Dollar Soft as Markets Search for Direction

July 09, 2021
  • We are approaching the weekend with markets searching for direction; jobless claims yesterday were mixed; consumer credit continues to grow; Canada reports June jobs data; Mexico June headline inflation came in at 5.88% y/y, slightly higher than expected and definitely enough to justify Banxico’s hawkish turn; Brazil inflation for June came in slightly below forecast at 8.35% y/y; Brazil intervened in FX markets yesterday for the first time since March to stem the sharp reversal of the real
  • ECB announced the results of its strategy review; Lagarde did little to address what we see as a disappointing outcome; ECB releases its account of the June 10 meeting; eurozone data have come in soft this week; U.K. monthly data dump came in softer than expected; Norway reported June CPI; Poland kept rates on hold at 0.1% but revised inflation forecasts higher
  • Greater Sydney has been put in a two-week hard lockdown; PBOC cut the required reserve ratio by 0.5%, as telegraphed earlier this week; rising case counts have prompted the South Korean government to increase its mobility restrictions for Seoul

The dollar is modestly weaker ahead of the weekend. After putting in a new cycle high near 92.845 on Wednesday, DXY is down two straight days. That said, the euro feels heavy and is having trouble breaking above the $1.1870 area. Similarly, weak U.K. data is weighing on sterling and making it difficult to get much traction above $1.38. USD/JPY is edging higher to trade near 110 after trading as low as 109.55 yesterday. The sharp drop this week in EUR/CHF and to a lesser extent EUR/JPY and USD/JPY really encapsulates the recent risk off impulses. EUR/CHF traded yesterday at the lowest level since mid-February and is on track to test the double bottom from December and January near 1.0737. SNB won't be happy with CHF strength and will undoubtedly be intervening to slow the move.

AMERICAS

We are approaching the weekend with markets searching for direction. The broad risk off impulses seem to be fading, at least for today. Equity markets are up, while bond markets are down. Yet parts of the globe are going back into hard lockdowns as the delta variant spreads. U.K. data came in much softer than expected (see below), underscoring just how difficult it is to fully recover from the pandemic. The U.S. data have also been soft of late, but still point to continued above-trend growth across most sectors. For now, we continue to believe that the U.S. economy stands to outperform in H2, which underscores are call for continued dollar gains.

Jobless claims yesterday were mixed. Initial claims rose to 373k vs. 350k expected and a revised 371k (was 364k) the previous week, while continuing claims fell to 3.339 mln vs. 3.335 mln expected and a revised 3.484 mln (was 3.469 mln) the previous week. Of note, emergency continuing claims are reported with a 2-week lag and fell to 10.7 mln from 11.2 mln the previous week. This is a new pandemic low. We think the data show continued healing of the labor market, albeit slowly and unevenly at times. May wholesale trade sales and inventories is the only U.S. data to be reported today.

Consumer credit continues to grow and that bodes well for consumption. Consumer credit rose $35.3 bln in May, nearly double the expected $18 bln and a revised $20 bln (was $18.6 bln) in April. Non-revolving credit, which includes auto and tuition loans, rose $26.1 bln, the most on record, while revolving credit, which includes credit cards, rose $9.2 bin.

Canada reports June jobs data. Consensus sees175k jobs added vs. -68k in May, while the unemployment rate is expected to fall to 7.8% from 8.2% in May. Since the April taper, the labor market has posted two straight months of job losses and so there really was no need for the bank to change anything at the most recent meeting June 9. That said, the bank said that it will adjust the QE program based on its “ongoing assessment of the strength and durability of the recovery.” That suggests further tapering is in the cards as the recovery continues. There will be updated macro forecasts released at the next meeting July 14. If the outlook continues to improve and jobs growth resumes in June, then the next round of tapering at that meeting is very possible.

