-2021, 0.8% at end-2022, 1.3% at end-2023, and 1.5% at end-2024. Since the June meeting, Governor Olsen has suggested that the bank could hike rates 25 bp per quarter, which was much more hawkish than its rate path would suggest. Next policy meeting is September 23, when a 25 bp hike is expected. Forward guidance then will be key.

ASIA

Australia reported firm July jobs data. A -43.1k drop in jobs was expected due to the lockdowns, but jobs rose 2.2k instead after a 29.1k rise in June. The unemployment rate fell to 4.6% vs. 5.0% expected and 4.9% in June, the lowest since December 2008. This drop is particularly important as the RBA sees wage pressures picking up when unemployment is in the low 4s. That said, further near-term labor market improvement is unlikely as the virus numbers continue to worsen, which means the lockdowns are likely to remain in place as we move into September. The RBA next meets September 7, when it begin tapering as scheduled. No change in policy is expected until mid-November, when the RBA said it would review its QE program. AUD continues to make new cycle lows near .7145, the lowest since last November and on track to test that month’s low near .6990.

Bank Indonesia kept its 7-day reverse repo rate on hold at 3.50% as expected. It’s not going anywhere soon as the bank signaled it will continue focusing on macroprudential measures to improve the transmission of the current accommodative policy stance. The bank kept its GDP forecast in the range of 3.5-4.3%, but it all depends on the infection rate and mobility restrictions going forward. According to Bloomberg, less than 11% of the population has been vaccinated so far. Bloomberg consensus sees steady rates through this year, with the first hike fully priced in by Q3 2022 and another hike by end-2022. Asset prices are down on the day, but well in line with the broad risk-off sentiment.

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