Dollar Firm Even as Risk Off Impulses Ebb

July 20, 2021
  • Risk off impulses have quieted down, at least for now; U.S. stock futures are higher today after falling yesterday in sympathy with the general risk off mood; the U.S. fiscal outlook remains unclear
  • Details of the ECB asset purchases for the week ending July 16 will be reported; the U.S. placed the U.K. on the highest travel advisory alert due to spiking cases and the prevalence of the delta variant; BOE policymakers are undergoing a similar debate as the Fed
  • Japan reported June national CPI; RBA minutes were somewhat dovish; South Australia implemented further mobility restrictions; trading is thin across EM Asia with several markets closed for holiday, but the overall sentiment remains fragile; geopolitical tensions with China went up another notch after several Western countries formally accused Beijing of being behind the Microsoft Exchange hack

The dollar remains firm even as risk off impulses ebb. DXY is up for the fourth straight day and traded at the highest level since April 5 near 93.04. Further gains are expected as it moves toward a test of the March 31 high near 93.437. The euro remains heavy ahead of the ECB decision Thursday and the clean break below $1.18 sets up a test of the March 31 low near $1.1705. Sterling is also heavy and trade at a new cycle low near $1.3625. Further losses are likely as the February low near $1.3565 comes into focus. USD/JPY has recovered a bit as risk off sentiment ebbs, with support holding at the key 109.10 area.


Risk off impulses have quieted down, at least for now. Global equity markets are up on the day, while bond prices are lower. Yet the dollar remains largely flat on the day after making new cycle highs against a variety of currencies earlier today. This supports our view that the dollar smile theory is in play for the time being. That is, the dollar gains from strong U.S. data as well as during periods of risk off activity. Today, only June building permits and housing starts will be reported and are expected to rise 0.7% m/m and 1.2% m/m, respectively. 

U.S. stock futures are higher today after falling yesterday in sympathy with the general risk off mood. Yet we can't think of a better place to invest right now. Data last week show that the U.S. recovery remains robust and likely to outperform within DM. Compare and contrast with the outlooks for Japan, eurozone, and the U.K. On top of that, overseas markets aren't looking so attractive for U.S. investors in a rising dollar environment. That the dollar can continue gaining despite the plunge in UST yields tells us that it’s no longer just about relative interest rate differentials. That said, we believe fears of another crippling round of global lockdowns are overblown and that yields are likely to rise in the coming days and weeks.

The U.S. fiscal outlook remains unclear. With talks in the Senate stalled, reports suggest House Speaker Pelosi will meet today with her caucus for the first time since Democrats on the Senate Budget Committee announced their broad budget framework last week. With Schumer’s deadline tomorrow looming, Pelosi will reportedly use the occasion to gauge the appetite of her House colleagues for moving stimulus ahead. Timing is everything as the August recess approaches and we believe odds favor a deal. However, it will likely go down to the wire.


Details of the ECB asset purchases for the week ending July 16 will be reported. Net purchases were reported yesterday at EUR22.1 bln, same as the week ending July 9 and up from EUR15.7 bln for the week ending July 2. Redemptions and gross purchases will be reported today. The ECB has been aiming for net weekly purchases of around EUR20 bln since the accelerated pace began in March, but there have been a couple of outliers on both sides. That said, the large net purchases the past two weeks underscore our belief that the ECB will not risk making any premature moves that could endanger the recovery. Indeed, it is widely expected to announce further stimulus measures this Thursday. We will be sending out an ECB preview shortly. Lastly, the euro remains heavy and the bottom line is that a weaker euro is a natural by-product of a dovish ECB. The March 31 low near $1.1705 is coming into focus but we think it can go below that to test the November 2020 low near $1.1605.

The U.S. placed the U.K. on the highest travel advisory alert due to spiking cases and the prevalence of the delta variant. Americans should avoid travel to the U.K. if possible after the U.S. Centers for Disease Control and Prevention raised its travel warning to “Very High,” its highest level. It warned that the surge in cases puts even fully vaccinated travelers at risk for contracting and spreading the delta variant. Ironically, the warning came on the U.K.’s so-called “Freedom Day,” with the economy now fully reopen. Rising virus numbers and political bumbling in the UK are leading sterling to trade at new lows for this cycle near $1.3625. The break below $1.3755 yesterday sets up a potential test of the January low near $1.3450. Ahead of that is the February low near $1.3565.

