Dollar Gains Traction as Rest of the World Looks Shaky

June 29, 2021
  • Drought across large parts of North America is causing a spike in agricultural prices; Fed officials are sounding more confident about the economic outlook; all signs point to a robust US economy as we move into H2; Peru’s new president will keep the central bank president; Colombia kept rates on hold at 1.75%, as expected.
  • Eurozone has a fairly busy day; if eurozone inflation eases in June as expected, the ECB’s dovish stance will be vindicated; several ECB officials sounded dovish yesterday; details of ECB asset purchases for the week ending June 25 will be reported; there are many reasons to be negative on sterling now
  • Japan reported May labor market and retail sales data; BOJ announced that it was shifting to a quarterly bond buying plan from the current monthly one; lockdowns in Australia are spreading; Korea unveiled a new and very generous budget

The dollar is getting some traction as markets reassess the U.S. outlook. Key data this week are expected to show a strong economy as we move into H2. This stands in contrast to many other parts of the world, where lagging vaccine roll-outs are allowing the delta variant to quickly spread, forcing some to go back into lockdown. DXY is poking above 92 to trade at the highest level since June 22 near 92.08. The euro remains heavy near $1.19 while sterling remains heavy for a variety of reasons (see below) and is headed towards support near $1.38. Lastly, USD/JPY continues to edge lower, trading near 110.50. Strong U.S. data this week should help the dollar see broad-based gains.

AMERICAS

Drought across large parts of North America is causing a spike in agricultural prices. On top of this, record high temperatures are further damaging crops. While markets and the Fed typically look through such supply-related price increases, this comes at a time when it was already very difficult to get a clean read on inflation. The drought simply adds to what we see as increased risks of a prolonged period of elevated inflation readings that could eventually spook the bond market. For now, however, all is well as the 10-year yield remains stuck near 1.50% and the 10-year breakeven rate remains stuck around 2.35%.

Fed officials are sounding more confident about the economic outlook. Barkin speaks today. Yesterday, he sounded quite upbeat, saying it’s clear that the Fed has made “substantial progress” on its inflation goal and may meet its full employment goal “in short order.” Barkin said he would prefer to sequence tapering and rate hikes, which is pretty much standard given the Fed’s past sequencing. As things stand now, we continue to expect a tapering announcement over the summer, with actual tapering by end-2021 and rate hikes by end-2022.

All signs point to a robust US economy as we move into H2. Yesterday, the Dallas Fed manufacturing index came in at 31.1 vs. 32.5 expected and 34.9 in May. All told, Richmond came in at 22 vs. 18 in May, Kansas City came in at 27 vs. 26 in May, Philly Fed came in at 30.7 vs. 31.5 in May, and Empire survey came in at 17.4 vs. 24.3 in May. Despite some modest softness, the U.S. manufacturing sector remains in solid shape, still going strong but at a slightly slower pace. June Conference Board consumer confidence (119.0 expected) and April S&P/CoreLogic house prices will be reported today.

Peru’s new president (yet to confirmed) sent another market-friendly signal by saying he would keep the central bank president. The re-appointment of Julio Vellarde is in line with other positive messages from President-elect Castillo to assuage investor concerns, most of which are focused on intervention in Peru’s mining sector. The Peruvian sol was up 2% against the dollar yesterday, but this comes on the back for six consecutive weeks of losses and a near 7% depreciation on the year. We can certainly see grounds for a technical bounce in sol, but we prefer a wait-and-see approach give the still very elevated political uncertainty.

Colombia’s central bank kept rates on hold at 1.75%, as expected. The decision was unanimous, and the communique highlighted the expected economic damage caused by the latest virus wave and recent protests. Despite rising headline inflation (3.3% y/y), core remains well contained at 1.6% y/y, nowhere near the 3% target. The bank raised its GDP growth forecast for the year from 6.0% to 6.5%. Colombia’s stance stands in stark contrast with most of the region, with Brazil, Mexico, and Chile already hiking or about to hike. With not even a hint of change in posture, we expect the bank to fall behind the nascent EM tightening cycle, increasing the risks to COP and a potential steepening of the yield curve.

