Dollar Gains Modest Traction After Friday Sell-Off

June 07, 2021
  • We do not believe that tapering discussions have been derailed by the jobs report; the other big unknown right now is fiscal policy; the ruling party in Mexico (Morena) suffered a notable defeat in the midterm elections and lost its super-majority in the lower house; initial tallies from Peru’s crucial presidential runoff elections show surprising gains for Keiko Fujimori
  • U.K.-EU tensions remain high; ECB asset purchases for the week ending June 4 will be reported; data come ahead of the ECB meeting Thursday, when it is expected to extend its accelerated asset purchases into Q3; Germany reported weak April factory orders; Chancellor Merkel’s CDU won an important victory the Saxony-Anhalt region; Russia reports May CPI data
  • China’s trade figures came in somewhat below expectations; on the trade front, the Biden administration doesn’t seem the least bit ready to back down from rising tensions with China
The dollar is likely to struggle near term after the soft jobs data. After trading Friday at the higher level since May 14 near 90.627, DXY ended the day just above 90. The euro is trading back near $1.22 after testing support near $1.21 Friday, while sterling is trading near $1.4150 after trading below $1.41 Friday. USD/JPY is trading just above 109.50 after being unable to make a clean break above 110 Friday. While we believe the fundamental story favors the dollar, there is a lot of ground recover in the coming days. Until we see a bigger move higher U.S. rates (both real and nominal), the greenback is likely to remain vulnerable to further bouts of selling. The 10-year yield ended last week near 1.55%, while the breakeven inflation rate edged lower to around 2.42%, pulling the real rate lower to around -0.87% from a cycle high of -0.79% Friday, the highest since late April.

We do not believe that tapering discussions have been derailed by the jobs report. Indeed, the data is unlikely to deter the Fed from discussing tapering at this meeting and the official statement and minutes should confirm this. That said, the Fed is likely to remain in the early stages of such discussions and will refrain from setting out any sort of timetable until later this year. Key dates to watch for ahead are FOMC meetings July 27-28 and September 21-22, along with the Jackson Hole Symposium August 26-28. Consensus sees Fed tapering in 2021 and hiking rates late in 2022, which are ultimately dollar-supportive. In a piece due out this week, we will show that global liquidity is approaching an inflection point, after which it is no longer as supportive for EM and other risk assets as it was at peak liquidity. With the media embargo in place for the June 15-16 FOMC meeting, there are no Fed speakers this week. April consumer credit ($20.5 bln expected)will be reported today.

The other big unknown right now is fiscal policy. The two parties remain at odds about the size of the infrastructure package. A Republican group led by Senator Capito last week offered a compromise offer of $928 bln over eight years that President Biden quickly rejected. The two sides remain far apart even after Biden lowered his number to $1.7 trln from $2.3 trln, as estimates suggest the Republican offer contains only $257 bln of net new spending. Talks will continue this week and Commerce Secretary Raimondo said there is no hard deadline.

The ruling party in Mexico (Morena) suffered a notable defeat in the midterm elections and lost its super-majority in the lower house, as expected. According to the latest count, Morena and its coalition partners will come out with less than 300 seats, meaning that major legislative initiatives (including those in the energy sector) will become much harder to pass. The opposition party (PAN) is expected to garner 106-117 seats, while the PRI will get 63-75. Although this will hamper governability in the country, a stronger check on President AMLO’s populist agenda may end up being a net positive for asset prices. Indeed, the peso is modestly outperforming today, up 0.6% against the dollar.

Initial tallies from Peru’s crucial presidential runoff elections show surprising gains for Keiko Fujimori. The market-friendly candidate is ahead with 51% compared to 48% for leftist-candidate Pedro Castillo, with over 80% of votes counted. The balance is likely to shift in favor of the latter as more rural votes come in, so it’s likely to be a very close call. We should expect a massive rally in Peru’s assets if the win goes to Keiko. The sol has underperformed other major regional currencies since mid-May. The country’s CDS prices have also move considerably higher, though the move started a few months ago, and is now just over 90 bp, converging with that of Mexico.

