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Sharp Dollar Setback may offer Bulls a Bargain

Overview: The dollar is having one of the largest setbacks in recent weeks. We expected the dollar to soften ahead of next week’s CPI, which may fan ideas/hopes of a peak in US price pressures, but the magnitude and speed of the move is surprising, and likely speaks to the extreme positioning. Still, we caution that the intraday momentum indicators are stretched, and the underlying bullish sentiment, may see North American operators take advantage of the dollar’s pullback. More broadly, risk assets are performing well. After a respectable equity performance in the US yesterday, Asia Pacific equities rose, led by Hong Kong, China, and Taiwan. Europe’s Stoxx 600 is up 1.6%, which if sustained, will be the most in a couple of months, and the first weekly gain in four. US futures are trading broadly higher. The 10-year US Treasury yield is off 5 bp to around 3.26%. The dollar’s pullback is helping lift commodity prices. Gold reached a new high for the week near $1730. October WTI, which fell to $81.20 yesterday, its lowest since February, is near $85. US natgas is up 2.25% but is still down 8% for the week. Europe’s natgas benchmark is off 5.3% today and is practically flat on the week. China’s drive to complete unfinished houses has helped lift iron ore prices. They rose 3.7% yesterday and almost 3% today. At $103, it is at a new two-week high. December copper has caught a bid and today’s 2.25% gain puts it up 5.7% on the week after falling 7.7% last week. December wheat is 1.3% firmer and, barring a reversal today, is poised to its third consecutive advancing week.

Asia Pacific

China reported lower than expected inflation and stronger than expected lending figures. August CPI surprisingly slowed to 2.5% from 2.7%. Food inflation stayed firm at 6.1% (vs. 6.3%) reflecting a 22.4% jump in pork prices from a year ago. This helps explain yesterday’s decision by the National Development and Reform Commission to release 37.7k tons of frozen pork from reserves. Wholesale pork prices have surged by 70% over the past six months. Floods and droughts have lifted vegetable and fruit prices. Non-food prices rose 1.7%, slowing from 1.9% in July. Core inflation (excluding food and energy) were steady at 0.8%. Producer prices continue to drop. August was the 10th consecutive month that producer price inflation has slowed. It is now below CPI at 2.3%, down from 4.2% in July and 10.3% at the end of last year. Falling commodity prices and production disruptions from electricity curbs weigh on PPI. Of note, and speaking to weaker demand, consumer durable goods producer prices fell by 0.6% in August year-over-year. It was the fifth consecutive negative print. Despite the lower inflation prints, the one-year medium term lending rate is unlikely to be cut next week after the 10 bp point reduction was delivered last month.

Separately, China reported that aggregate lending jumped to CNY2.4 trillion, recovering more than expected from the dramatic weakness in July (CNY756 bln). Chinese officials have encouraged more lending to the property sector and government infrastructure projects. What is notable about today’s figures is that was that non-bank lending accounted for the bulk of the improvement. Bank lending rose to CNY1.25 trillion, accounting for a little more than half of the overall lending. In July, bank loans were almost CNY680 bln of the CNY756 bln lent. The difference between the aggregate figures and bank loans (new yuan loans) is shadow banking.

It is interesting to review Japanese investors fixed income moves in the latest balance-of-payments data for July. Japanese investors continue to sell their foreign bond holdings. It could be both contributing to the bear market and responding to it. It also may be taking profits on foreign assets that repatriate into more yen given the dramatic depreciation. Given the size of the US bond market, divesting foreign bonds means selling US Treasuries. Japanese investors sold US bonds for the ninth consecutive month, the longest selling spree since at least 2005. They sold JPY1.04 trillion (~$7.7 bln) of US Treasuries in July after selling an average of a little more than twice as much on average over the previous four months. After Treasuries, Japanese investors sold the most amount of French bonds (JPY723.30 bln), the most since March 2002. Of the ten largest country allocation, there was only one country’s bonds that Japanese investors bought in July: Italy. Its JPY29 bln of purchases did not quite replace the JPY31.7 bln Italian bonds sold in June.

Japanese officials who have stepped up their rhetoric in recent day may enjoy the weekend as the dollar weakens broadly. The dollar reached a high of almost JPY145 in the middle of the week and approached JPY141.65 today. It corresponds with to a (61.8%). retracement objective of the last leg higher. The Australian dollar probed the $0.6700 area in the middle of the week. After an inside day yesterday, the Aussie has jumped to day to around $0.6875, where the 20-day moving average is found. The next technical target is seen near $0.6900-10. The greenback is off a little more than 0.5% against the Chinese yuan. If sustained, it would be the biggest loss since May. It would also be the first back-to-back loss since May. The PBOC set the dollar’s reference rate at CNY6.9098 compared with expectations (median in Bloomberg’s survey) of CNY6.9484. There were reports of net foreign inflows into Chinese stocks for the first time this month.


The ECB delivered the 75 bp hike with a unanimous decision. For the most part, President Lagarde stuck with a hawkish script. Additional rate hikes were signaled. Lagarde warned that while the labor market was still robust, that the normalization of monetary policy would likely mean higher unemployment. She also responded to critics who worry about the debasement of the euro as its traded at 20-year lows. Lagarde pushed back and noted that while the euro has fallen 12% against the dollar so far this year, it overstates the case. On an effective basis (weighed index of trading partners and competitors) it is off 4%. At the same time, we note the euro is 42% undervalued according to the OECD’s purchasing power parity model.

