Dollar Mixed As Market Consolidates, Risk Appetite Pared Back

From the BBH Currency Strategy Team.

Highlights

US dollar is mixed vs. the majors as consolidative trade is being seen today.  Sentiment remains positive overall in the wake of the bank stress tests, but risk on FX trading appears to be taking a breather right now as evidenced by the largely firmer yen and Swiss franc.  Dollar is up against the antipodeans (helped by soft Aussie CPI, see below) and basically flat against GBP and EUR.  The euro has so far been unable to break yesterday’s high against the dollar.  EM FX is mostly softer, with ZAR the worst of the lot after very soft inflation numbers raise the prospect of further easing (see below).  Biggest gainers on the day so far vs. USD are CAD, ILS, PHP, NOK, and CHF, while the biggest losers vs. USD so far today are AUD, NZD, ZAR, SGD, and PLN.

Asian markets were higher, with MSCI Asia Pacific up 1.1% today.  Japan and China markets outperformed, while India underperformed on the day.  European markets are flat so far today, with Euro Stoxx 50 unchanged.  Futures markets are currently pointing to a modest down open for US equity markets today.     

US bond market is firmer as global risk sentiment is pared back today, and should be underpinned by the weak US growth outlook.  Japan bond market was lower as 10-year yields were up 4 bp today, while European bond markets are mostly higher as 10-year yields in UK, France, and Germany are down 4 bp, 2 bp, and 2 bp, respectively.  Greek 10-year yields are up 3 bp, Portugal down 16 bp, Ireland down 13 bp, Italy flat, and Spain down 3 bp.

Currency Markets

We continue to watch for clues that the bank stress tests have eased the dislocations in the European banking sector. Yes, peripheral bond spreads continue to narrow, but we note that 3-month EURIBOR continues to creep higher and was fixed today at another new high for this cycle and at its highest level (.831%) since the summer of 2009.  EURIBOR rates have been rising steadily since April, due in large part to perceived jump in counterparty risk.  As a result, weaker banks from the periphery have been big users of cheap ECB funding as an alternative.  The euro remains bid today, so far unable to break yesterday’s high around 1.3050 but remaining within sight of the post-ESFS high from May 10 around 1.31.  Given the continued spread tightening in the periphery, the upside for the euro is likely to remain intact for now.  It has been a slow slog, though, and the euro has basically traded in a 1.27-1.30 range since mid-July and making only marginal new highs from time to time. 

US data may not be helpful for the dollar near-term.  With most of the Q2 earning season now out of the way with no major hiccup and with the European bank stress tests also out of the way with no major damage, market attention should shift back to economics this week, with the release of the US Q2GDP data on Friday.  Past fiscal stimulus is fading away quickly and so the US growth profile has failed to impress of late.  In Q2, the economy is expected to show a 2.5% annualized growth rate, a slow-down from the 2.7% pace recorded in the first quarter and down from the impressive 5.6% rate seen in Q4 09 (when fiscal stimulus was helping the economy significantly). Domestic demand and in particular personal consumption would have lost momentum in Q2 (expected at 2.4% vs. 3.0% in Q1), with a still uncomfortably high unemployment level and the negative wealth effects from the latest housing sector weakness setting a more hesitant mood amongst consumers. 

After the GDP report, next Friday’s jobs report is the next potential flashpoint. With regards to the July jobs number, analyst forecasts have softened slightly over the course of this week.  Bloomberg consensus is for -100k (vs. -98k earlier this week) nonfarm payrolls vs. -125k in June.  Census workers continue to distort the headline number, as markets are looking for +98k (was +115k earlier this week) in private payrolls vs. +83k in June, so a marginal improvement in the job market is still seen, though hardly robust.  Unemployment is seen ticking up to 9.6% from 9.5% in June.

The Aussie was the weakest performer in the G10 world overnight.  The weaker than expected Australian Q2CPI data gave a good opportunity to take profit and is seen as weakening the case for a RBA interest rate hike at next week’s policy meeting. In the event, Q2 CPI was reported at +0.6% q/q (vs. +1% expected) following a 0.9% quarterly increase previously and for a trimmed yearly inflation rate reported at 2.7%, down from 3.0%. The AUD softened back below the 90.00 mark on the back of this, but in isolation, this data does not alter the highly supportive environment for the Aussie, with strong fundamentals and higher rates to come still a dominant theme.  We continue to see Aussie pull backs as good buying opportunities. 

Meanwhile, the kiwi July business confidence index was also reported on the weak side of expectations, at 27.9 from 40.2 and with the forward looking expectations index also down.  This comes ahead of tonight’s RBNZ meeting, with a further 25bp rate rise (only the second one in the cycle) widely expected to be delivered. This would take the cash rate to 3%.  The meeting comes in a context of mixed economic news, while underlying price pressures are gradually picking up.  Starting with the real economy, it has been a mixed bag of late, with a weaker profile emerging from domestic demand while net exports have picked up significantly so far this year.  Meanwhile, the Q2 headline CPI rate ran at just 1.8% y/y (from 2%), but underlying inflation which is more relevant from a monetary policy direction perspective is picking up and the Bank is forecasting inflation to peak at 5.3% next year – most analysts see this as a conservative forecast. July 1 year inflation expectation has picked up to 5% from 3.4%. The price outlook should provide enough ground for the central bank to deliver a further rate rise this week, but the economic case for more rate hikes is not all that convincing and a pause in the tightening cycle initiated last month may be seen before the end of the year. The disappointing business confidence survey out overnight validates this view.   

South Africa CPI rose a lower than expected 4.2% y/y in June vs. 4.6% y/y in May, the lowest since May 2006 and within the SARB’s 3-6% target for the fifth straight month.  We do think that the case for a rate cut remains in place, with upcoming meetings scheduled for Sep 8/9 and then Nov 17/18.  Any decisions will be data-driven, but we note that SARB officials have said that price pressures are expected to ease further in Q3.  Note that the recovery remains spotty, with the PMI dropping below 50 in June for the first time in 8 months.  The rand had been on track to test the April lows around 7.20, but is one of the worst performers today.  We think high yields are the only thing going for it right now.  If rates come down as we expect, then the rand should lose more of its appeal.  ZAR outlook will of course be driven largely by overall risk appetite, and remains one of the more vulnerable EM currencies moving forward.  Lower interest rates won’t help the rand’s situation, and we do not see any tightening until H2 11. 

Upcoming Economic Releases

US durable goods orders for June due out 8:30 EST/12:30 GMT and expected to rise 1.0% m/m (ex-transport +0.4% ) vs. -0.6% m/m (ex-transport +1.6%) in May.  At 14:00 EST/18:00 GMT, Fed releases its Beige book for the upcoming FOMC meeting.  US Senate votes on Fed nominees at 14:30 EST/18:30 GMT.  RBNZ announces its policy decision at 17:00 EST/21:00 GMT.