U.K.-EU tensions remain high. Senior U.K. trade negotiation Frost wrote in an op-ed that “The EU needs a new playbook for dealing with neighbors, one that involves pragmatic solutions between friends. Not the imposition of one side’s rules on the other and legal purism.” Senior French official noted that the Brexit agreement’s Northern Ireland Protocol isn’t the problem, but instead is “a solution to a problem that we haven’t created.” Irish Foreign Minister Coveney also weighed in, rejecting the idea that EU inflexibility is the problem. These latest comments come ahead of a key meeting this week, where the two sides will seek ways to prevent further unrest in Northern Ireland. Reports suggest President Biden will warn U.K. Prime Minister Johnson not to renege on the deal when they meet at the G-7 summit this week. Biden will reportedly tell Johnson that the U.S. regards the deal as key to maintaining long-term peace in Northern Ireland.

ECB asset purchases for the week ending June 4 will be reported. Net purchases were EUR20.0 bln for the week ending May 28 vs. EUR21.7 bln for the week ending May 21 while gross purchases were EUR25.0 bln for the week ending May 28 vs. EUR23.7 bln for the week ending May 21. Both net and gross purchases have picked up noticeably over the last few weeks, and yet eurozone yields are still higher.

Data come ahead of the ECB meeting Thursday, when it is expected to extend its accelerated asset purchases into Q3. New macro forecasts will be released, and growth and inflation projections are likely to be revised higher. Yet the doves should have no problem maintaining its dovish stance at this meeting. Since the ECB announced accelerated asset purchases at the March 11 meeting, eurozone yields have still risen. The 10-year Italian yield traded as low as 0.57% that day, rose to a high of 1.16% May 19, and remains elevated at 0.89% currently. Similarly, the 10-year French yield traded as low as -0.13% that day, rose to a high of 0.32% May 19, and remains elevated at 0.17% currently.

Germany reported weak April factory orders. They were expected to rise 0.5% m/m but instead fell -0.2% m/m. However, the March gain was revised to 3.9% vs. 3.0% previously. Of note, the Economy Ministry said the weakness was driven largely by weaker domestic demand, as foreign orders were up 2.7% m/m. April IP and June ZEW business survey will be reported tomorrow, with IP expected to rise 0.4% m/m vs. 2.5% in March. Elsewhere, Spain reported IP up 48.2% y/y vs. 44.4% expected, while Italy (0.3% m/m expected) and France (0.6% m/m expected) report IP Thursday. The eurozone reading won’t be reported until June 14.

Chancellor Merkel’s CDU won an important victory the Saxony-Anhalt region. More importantly, it suggests that Merkel’s heir Armin Laschet will be able to reverse years of declining support when national elections are held in September. The CDU won 37% of the votes in Saxony-Anhalt, up more than seven percentage points from the last vote in 2016. Support for the far-right Alternative for Germany dropped more than three points to 21%, putting it at a distant second. Of note, Saxony-Anhalt Premier Haselhoff supported Laschet’s rival Soeder in the CDU leadership race but is expected to throw his weight behind Laschet this fall. The Greens won only 6% of the vote this weekend but is still widely expected to make a strong showing in September that may rival the CDU’s.

Russia reports May CPI data. Headline inflation is expected to accelerate to 5.8% y/y from 5.5% in April. If so, it would be back at the cycle high from March and further above the 4% target. Central Bank of Russia meets Friday and is expected to hike rates 25 bp to 5.25%. About a quarter of the analysts polled by Bloomberg look for a larger 50 bp hike to 5.5%.

China’s trade figures came in somewhat below expectations, but not dramatically so. Exports rose 27.9% y/y and imports rose 51.1% y/y, both a few percentage points below Bloomberg’s median forecast. It looks like weaker foreign demand is starting to weigh on China’s numbers given the delayed re-opening in many major trading partners. Moreover, shipments of many pandemic-related trade items – such as medical equipment and work-from-home electronic components – were on the weak side. The trade balance continued rising, now at $45.5 bln, but still close to its 5-year average. Elsewhere, foreign reserves rose to $3.222 trln from $3.198 trln in April and was due largely to valuation effects from the weaker dollar.

On the trade front, the Biden administration doesn’t seem the least bit ready to back down from rising tensions with China. U.S. Trade Representative Katherine Tai pointed out the “significant imbalance” in the relation between the two sides, calling it “unhealthy” and “damaging” to the U.S. economy. Elsewhere, tensions are likely to remain high after a bipartisan group of U.S. Senators visited over the weekend to meet with Taiwan officials. The group announced that the U.S. will donate 750,000 doses of Covid vaccines to Taiwan whilst underscoring that U.S.-Taiwan ties remain important. Official Chinese media has been unusually silent on the visit, which has apparently triggered online complaints from nationalists that Beijing should have taken the opportunity to remind the world that Taiwan remains part of China.

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