Bank of England policymakers are undergoing a similar debate as the Fed. Last week’s CPI data came in higher than expected, but officials for the most part continue to frame this as a transitory spike. Yet virus numbers continue to rise even as the economy fully reopened this week. External MPC member Mann warned that “The recovery from Covid is more fragile than might appear,” and so the bank should “not be premature in terms of tightening.” Another MPC member Haskel said “In the immediate term, the risk of a pre-emptive monetary tightening curtailing the recovery continues to outweigh the risk of a temporary period of above-target inflation” and added that “For the foreseeable future, in my view, tight policy isn’t the right policy.” This stands in contrast to Deputy Governor Ramsden and MPC member Saunders, who have both hinted that they favor eliminating the final GBP50 bln of QE. Of note, lead hawk Haldane has departed the BOE and so the debate will be a lively one for the remaining eight members of the MPC. Next BOE meeting is August 5 and a dovish hold is expected.


Japan reported June national CPI. As expected, headline inflation came in at 0.2% y/y vs. -0.1% in May and core came in at 0.2% y/y vs. 0.1% in May. The BOJ delivered a dovish hold last week, as widely expected. Updated forecasts were released and the bank sees targeted core inflation at 0.6% (0.1% previously) for FY2021, 0.9% (0.8% previously) for FY2022, and steady at 1.0% for FY23. The bottom line is that even with these forecast tweaks, inflation is still seen remaining below the 2% target through FY23. As such, the BOJ continues to signal that it intends to keep policy accommodative until FY24 at least. With risk off impulses building this week, the yen is back to its old top spot as a haven. USD/JPY saw support yesterday near 109.10, which is a key retracement objective. A clean break below would set up a potential test of the April low near 107.50.

RBA minutes were somewhat dovish. At the July 6 meeting, the RBA delivered a hawkish hold by not extending its YCC policy beyond April 2024 and by tapering its weekly AUD5 bln purchases to AUD4 bln in September followed by a mid-November review of its policies. Minutes show that “Given the high degree of uncertainty about the economic outlook, members agreed that there should be flexibility to increase or reduce weekly bond purchases in the future.” Any decisions will be made “as warranted by the state of the economy at the time, rather than a commitment to a specific rate of purchases over an extended period.” It noted that the “effect of the recent virus outbreaks and the lockdowns had created additional uncertainty” but added that “experience to date had been that the economy bounced back quickly once outbreaks were contained and restrictions eased.” Next policy meeting is August 3 and no change is expected then.

South Australia implemented further mobility restrictions and now half of the country’s population is under lockdown. The region’s new rules include a 6 P.M. curfew and a 2.5 km movement restriction from a person’s home. Victoria state and Melbourne are also under lockdown. Greater Sydney is now in the fourth week of lockdown, and the risk is that the economy is impacted more than the RBA expects. Part of the problem is the slow vaccine rollout. The latest data shows that less than 30% the population have received one dose and only 11% are fully vaccinated. AUD is making new lows for the cycle near .7310 and yesterday's break below .7380 sets up a potential test of the November low near .6990.

Trading is thin across EM Asia with several markets closed for holiday, but the overall sentiment remains fragile. This is due to the combination of concerns about the delta variant, little support from the rate side (carry), and continued investor outflows from some local markets. In the Philippines, for example, the local stock exchanged recorded the 11th consecutive session of outflows, with year-to-date outflows approaching -$2 bln. Yesterday, Taiwan’s exchange recorded the largest single-day foreign investor outflow since February, worth some -$1.5 bln.

Geopolitical tensions with China went up another notch after several Western countries formally accused Beijing of being behind the Microsoft Exchange hack. Actors affiliated with the government have supposedly undertaken “malicious cyber activities.” This is an impressive act of international coordination, even if toothless for the time being, since it involved the U.K., EU, Australia, Canada, New Zealand, Japan, and NATO. Of course, China denied any involvement. There is nothing we can add to this debate aside from reaffirming the ever-widening rift between China and Western countries, which we see no chance of narrowing for the foreseeable future.

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