Interest rates surged in Europe, without spreads widening. Two-year rates were up 21-22 bp in Germany, France, and the Netherlands, and 16-17 bp in Italy, Portugal, and Greece. Spain acted more than a “donor” country with a nearly 24 bp rise in its two-year yield. Two years rates are up 5-9 bp Benchmark 10-year yields rose by 10-11 bp in Italy, Spain, and Portugal, while rising 11-13 bp in Germany, France, and the Netherlands. Rates are up another 3-5 bp today. The market initially began to price in a 75 bp hike in October rather than a half-point move, but in answer to question, Lagarde was explicit while rates would be raised at future meetings, it would not necessarily be 75 bp. This seems an unnecessary even if true statement. Here is where strategic ambiguity may have been more useful.

After peaking a little above the 20-day moving average (~$1.0025), the euro was coming off, perhaps on this seemingly less than hawkish comment, ahead of Fed Chair Powell’s hawkish comments that sent the euro to almost $0.9930. Powell, as we note below, did not break new ground and after Europe went home yesterday, the market took the single currency back to parity. Lastly, we note that the two-tier of reserves at the ECB was suspend, and the net effect is a gift to banks who can earn a higher deposit rate with cheap TLRO funds. Yet whatever this subtle extra cushion is worth, it did not prevent the MSCI index of eurozone banks from underperforming yesterday. It weakened by almost 0.3%, while the broader market gained about 0.5%. Today the bank index is playing catching, rising 3% compared with nearly 1% gain in the broader market.

European energy ministers are meeting today to coordinate efforts to contain energy prices. There are several different proposals that involve capping prices, decoupling gas and electricity prices, and conservation efforts. In addition, the volatility has lifted required margins (collateral), which is also disrupting activity and forcing power companies to seek more liquidity. Sweden and Finland have already announced an initiative to address this. Separately, note that Sweden has a general election Sunday. The far-right Swedish Democrats appear to be in ascendancy on the back of a surge in violent crime. The Swedish Democrats have campaigned on a law-and-order and anti-immigration platform and is seen emerging as the second largest party in the country.

The short squeeze has lifted the euro to nearly $1.0115, its highest level since August 18. This meets the (50%) retracement objective of the slide since the August 10 high near $1.0370. Above there, the next retracement (61.8%) is $1.0175. Initial support now is likely around $1.0050. For its part, sterling ran up to almost $1.1650, its best level this month. The gains, thus far, are not particularly impressive. The previous high for the week was set on Monday, almost $1.1610. Still, a move above $1.1650 could signal a test on the $1.1715-35 area, which houses some short-term retracement targets and the 20-day moving average. Sterling has not closed above its 20-day moving average since August 12. The swaps market has had second thoughts about a 75 bp hike that was seen as an 82% probability at the start of the week. Now pricing is consistent with a 50 bp hike. The euro is hovering around GBP0.8700. The high for the year was set in mid-June near GBP0.8720.


US rates rose yesterday, but the market did not learn anything new, except, perhaps that weekly initial jobless claims fell for the fourth consecutive week. At 222k, they are the lowest since the end of May. Continuing claims continued to creep higher. With last week’s 36k increase, they have risen in five of the past six weeks. It is what you would expect if it were becoming more difficult to get a new job, though to be sure, the level (1.473 mln) is still low by nearly any measure. The odds of a 75 bp Fed hike this month seemed to diminish at the end of last week, perhaps placing too much importance of the rise in the unemployment rate, but it has risen every day this week. What was about a 55% chance a week ago is now closer 86%. The Fed’s Waller, Evans, and George speak today, but it will be difficult to add to the signal from Powell (Jackson Hole comments reinforced yesterday) and Brainard on Wednesday.

Canada reports August jobs data. The labor market improvement appears to have stalled. It has lost 17k full-time jobs between June and July. Part-time positions have fallen for three months through July for a cumulative loss of 152k jobs. The participation rate has not risen since February. The Bank of Canada lifted its target rate by 75 bp earlier this week 3.25%. The swaps market favors a 50 bp hike next month (82% discounted). The market sees the terminal rate between 3.75% and 4.0%.

Mexico’s August CPI, released yesterday, was slightly firmer than expected at 8.7% and the core rate poked above 8.0%. Banxico is seen as having little choice but to follow the Fed’s move later this month. Today, it reports July industrial output figures. They are expected to have slowed sequentially. The government assumptions in the budget seemed optimistic, with next year’s growth seen at 3% and inflation to slow to 3.2%. The central bank’s forecast was updated last week. It concurs with the government projection of 3.2% CPI at the end of next year, but its growth forecast was cut to 1.6% from 2.4%. Separately, Brazil reports IPCA inflation. Brazil’s inflation appears to have peaked near 12.1% in April. It approached 10% in July and is expected to have slipped below 8.7% in August. The Selic rate is at 13.75% and the central bank has not ruled out another hike. That said, it is likely to stand pat when it meets on September 21.

After fraying CAD1.32 on an intraday basis in middle of the week, the US dollar has come off and is now at new lows for the month, trading below CAD1.30 in Europe. The risk-on mood has pushed the greenback below its 20-day moving average (~CAD1.3030) for the first time since August 17. The CAD1.2970 area is the halfway mark of the greenback’s advance that began on August 11 near CAD1.2730. A break of it could signal a move toward CAD1.29. The US dollar is heavy against the Mexican peso and is also at new lows for the month. It reached MXN19.87 in the European morning. There is a band of support between MXN19.81 and MXN19.85. A convincing break of that area leaves little to stop a test on MXN19.50.

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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