Rising Rates Underpin the Greenback
• The US dollar is firmer across the board, helped by rising short-term interest rates. The 2-year premium over Germany is the most since March 2020. The euro is holding above $1.17 while the greenback traded JPY110.80, up from JPY108.80-on August 4.
• China’s lending figures slowed dramatically last month and this adds to the pressure on the PBOC to ease policy.
• China’s sentencing of two Canadians seems related to Canada’s extradition hearing for Huawei’s CFO. Canada’s Prime Minister Trudeau has little room to maneuver without antagonizing the US ahead of what is expected to be an election announcement possibly in the coming days.
• German rail workers begin a two-day strike.
• A domestic political crisis in Poland has yet to be resolved, but the pressure on the currency is modest.
• The US reports July CPI figures today. A slowing of the monthly increases, coupled with the base effect, could see the year-over-year rate soften for the first time this year.
Overview: The US dollar remains firm ahead of the July CPI release, and even though Chicago Fed Evans demurred from the hawkish talk, the market is getting more comfortable with the idea of a rate hike next year. The implied yield of the December 2022 Eurodollar futures is rising for the sixth consecutive session. Most emerging market currencies are also under pressure. The JP Morgan Emerging Market Currency Index edged up yesterday to snap a five-day drop but is resuming its decline today. The US 10-year yield is near 1.37%, ahead of today’s auction, which is the highest level in nearly a month. European benchmark yields are 2-4 bp higher. Record highs in the S&P 500 and Dow Industrials yesterday had limited impact on activity in the Asia Pacific region. The local equity markets were mixed, with Hong Kong, Japan, Australia, and Chinese equities advancing. Of note, South Korea and Taiwan’s markets extended their swoon for a fifth consecutive session. Europe’s Dow Jones Stoxx 600 is edging higher to extend its advance to the eighth consecutive session. US futures are slightly softer. Gold is continuing to consolidate in narrow ranges after Monday’s flash crash. Oil is slightly higher, building on yesterday’s 2.7% rally, the most since July 21, on the back of US infrastructure plans, anticipating falling US inventories (API reportedly estimated a 815k barrel draw of oil and 1.1 mln barrels of gasoline). China’s iron ore futures contract ended its five-day 12% drop. Copper is giving back about a third of yesterday’s 1.5% gain. The CRB Index rose nearly 1.7% yesterday, recouping in full the losses from the previous two sessions.
China reported a sharp decline in lending last month. Bank loans were practically halved to CNY1.08 trillion from CNY2.12 trillion in June and well below expectations. Aggregate financing, which includes non-financial lending and the wealth management arms of financial institutions, was lower than bank lending, which means that shadow banking did not extend fresh loans last month. Aggregate financing rose CNY1.06 trillion after June’s CNY3.67 trillion. It is the lowest since last February as the covid virus struck. These disappointing lending figures come on the heels of yesterday’s PBOC quarterly report hinting at easier policy.
Beijing has sentenced one Canadian to 11 years in prison for spying and has confirmed another Canadian’s death sentence for drug trafficking. China has linked the two cases to the extradition proceedings of Huawei’s CFO, Wanzhou, taking place in Canada. While there could still be room for a grand deal, other considerations argue against it. Even though Wanzhou is accused of lying to HSBC about Huawei’s business with Iran, the penalty is usually a fine. The US is pressing hard, and a deal with China would likely irk Washington. Also, note that Canadian Prime Minister Trudeau appears to be preparing to call elections shortly, and this may also limit his room to maneuver.
The dollar recorded a two-month low against the yen on August 4 near JPY108.70 before reversing higher. With today’s gains, it has advanced for the sixth consecutive session and reached JPY110.80 in early European turnover. The greenback looks stretched, and initial support now is seen in the JPY110.40-JPY110.50 area. Recall the year’s high was set in early July near JPY111.65. The Australian dollar is holding above the year’s low set last month, near $0.7290, but it shows no enthusiasm for the upside. For the fifth consecutive session, it is recording a lower high. There is an option for nearly A$700 mln at $0.7300 that expires tomorrow. The Chinese yuan is steady today and is largely flat so far this week in narrow ranges. On Monday, the dollar traded between roughly CNY6.4740 and CNY6.4885. Today, the dollar initially edged higher to nearly CNY6.4890, its highest level in two weeks, but it quickly saw the gains pared, and the greenback returned to yesterday’s close. For the most part, the PBOC’s reference rate has been close to the market’s projection. Today’s fix was at CNY6.4831, and the median forecast in Bloomberg’s survey was CNY6.4835.
