Dollar Firms as Key Week Begins

July 19, 2021
  • The dollar smile theory seems to be in play; the outlook for fiscal policy in the U.S. remains uncertain; the results of the Chilean primary presidential elections brought some tentative good news for markets
  • ECB asset purchases for the week ending July 16 will be reported; U.K. policymakers are struggling to present a coherent message on the economy; between the worsening economic outlook and rising virus numbers, sterling is trading at the lowest level since April 13
  • Japan’s Cabinet Office maintained its economic assessment for a third straight month; public approval for Prime Minister Suga’s cabinet fell to record lows in two polls; risk sentiment has taken a turn for the worse in emerging Asia with rising delta variant fears; oil markets continue on a downward trend after OPEC+ confirmed the rumored supply deal
  • Cross-market implied volatility measure continue to reflect growing concerns about the impact of the delta variant. The Vix is back above 20, though still well off levels seen earlier in the year. The Move index at just under 60 is has been holding above its 1-month average for several weeks. G7 FX implied fall has been the outlier, still dormant at around 6%, well below its 1-year average of over 7%.

The dollar remains firm as the new week begins in risk off mode. DXY is up for the third straight day and is trading at the highest level since April 5 near 93. 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 break below $1.18 sets up a test of the March 31 low near $1.1705. Sterling is also trading heavy as the government’s pandemic response comes under renewed scrutiny (see below). Cable is about to test the April 12 low near $1.3670 and further losses are likely. USD/JPY remains under pressure as risk off sentiment continues to take hold, though near-term support is seen around the July 8 low just above 109.50.


The dollar smile theory seems to be in play. That is, strong U.S. data are feeding into increased dollar bullishness as the Fed continues to take tentative steps towards tapering. With the ECB and BOJ remaining ultra-dovish, the relative stances would seem to favor the dollar. On the other hand, growing risk off impulses are helping the dollar recently. This supports the view that the greenback is likely to benefit in either situation. Hence, the smile as the dollar turns up at both ends of the risk spectrum. The yen is the only currency that’s higher against the dollar today, as its old status as a haven appears be making a comeback. USD/JPY should see solid support near 109.50 but a break below the 109.10 area would signal a deeper correction to the April 23 low near 107.50.

The outlook for fiscal policy in the U.S. remains uncertain. Senate Majority Leader Schumer will reportedly take two major steps in an effort to force action this week on the bipartisan $579 bln traditional infrastructure plan and a separate $3.5 trln “human infrastructure” plan. Schumer announced he’ll take a preliminary step today that will lead to a first test vote on the infrastructure plan by Wednesday. He also set Wednesday as the deadline for all Senate Democrats to unite behind a budget blueprint that would carry out the bulk of Biden’s “human infrastructure” plan later this year. The former will take the traditional route and will need Republican support to get 60 votes, while the latter will reportedly be passed via budget reconciliation and will need unanimous Democratic support to get 50 votes. Neither seems assured by Schumer is clearly running out of patience and time. Stay tuned.

The results of the Chilean primary presidential elections brought some tentative good news for markets. On the left, the Communist Party candidate Daniel Jadue lost to the more moderate Gabriel Boric. Boric came to the scene during the mass student protests in 2011 and then won an election to the lower house. On the right, former minister Sebastian Sichel scored a surprise victory. The results plus the incipient tightening cycle should provide some support for the peso, at least in relative terms, but it will be limited to a tactical game. We doubt investors will gain enough conviction to re-establish any sizable positions until the political fog has cleared up further. The peso is still down 6% on the year, around the middle of the LatAm FX pack.


ECB asset purchases for the week ending July 16 will be reported. Net purchases were EUR22.1 bln for the week ending July 9 vs. EUR15.7 bln for the week ending July 2. 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 last week underscore our belief that the ECB will not risk making any premature moves that could endanger the recovery. Indeed, it is expected to announce further stimulus measures this Thursday. We will be sending out an ECB preview tomorrow.

U.K. policymakers are struggling to present a coherent message on the economy. Last week’s CPI data came in higher than expected, but officials continue to frame this as a transitory spike even as the real sector data soften. Yet virus numbers continue to rise even as the economy fully reopens today. With daily new cases rising above 50k over the weekend, it seems that dire warnings about potential for 100k per day are becoming increasingly prescient. Prime Minister Johnson and his government are under fire for the botched handling of Johnson and Chancellor Sunak’s exposure to Home Minister Javid, who tested positive despite being fully vaccinated.

Between the worsening economic outlook and rising virus numbers, sterling is trading at the lowest level since April 13. Cable is testing the 200- day moving average near $1.37 currently and below that is the April 12 low near $1.3670. After that is the February 4 low near $1.3565 and then the January 11 low near $1.3450. Next BOE meeting is August 5 and a dovish hold is expected, which should add fuel to the sterling sell-off. MPC member Haskel today warned that tighter policy would risk the recovery, adding that some inflation is temporary.


Japan’s Cabinet Office maintained its economic assessment for a third straight month. However, it noted that weak consumer spending continues to weigh on the recovery. On the other hand, shipments abroad, business investment, industrial production, and overall corporate profits are improving. No wonder the BOJ delivered a dovish hold last week. 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 likely to remain below the 2% target through FY23. As such, the BOJ continues to signal that it intends to keep policy accommodative until FY24 at least.

Public approval for Prime Minister Suga’s cabinet fell to record lows in two polls. A Kyodo survey showed the approval rating dropping 8.1 points from last month to 35.9%, while the disapproval rate reached 49.8%, the highest since Suga took office in September. A separate survey by the Mainichi Shimbun newspaper saw the approval rating falling 4 points to 30%, while the disapproval rate rose 7 points to 62%. With the economy struggling and Suga’s support falling, we continue to expect another fiscal package to be announced soon.

Risk sentiment has taken a turn for the worse in emerging Asia with rising delta variant fears. Some of the notable price action include a 4.3% tumble for Vietnam main equity index on stricter mobility measures. The capital will go into a soft lockdown allowing citizens to leave only when “truly necessary” and non-essential services will shut. The Philippine peso fell about 0.5%, reaching the weakest level in over a year after 16 new delta variant cases were reported. The combination of worsening virus outlook, mostly low vaccination rates, and some negative sentiment coming from sell-off in Chinese stocks has dented the positive narrative many of these equity markets started the year on. Most EM Asian markets are significantly underperforming the MSCI world index year to date.


Oil markets continue on a downward trend after OPEC+ confirmed the rumored supply deal. Output will increase by 400k barrels a day starting in August until they reach 5.8 mln, thus re-establishing the supply level from before the cuts. The deal also included higher baseline production levels for some of the larger produces. Of course, these numbers can and will be adjusted depending on changing market condition, but for now it eases the concerns about the Saudi-UAE spat, providing greater visibility to the energy market. Brent front-month futures are down 2.3% on the day, on top of last week’s 2.6% decline. Perhaps more telling, the deep backwardation in the futures curve has roughly halved in the last few sessions to -$3.8 dollars spread between the front-month and the 12-month contracts.

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