Dollar Continues to Soften Ahead of the Weekend

February 19, 2021

The global increase in longer-dated yields continues; US surveys for February will continue to roll out; Canada reports December retail sales
Eurozone preliminary PMI for February came in mixed but more positive on balance; the eurozone economy will continue to underperform in Q1 from the poorly run vaccine rollout; sterling traded above $1.40 for the first time since mid-2018; UK retail sales for January released today were much worse than expected; preliminary February PMI readings suggest the bounce back may already be under way
Russia central bank can’t rule out a rate hike this year; Japan reported preliminary February PMI readings and January national CPI; Australia reported softer preliminary February PMI readings and January retail sales; China might be taking one more step towards opening its capital market by allowing greater outbound investment

The dollar continues to soften ahead of the weekend. DXY is down for the second straight day today and is nearing this week’s low near 90.118. A clean break below 90.123 would set up a test of the January near 89.209. The euro is on track to test this week’s high near $1.2170, found support around the $1.2035 area but remains heavy, while sterling is trading above $1.40 for the first time since 2018 (see below). USD/JPY is trading back below 105.50 and feels heavy. A break below 105.10 would set up a test of the February 10 low near 104.40. We are increasingly confident that the dollar can carve out a bottom in Q1 as the vaccination rollout continues and the economy recovers. However, the recent volatile price action suggests its recovery path won’t be a straight line.

AMERICAS

The global increase in longer-dated yields continues. US 10-year yields reached 1.30% for the first time since February last year. This is comparable only to yields in Australia and New Zealand, both well over 1.4%. Interestingly, UK yields (rising with vaccine optimism) are now at the same level as those in Italy (falling with positive political developments), both around 0.64%. The moves higher still seem to be anchored on a growth rebound and a still manageable inflation pick-up, but markets (including us) are getting concerned about a Covid-related taper-tantrum event on the horizon. This would have huge implications to the trajectory of the dollar and risk in EM assets.

US surveys for February will continue to roll out. Markit reports preliminary February PMI readings, with manufacturing expected at 58.8 vs. 59.2 in January and services expected at 58.0 vs. 58.3 in January. So far this week, Empire manufacturing survey came in at 12.1 vs. 6.0 expected and 3.5 in January, while Philly Fed business outlook survey came in at 23.1 vs. 20.0 expected and 26.5 in January. These are the first snapshots for February and will help set the tone for other data to come. January existing home sales (-2.4% m/m expected) will also be reported, while Barkin and Rosengren speak.

Canada reports December retail sales. Headline sales are expected to fall -2.6% m/m vs. 1.3% in November, while sales ex-auto are expected to fall -2.4% m/m vs. 2.1% in November. For now, the Bank of Canada is on hold while fiscal policy carries the load in 2021. Next policy meeting is March 10 and no change is expected then. The Loonie has been benefitting from higher oil prices and general USD weakness and so USD/CAD is back at the cycle lows near 1.26. Break below 1.26 would set up a test of the April 2018 low near 1.2530. After that, there are no bog targets until the February 2018 low near 1.2250.

EUROPE/MIDDLE EAST/AFRICA

Eurozone preliminary PMI for February came in mixed but more positive on balance. The manufacturing-services wedge continues to widen, however, with the former rising to 57.7 from 54.8 in January and the latter dropping slightly to 44.7 from 45.4 in January. Overall, the region’s composite reading increased to 48.1 from 47.8 in January. The same pattern can be seen in Germany, with manufacturing PMI rising to 60.6 from 57.1 in January and services dropping slightly to 45.9 from 46.7 in January, boosting the composite to 51.3 from 50.8 in January. France also saw a similar dynamic but saw its composite PMI fall sharply to 45.2 from 47.7 in January.

The eurozone economy will continue to underperform in Q1 from the poorly run vaccine rollout. Next European Central Bank decision is March 19. New macro forecasts will be released then and will likely be marked down from December. Most believe the ECB is done adding stimulus but we are not yet convinced. The account of the January ECB meeting were a bit more downbeat than what Madame Lagarde let on at her press conference, as “It was argued that the fast rebound in growth foreseen in the December staff projections might be too optimistic, with growth in the second quarter of 2021 possibility at risk from extended lockdowns.”