Mexico’s June headline inflation came in at 5.88% y/y, slightly higher than expected and definitely enough to justify Banxico’s hawkish turn. This is still below the April peak of 6.08% y/y but well above the upper limit of the bank’s 2-4% target range. Core inflation also accelerated and at 4.58% y/y is the highest since December 2017. There will probably be growing calls for upsizing tightening in the next policy meeting, but there is a long way to go before August 12. The vote to hike was 3-2, suggesting it will be hard to get a larger hike. Banxico already delivered before most had expected and the global growth outlook is softening, so for now we keep with our call for a 25 bp hike then.

In contrast to Mexico, Brazil’s inflation for June came in slightly below forecasts at 8.35% y/y, but core readings still show resilient price pressures. Inflation is still running well above the upper limit of the target range of 2.25-5.25% and there is nothing here to suggest BACEN will hesitate in tightening. In fact, the question is whether it will accelerate from 75 bp to 100 bp at the next meeting August 4, which markets already began pricing in. We don’t think there is a need for upsizing given Bacen has already frontloaded its cycle and the currency has appreciated substantially over the last few months.

The Brazilian central bank (BCB) intervened in FX markets yesterday for the first time since March to stem the sharp reversal of the real. The bank sold $500 mln via swaps when USD/BRL breached the BRL5.30 level. After a stellar Q2 performance, BRL has started to give up its gains in recent weeks as the political outlook began to deteriorate once again. The local drama surrounding allegation of corruptions in vaccine procurements took another turn for the worse yesterday after the President’s former logistics director, Roberto Dias, was detained by justice officials. The investigation over mismanagement of the pandemic by the government, and directly by President Bolsonaro, is gaining traction and weighing on his popularity (now at an all-time low of 34%).

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank announced the results of its strategy review. As expected, ECB policymakers agreed to target 2% inflation over the medium-term with a “symmetric” aim that could allow it to “moderately” overshoot during a “transitory period.” The new strategy will be applied at the next policy meeting July 22. Quite frankly, this is really not such a big deal and falls short of average inflation targeting (AIT), which explicitly calls for a period of above-target inflation to make up for any period of below-target inflation. The ECB's weak tweak allows for some overshoot but it is simply not as strong a statement as the Fed's AIT framework.

At her press conference following the announcement, Madame Lagarde did little to address what we see as a disappointing outcome. She stressed that the ECB is not doing Fed-style AIT and that the new goal is not pushing out eventual policy tightening. Talk about snatching defeat from the jaws of victory. We understand that Lagarde has her hands effectively tied by the hawks. The Fed used its framework review to underscore that it had effectively moved to a much more dovish stance. The ECB? Well, we’re simply not sure what they were trying to achieve with its review.

The ECB also said that it added climate change considerations in setting monetary policy. Call us old school (or just old), but we can't quite get why a central bank should be getting involved in climate policy. To us, that is a very important issue that is better addressed with fiscal/regulatory policies. And it's not just the ECB, as the BOJ is also talking about it. We don't think the Fed is totally on board yet, but they are instead keeping busy worrying about income inequality, which is another important issue that is better addressed with fiscal policy.

The ECB releases its account of the June 10 meeting. Rates were kept steady then and the bank promised to maintain a “significantly higher” pace of purchases that was first announced at the March meeting. Growth and inflation forecasts were upgraded. Of note, the ECB forecasts 2021 inflation at 1.9% vs. 1.5% in March, 2022 inflation at 1.5% vs. 1.2% in March, and 2023 inflation at 1.4% vs. 1.4% in March. As Madame Lagarde pointed out, inflation is seen below target for the entire forecast horizon, which of course implies no rate hikes before 2024. The account should help markets assess how strong the resistance was to extend the higher pace of purchases. For now, the doves have the upper hand. Rehn, Lagarde, and Hernandez de Cos all speak today.

Eurozone data have come in soft this week. Today, Italy reported May IP at -1.5% m/m vs. an expected gain of 0.3%. April was revised down to 1.5% m/m from 1.8% previously. This was the final major clue for eurozone IP due out July 14. A 0.2% m/m gain is expected vs. 0.8% in April. Of note, German and French IP both fell -0.3% m/m in May and so there are clear downside risks to the headline eurozone reading.

