Dollar Continues to Gain Ahead of Jobs Data

July 02, 2021
  • We believe that the central bank divergence story will be one of the major drivers for FX in H2; US jobs data will be the highlight; other important snapshots for June point to underlying strength in the economy; Canada reports May building permits, trade, and June Markit manufacturing PMI; Fitch downgraded Colombia’s long-term foreign currency rating from investment grade (IG) to high yield (HY).
  • U.K. relations with the EU are back on a slow boil; Chancellor Sunak pretty much admitted that so-called equivalence for U.K. financial institutions is dead in the water; U.K. opposition Labour Party notched a narrow win in yesterday’s by-election
  • Polls suggest the ruling LDP will gain seats in this weekend’s municipal elections in Tokyo; Korea’s June inflation readings came in slightly below expectations

The dollar is getting more traction ahead of the jobs data. DXY is up for the eighth straight day and trading at the highest level since April 6 near 92.70. It is on track to test the March 31 high near 93.437. The euro is trading at a new low for this move near $1.1820 and is on track to test the March 31 low near $1.1705. Likewise for sterling, which is trading at a new low near $1.3735 and on track to test the April 12 low near $1.3670. Lastly, USD/JPY is making a marginal new high for this move just below the March 2020 high near 111.70. Break above would set up a test of the February 2020 high near 112.25 and the April 2019 high near 112.40.

It was a mixed last week of H1 for global equities. Nasdaq (+1.6%, based on futures) outperformed by a wide margin as the Covid delta-variant wave forces investors to consider growth in favor value positions. EM underperformed (-2.0% based on the MSCI EM ETF), weighed down by underperformance of China and Brazilian equities. European and UK equity indices are little changed at the time of writing. Earnings season will begin next week and will help determine whether this year’s rally can carry over into H2. Even though the post-pandemic landscape continues to shift, we suspect earnings will remain supportive for equity valuations.

AMERICAS

We believe that the central bank divergence story (driven by the underlying economic fundamentals) will be one of the major drivers for FX in H2. The four worst major currencies YTD are JPY, CHF, SEK, and EUR. Those also happen to have the most dovish central banks since all of them were fighting deflation before the pandemic even hit. On the other hand, the two best performers are CAD and GBP, where both central banks have started tapering. NOK comes in third as the Norges Bank has flagged a rate hike before year-end. Of course, the central bank divergence reflects economic divergence. Where does the US fit into this? We still think the Fed tapers by end-2021, putting the USD into the outperform camp. Let's hope the US data cooperates.

At the heart of the matter is that those economies that were in strong shape before the pandemic are seeing strong recoveries. This group is comprised of the U.S., U.K., Canada, Australia, New Zealand, and Norway. As a result, these central banks are removing or about to remove accommodation. On the other hand, the eurozone, Japan, Switzerland, and Sweden were all struggling with deflation before the pandemic and so their recoveries are shaping up to be more vulnerable and spottier. As a result, they are nowhere near removing accommodation. The one central bank that may need a major rethink is the BOE, as this current wave of infections risks the strong recovery story that has led to heightened BOE tightening expectations. Governor Bailey sounded much more cautious this week, which suggest that the BOE is aware of the growing risks but it’s still too early to say if there has been a material shift in its policy stance yet.

US jobs data will be the highlight. Consensus sees 720k jobs added vs. 559k in May, with the unemployment rate expected to fall two ticks to 5.6%. Average hourly earnings are expected to rise 3.6% y/y vs. 2.0% in May. By all accounts, the softer jobs numbers seen in recent months are due more to supply than demand, in which case wages will have to adjust higher to help clear the excess demand. Perhaps this is behind the expected jump in average hourly earnings. Yesterday’s weekly claims data were mixed, as initial claims of 364k were lower than expected and at a new pandemic low, while continuing claims of 3.469 mln were higher than expected. Emergency continuing claims are reported with a 2-week lag and fell slightly to 11.2 mln for the BLS survey week, also a new pandemic low. Overall, the data support the view that the labor market continues to heal, albeit slowly and unevenly. May trade data (-$71.3 bln expected) and factory orders (1.6% m/m expected) will also be reported.

Other important snapshots for June point to underlying strength in the economy. ISM manufacturing PMI yesterday came in at 60.6 vs. 61.2 in May, still very high by historical standards. Indeed, the headline number has remained above 60 for five straight months, something that was unheard of pre-pandemic. Of note, the prices paid component rose to 92.1 vs. 88.0 in May and is the highest since 1979. The employment component fell to 49.9 from 50.9 in May, which suggests job losses in this sector. Still, the services PMI is more important for the US economy and that won't be reported until next Tuesday. That headline was 64.0 in May and has remained above 60 for three straight months. The consensus sees 63.7, which would make it four straight.