German rail workers have declared a two-day strike. More than 35k workers are on strike that will be more disruptive than economically impactful. The union seeks a 3.2% pay increase and a one-off 600 euro payment, in line with what public sector workers received. The employer, Deutsche Bahn, rejects the demand. Deutsche Bahn suffered losses last year and with the latest floods. Ironically, yesterday the EU approved 550 mln euro state aid to compensate its subsidiary DB Fernverkehr for losses related to covid.
The Polish zloty is trading slightly lower, but it is not the weakest in the region as the market digests yesterday’s political developments. The prime minister dismissed the head of a coalition party for ostensibly not supporting the government’s stimulus plan and tax reform initiatives. Gowin’s Agreement Party, with 13 members in parliament, gave the government its majority. The Agreement Party was moderate, and without it, the Law and Justice party is in alliance with the rightist United Poland, who wanted to veto the EU’s recovery package and talks about leaving the EU. A snap election is possible, but the last time it was tried in 2007, it backfired, and Law and Justice were out of power for eight years.
The euro has edged lower but is holding above $1.1700, the low of the year set in late March, the (38.2%) retracement of the rally since last March’s low near $1.0625, and holds a 914 mln euro option that expires today. It is the seventh consecutive session that a lower low was recorded and the fifth session of lower highs. Note that the US 2-year premium over Germany is just shy of 100 bp, its highest level since March 2020. A break of $1.17 could spur a move toward $1.1650, where a nearly 1.4 bln euro option expires tomorrow. Sterling is trading heavily and is recording a lower low for the fifth consecutive session, just above $1.3800 today. A break of $1.38 could signal a return to the $1.3735-$1.3765 low from the last week in July. It is also the fifth session of lower highs. Today’s high of $1.3845 is below last week’s lows. Note that there is an option for about GBP475 mln at $1.3850 that expires tomorrow.
Today’s focus is on the US July CPI print. The core and headline rates are expected to rise by around half of June’s 0.9% increase, and given the base effect, it would allow the year-over-year pace to moderate slightly. That said, the market, like Fed officials, has underestimated the rise of consumer prices this year, and the dollar has tended to respond positively to the upside surprises. Typically, economists are concerned about wage pressures, but yesterday’s Q2 productivity and unit labor cost showed little pressure. Revisions to Q1 data showed unit labor costs fell by 2.8% at an annualized pace, while they bounced back by 1% in Q2. Instead of wages, many economists worry about housing prices (shelter costs, owner equivalent rents) as a more substantive risk to the “transitory” inflation thesis. The Atlanta Fed’s Bostic suggested earlier this week that a five-year core PCE deflator may be the appropriate measure. Leave aside the fact that the Fed currently targets headline PCE deflator, not the core. The five-year average is near 1.79% (and 1.70% for the headline).
Mexico’s July CPI was elevated at 5.81%, well above the central bank’s 3% target +/-1%. Today Mexico reports June industrial output figures. A 0.1% increase, as the median forecast in Bloomberg’s survey anticipates, would leave Q2 industrial production practically unchanged. The market anticipates Banxico to hike rates tomorrow by 25 bp following the June hike made by a split decision. If the market is wrong, it is that the central bank stands pat rather than hikes by 50 bp, even though economists are anticipating 75-100 bp hikes here in H2. The rub is that six Mexican states plus Mexico City just entered the highest alert (red) status due to the covid virus. A little more than 20% have been vaccinated, and the virus is on a rampage. Brazil reports June retail sales today, and a small increase (~0.5%) is expected. Yesterday’s inflation was slightly higher than expected, just shy of 9%. The drought is rising hydroelectric prices, and the economic recovery appears to be gaining traction. Meanwhile, note that President Bolsonaro was dealt a setback in pressing for electoral reform.
The US dollar lost nearly 0.5% against the Canadian dollar, only its second loss since July 29. It has recovered slightly but held above CAD1.2510, where a $360 mln option expires today. On the upside, the 200-day moving average has restrained stronger gains. It is found near CAD1.2570 today. The greenback also flirted with its 200-day moving average against the Mexican peso yesterday (~MXN20.13). The dollar peaked near MXN20.17 yesterday, nearly a three-week high. Last month’s high was near MXN20.25. The week’s low so far was set on Monday near MXN19.9960. The dollar rose for the third consecutive session yesterday. It was the longest advance since June 29-July 1. The greenback fell by almost 0.85% against the Brazilian real yesterday, the most in nearly two weeks. Brazil’s central bank has signaled another 100 bp hike next month, and the market is pricing another 100 bp after that.
Bannockburn Global Forex