The U.K. monthly data dump came in softer than expected. May GDP rose 0.8% m/m vs. 1.5% expected and a revised 2.0% (was 2.3%) in April, IP rose 0.8% m/m vs. 1.4% expected and a revised -1.0% (was -1.3%) in April, and services rose 0.9% m/m vs. 1.6% expected and a revised 2.8% (was 3.4%) in April. Of note, manufacturing fell -0.1% m/m vs. 1.0% expected and a revised flat (was -0.3%) in April, while construction fell -0.8% m/m vs. 1.0% expected and a revised -0.7% (was -2.0%) in April. May trade data were delayed and will be reported shortly, with a deficit of -GBP1.25 bln expected. It appears that the economy is faltering a bit from the current wave of infections, though there is some hope for some acceleration as restrictions come to an end this month. Still, it’s clear that the pandemic still poses risks to the economy as we enter H2. BOE Governor Bailey sounded very cautious last week. Next BOE meeting is August 5. While further tapering is expected in H2, this meeting may be too soon given the rising uncertainties.

Norway reported June CPI. Headline inflation picked up as expected to 2.9% y/y from 2.7% in May, reversing last month’s deceleration and moving further above the 2% target and likely cementing an imminent rate hike. At the last policy meeting June 17, Norges Bank delivered a hawkish hold. It kept rates steady at 0%, as expected, but said that it would “most likely” hike rates in September. The previous rate path suggested hikes would start in Q4. Governor Olsen later suggested that the bank could hike rates 25 bp per quarter, which is much more hawkish than its previous guidance. Next policy meetings are August 19 and September 23, and we suspect the bank will use the August meeting to confirm a hike in September.

Poland’s central bank kept rates on hold at 0.1% as expected, but revised inflation forecasts higher. The bank now expects inflation to exceed the target range this year, an important concession to the hawks. We are still waiting for further details, but we suspect that the we could see a gradual shift in the language. This is not to say that the NBP will catch up with the far more hawkish central banks of Hungary and Czech Republic, but the gap is likely to start narrowing soon.


ASIA

Greater Sydney has been put in a two-week hard lockdown. Virus numbers continued to rise after an earlier two-week soft lockdown. Prime Minister Morrison said he supported the decision to impose tighter restrictions, noting "This is a very necessary set of restrictions that have been put in place by the NSW government, I strongly support them. I know it is tiring, exasperating and frustrating. But we need to keep pushing through." The vaccination rate in the state of New South Wales is under 10%, and so there was no choice but to lock down again. Morrison confirmed the planned arrival of more Pfizer vaccines that should see the vaccination availability rise to 1 mln a week in August, pushing that up from September previously. Morrison also pledged that all Australians can have at least one dose by year-end.

The PBOC cut the required reserve ratio by 0.5%, as telegraphed earlier this week. The lower RRR will be effective from July 15 and unlock an estimated RMB 1tlrn in liquidity. Interestingly, aggregate financing figures reported today showed an increase of RMB3.7 trln in June, well above expectations for CNY2.9 trln. New loans were also higher at CNY2.1 trln. Separately, China’s CPI came in a tick lower than expected at 1.1% y/y in June. Food inflation declined -1.7% y/y, offsetting increases in other categories, including fuel prices. Core CPI was up 0.9% y/y. PPI decelerated a bit too but was right on forecasts at 8.8% y/y vs. 9.0% in May, suggesting that some of the official efforts to control commodity prices have yet to kick in significantly.

Rising case counts have prompted the South Korean government to increase its mobility restrictions for Seoul. The capital will now be under level 4, the highest level of restriction, effective July 12 and lasting for two weeks. The country is trying to speed up its vaccination efforts but as it stands, only 11% of the population has received two doses and 30% have received one. It’s hard to estimate the economic impact of the new restrictions, but we imagine them to be relatively mild. The more important factor in determining the recovery speed and central bank policy will likely be the global demand trend. At this point we still think the BOK will hike later this year, but our conviction level has been reduced. The Kospi was down 1% overnight, underperforming most regional indices.

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