Sterling traded above $1.40 for the first time since mid-2018. It’s the top performing currency against the dollar, up 2.4% YTD and outperforming the euro at -0.6% YTD. The trend higher has been seen for several months now, through the Brexit discussion finale last year and then gaining additional momentum with the successful vaccine rollout. We also assume that investors have largely priced out the risk of negative rates in the UK (as we had expected), even though the BOE insists on leaving that door open.

UK retail sales for January released today were much worse than expected. Headline sales sank -8.2% m/m vs. -3.0% m/m and a revised 0.4% (was 0.3%) in December, while sales ex-auto fuel fared even worse and fell -8.8% m/m vs. -2.1% expected and 0.4% in December. Consumption will be crushed by the latest lockdown but should revert in Q2 with extra household savings and pent-up demand. UK real sector data have not been too encouraging of late but should start to improve when the impact of the vaccines kicks in.

Indeed, preliminary February PMI readings suggest the bounce back may already be under way. Headline manufacturing PMI rose to 54.9 vs. 54.1 expected and 54.1 in January, services PMI jumped to 49.7 vs. 42.0 expected and 39.5 in January, and composite PMI surged to 49.8 vs. 42.6 expected and 41.2 in December. UK CBI also released results of its February industrial trends survey, with total orders coming in at -24 vs. -35 expected and -38 in January.

Russia central bank Governor Nabiullina said she can’t rule out a rate hike this year. Last week, the bank left rates unchanged at 4.25% and Nabiullina said then that potential for further easing has been exhausted. However, she added that it’s too early to speak about the timing for a return to neutral policy and so we looked for an extended period of steady rates ahead. Well, that seems to have changed now. The bank releases its quarterly monetary policy report tomorrow and will be scoured for more clues.

ASIA

Japan reported preliminary February PMI readings and January national CPI. Manufacturing PMI came in at 50.6 vs. 49.8 in January, services PMI came in at 45.8 vs. 46.1 in January, and composite PMI came in at 47.6 vs. 47.1 in January. Elsewhere, headline CPI came in at -0.6% y/y vs. -0.7% expected and -1.2% in December, while core (ex-fresh food) came in as expected at -0.6% y/y vs. -1.0% in December. Recent real sector data suggest the economy is not suffering too much from the lockdowns, but is slowing nonetheless even as deflationary pressures remain persistent. The government cut its assessment of the economy for the first time in ten months. In its monthly report for February, the Cabinet Office still described overall conditions as improving from a severely low base, but said consumer spending was weakening again. While monetary policy is on hold, we fully expect another round of fiscal stimulus later this year. Next Bank of Japan policy meeting is March 18-19 and no change is expected then.

Australia reported softer preliminary February PMI readings and January retail sales. Manufacturing PMI came in at 56.6 vs. 57.2 in January, services PMI came in at 54.1 vs. 55.6 in January, and composite PMI came in at 54.4 vs. 55.9 in January. Elsewhere, sales rose only 0.6% m/m vs. 2.0% expected and -4.1% in December. A brief lockdown in the state of Queensland was the apparent culprit and so sales should pick up this month. For now, the RBA is on hold as the nation continues to make good headway containing the virus. Next RBA policy meeting is March 2 and no change is expected then. AUD has broken above the January high near .7820 to trade at the highest level since April 2018, setting up a test of the January 2018 high near .8135.

China might be taking one more step towards opening its capital market by allowing greater outbound investment. Reports suggest that regulators are studying the possibility of letting domestic investors buy foreign securities with their $50k annual FX quotas. This makes sense as the country is receiving huge amounts of foreign inflows into local bound markets and the yuan has been on a steady appreciating trend. It’s also a risk of course, as outflows could pick up rapidly as local investors diversify their portfolio during times of domestic stress. If this were to happen, policymakers would not hesitate to clamp down hard on domestic outflows.

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