EUROPE/MIDDLE EAST/AFRICA

Eurozone has a fairly busy day. Germany reports preliminary June CPI shortly. Headline inflation is expected to ease to 2.1% y/y from 2.4% in May EU Harmonized, but state data already reported today suggests modest downside risks to the national reading. Spain reported June CPI earlier. Headline inflation was expected to remain steady at 2.7% y/y but instead fell a tick to 2.6%. France reports June CPI tomorrow, with headline inflation expected to rise to 1.9% y/y from 1.8% in May EU Harmonized. Eurozone CPI will also be reported tomorrow, with headline expected to ease to 1.9% y/y from 2.0% in May.

If eurozone CPI measures ease in June as expected, the ECB’s dovish stance will be vindicated. ECB speakers this week are too many to name here. Suffice to say that most will maintain the dovish narrative. We thought the only exception was likely to be Weidmann yesterday and today, but even he has moved toward the dovish camp. Also speaking today are Lagarde and Villeroy, both doves.
Several ECB officials sounded dovish yesterday. Holzmann said there is no room to raise rates given weak inflation. He added that once the virus emergency is over, PEPP will end. However, Holzmann admitted that we don’t know yet if the emergency is over. Elsewhere, Weidmann said the ECB will look through the short-term rise in inflation, adding that the bank can’t decide on PEPP exit too far in advance. He added that the spike in German inflation is due to temporary factors. Of note, Holzmann is from Austria and Weidmann is from Germany and so perhaps their dovish comments take on more weight.

Details of ECB asset purchases for the week ending June 25 will be reported. Yesterday, net purchases were reported at EUR24.3 bln vs. EUR19.4 bln for the week ending June 18. 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 believe that the ECB will not risk making any premature moves that could endanger the recovery. The ECB is likely to be happy with the recent slump in eurozone yields, but they will maintain their aggressive asset purchases to ensure loose monetary conditions persist in H2.

There are many reasons to be negative on sterling now, which up until recently was a market darling due to the vaccine rollout. To wit: 1) political tensions from the Hancock scandal, 2) rising virus numbers, 3) possible extension of restrictions, 4) Brexit tensions regarding Northern Ireland, and 5) a dovish BOE. We think the last two have the potential for the biggest market fallout. Recall that the grace period for some customs-free movement between Britain and Northern Ireland ends June 30. A deal is nowhere in sight and the UK may unilaterally extend it, which the EU says would merit a punitive response like tariffs. The BOE delivered an unequivocally dovish hold this month, and with the departure of Chief Economist Haldane, there are simply no hawks left on the MPC. One can make a case for straight up cable weakness as well as weakness in the EUR/GBP cross.

ASIA

Japan reported May labor market and retail sales data. Unemployment rose a couple of ticks to 3.0%, the second straight rise and the highest since December. However, the jobs-to-applicant ratio was steady at 1.09. Elsewhere, sales fell -0.4% m/m vs. -0.7% expected and -4.6% in April. Given the state of emergency was just lifted, we suspect June sales will also show some weakness. The Q2 economic outlook remains cloudy, but Q3 may finally see some improvement if expectations for a firmer Tankan survey this week hold true.

The Bank of Japan announced that it was shifting to a quarterly bond buying plan from the current monthly one. The bank also cut the size of its planned purchases across the 1- to 3-year, 5- to 10-year, and 10- to 25 year parts of the curve in Q3. This is a purely technical move as its purchases are basically on auto-pilot with little change in yields seen this year. The BOJ said it may “exceptionally” adjust the amounts to be purchased in case the yield curve changes substantially. The schedule of purchases for the following month will continue to be released at the end of each month.

Lockdowns in Australia are spreading. Brisbane became the fourth regional capital city to restrict movement outside of homes except for essential reasons for at least three days. This comes less than a day after Perth took similar measures. Sydney and Darwin announced longer lockdowns of up to two weeks over the weekend. As a result, nearly half of Australia’s population is now in lockdown. Despite great success in containing the virus this past year, Australia’s vaccine roll-out has been slow, leaving it vulnerable to the current wave driven by the delta variant.

South Korea’s government unveiled a new and very generous budget. It will funnel excess tax revenues into a transfer program to 80% of households. Small business will also receive some support. In total, the budget amounts to nearly $30 bln, the second-largest pandemic spending proposal. We expect that higher spending, along with the strong recovery, will be enough to offset the BOK’s usual financial stability concerns over household leverage. This also confirms our view of BOK tightening starting in Q4. Shorter-dated yields continue to rise rapidly, with the 3-year now at nearly 1.5% from sub-1% at the start of the year. The won is outperforming on the day, but moves have been small.

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