Canada reports May building permits, trade, and June Markit manufacturing PMI. Due to a calendar quirk, Canada reports June jobs data next Friday, not today. A 40k gain is expected vs. a -68k drop in May. For now, the Canadian economy appears to be healing but after two straight months of weak jobs, the Bank of Canada is likely to remain on hold for now. Next policy meeting is July 14 and no change is expected then.

As expected, Fitch downgraded Colombia’s long-term foreign currency rating from investment grade (IG) to high yield (HY). Fitch cut its rating from BBB- to BB+ and in line with S&P’s move back in May, leaving Moody’s the last remaining major agency to consider Colombia IG (for now). In any case, having two agencies rating its credit HY means that the country’s external debt may now be excluded for many investors. Fitch’s decision reflects the well-known post-pandemic budget deterioration, and no prospects for improvement following the recent violent protests. Despite still supportive commodity prices, the Colombian peso is now the weakest major Latin American currency this year, down nearly 10% against the dollar. CDS prices, however, have barely budged, remaining around 135 bp, right between Brazil (165 bp) and Peru (82 bp).

EUROPE/MIDDLE EAST/AFRICA

U.K. relations with the EU are back on a slow boil. The two sides kicked the Brexit can down the road for another three months, extending the grace period for customs free movement of some meats between Britain and Northern Ireland until September 30. While the extension is welcome in that a potential trade war was averted, the two sides are no closer to compromise on the Northern Ireland protocol than they were at the start of the year.

Elsewhere, Chancellor Sunak pretty much admitted that so-called equivalence for U.K. financial institutions is dead in the water. He put a positive spin on it, saying “We now have the freedom to do things differently and better, and we intend to use it fully, but I can equally reassure you, the EU will never have cause to deny the U.K. access because of poor regulatory standards.” However, there is simply no reason why the EU should give back the competitive edge that is has gained. Of note, London edged ahead of Amsterdam as Europe’s biggest share trading hub in June, a position it has not held all year due to Brexit. However, London’s EUR8.92 bln average daily share trading in June was barely ahead of Amsterdam’s EUR8.8 bln. Back in December, the margin was much larger at EUR14.3 bln vs. EUR2.2 bln. Why would the EU give this up?

U.K. opposition Labour Party notched a narrow win in yesterday’s by-election. Labour won in Batley and Spen by 323 votes out of 13,296 counted. The seat has been held by Labour since 1997, but the Tories have been picking off seats in the so-called “Red Wall” of northern districts that Labour counts as its traditional constituencies. Labour lost Hartlepool, another former stronghold, to the Tories in May. For Johnson’s Tories, this is the second setback recently, as the Liberal Democrats shocked them by winning a special election in Chesham and Amersham last week, a seat held by the Tories since 1974. On a personal note, incoming Batley and Spen MP Kim Leadbeater is the sister of former MP Jo Cox, who was murdered by a right-wing extremist there back in 2016 ahead of the Brexit referendum.

ASIA

Polls suggest the ruling LDP will gain seats in this weekend’s municipal elections in Tokyo. A recent Nikkei survey in late June found 32% support for the LDP vs. 12% for Tokyoites First. Currently, the LDP holds only 25 of the 127 seats in the Tokyo Assembly vs. 45 for Tokyoites First. A win but be good news for Prime Minister Suga and his party ahead of fall general elections, as they have seen their support plunge during the pandemic. Indeed, the LDP lost three by-election in April. While Suga’s popularity has been creeping up as the vaccine rollout continues, we think a fiscal package over the summer remains likely, especially if the economy remains sluggish in Q3.

South Korea’s June inflation readings came in slightly below expectations. However, it is probably inconsequential for the BOK. CPI inflation declined to 2.4% y/y vs. 2.6% previously, with core unchanged at 1.5%. Headline remains decidedly above the BOK’s 2% target, but it’s likely to moderate further. We still expect the bank to tighten later this year, which has already been well-telegraphed, but more due to concerns over elevated household leverage and risks to financial stability. This seems to be well priced in markets for now, as seen by the sharp rise in the country’s shorter-dated yields. Of note, Korea stands out as basically the only major country in Asia that is likely to tighten this year.

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