Dollar Firm as U.S. Returns from Holiday

September 07, 2021

The U.S. returns from holiday facing higher yields and a firmer dollar; markets are still digesting the jobs data and the implications for Fed policy; Brazil’s political risk remains very elevated with protests scheduled for today (Independence Day)
BOE official is sounding dovish; Germany reported mixed data
Japan reported mixed data; RBA left rates steady and commenced tapering but pushed back the next review; China’s August trade figures surprised on the upside

The dollar is getting some traction as the U.S. returns from holiday. DXY is up today for the first time after six straight down days and has recouped its post-NFP losses to trade near 92.314. The euro remains heavy after failing to make a clean break above $1.19 last Friday. Sterling is underperforming and trading below $1.38 on the back of dovish BOE comments, while USD/JPY is testing the 110 area. While we remain positive on the dollar, it may not be able to sustain these gains until the U.S. data are more supportive.

AMERICAS

The U.S. returns from holiday facing higher yields and a firmer dollar. The 10-year yield is trading near 1.36%, the highest since August 26 and on the way towards testing the July 14 high near 1.42%. The 10-year breakeven rate is holding steady and so the real yield has risen to -0.98%, the highest since mid-July. This has helped DXY recoup its post-NFP losses and then some.

Markets are still digesting the jobs data and the implications for Fed policy. The 235k NFP gain was very disappointing despite the upward revision to 1.053 mln for July. Yet it’s not entirely clear if this is a supply issue or a demand issue for the labor market. Because of this uncertainty, we have moved back the Fed’s expected tapering announcement from the September 21-22 FOMC meeting to the November 2-3 meeting. By that time, the Fed will have gotten the September jobs report. Unfortunately for the Fed, the October jobs report comes November 5, two days after the FOMC decision. There will be some debate in the market about whether the Fed will actually start tapering at the December 14-15 meeting or wait until January 25-26. Does one month really make much difference?

Brazil’s political risk remains very elevated with protests scheduled for today (Independence Day) in the country’s deepening constitutional crisis. The protests will be organized by government supporters as President Bolsonaro adopts a more confrontational stand against the Supreme Court. The recent events have led many observers to openly discuss the possibility of a “self-coup,” by which the president would rely on his support base in the military and police to impose some form of autocratic regime. This sounds far-fetched to us, but it shows the extent of political brinkmanship Bolsonaro is engaging in. Asset prices seem to agree, largely ignoring the protest risks and continuing to focus on inflation risks and the steepness of the local curve.

EUROPE/MIDDLE EAST/AFRICA

Bank of England official is sounding dovish. MPC member Saunders said that if rates do rise next year, they won’t rise by much if the economy evolves as the bank forecasts and the current inflation spike is indeed temporary. He noted that the neutral level for the policy rate has fallen significantly over the past 20 years, adding “It’s not clear we would even need to get back to neutral.” Saunders comments are particularly noteworthy as he was the lone dissent at the last policy meeting in favor of reducing QE. The short sterling strip is still pricing in lift-off by mid-2022 followed by further tightening in H2 2022. Market expectations may have to be dialed down a bit if the dovish talk out of the BOE continues. Next BOE decision is September 23 and will be closely watched.

Germany reported mixed data. IP c rose 1.0% m/m vs. 0.8% expected and a revised -1.0% (was -1.3%) in June. However, September ZEW survey came in much weaker than expected. Current situation came in at 31.9 vs. 34.0 expected and 29.3 in August, while expectations came in at 26.5 vs. 30.3 expected and 40.4 in August. Germany reported July factory orders yesterday, which jumped 3.4% m/m vs. -0.7% expected and a revised 4.6% (was 4.1%) gain in June.

ASIA

Japan reported mixed data. July real cash earnings rose 0.7% y/y vs. 0.6% and a revised -0.1% (was -0.4%) in June. However, household spending rose only 0.7% y/y vs. 2.4% expected and a revised -4.3% (was -5.1%) in June. So far in Q3, the economy has held up better than expected but the state of emergency may stretch into Q4 if the virus numbers don’t improve soon. Until the LDP leadership race has been settled, it appears that the long-awaited fiscal package will be delayed.

Reserve Bank of Australia left rates steady and commenced tapering but pushed back the next review. Some analysts were calling for a delay but we did not believe one was needed right now. Despite concerns about growth this quarter, Q2 GDP data last week showed the economy had stronger than expected momentum (0.7% q/q vs. 0.4 expected) as it entered the lockdowns in Q3. The new weekly QE pace of AUD4 bln will be maintained until at least mid-February rather than mid-November, as the bank said the extension was needed due to a delay in the economic recovery and increased uncertainty stemming from the most recent outbreak. Much will of course depend on how the virus numbers look then but we suspect the RBA will continue the tapering process in a measured manner.

China’s August trade figures surprised on the upside. Exports rose sharply by 25.6% y/y, well above the 17.3% expected, while imports came in at 33.1% y/y vs 26.9% expected. Both readings accelerated from July. The data should allay concerns about a delta variant-led drag on external demand for now, but it’s hard to imagine it won’t eventually lead to a slowdown in Q4. Exports of steel and car related items were amongst the main highlights, especially semiconductors. On the import side, oil and natural gas saw especially strong demand. The trade balance improved for fifth consecutive month to $58.3 bln, well above its 5-year average of around $40 bln. While the strong trade data are welcome, we believe markets will put more weight on new money and loan data, which are out sometime over the next week. New loans are expected at CNY1.375 trln vs. CNY1.08 trln in July, while aggregate financing is expected at CNY2.80 trln vs. CNY1.06 trln in July. We fully expect another RRR cut in the coming weeks if loan growth remains sluggish.

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