USD under renewed pressure from a combination of renewed China data disappointment, weak US manufacturing ISM and lingering chatter of a September Fed hike. US stock futures began selling off 6 hours before the release of China's manufacturing PMI, which showed the first contraction in six months and the lowest figure in three years. The largely-weaker than expected manufacturing ISM (lowest in 27 months) was accompanied by broader weakness in all components.
We reiterate since December that the Fed will NOT raise rates this year and any rate hike this year will be policy mistake.
The disinflationary impact of USD strength and inevitable depreciation of the Chinese yuan will continue to supress US inflation to the extent of shadowing declines in US jobless rate. Saudi Arabia, a key strategic partner of the US is already suffering from the combination of plunging oil prices, rising budget deficit and having its currency –riyal-tied to a strong USD. Not dissimilar from China FX situation.
We reiterate that the cyclical peak of the US dollar against both the yen and euro is already behind us. USDJPY will not return to the 125.00 yen highs and EURUSD will not return to the $1.0530 lows seen earlier this year.
No Decoupling againIn 2007, it was erroneously & widely predicted by pundits that emerging markets would decouple from G7 and escape the 2008-9 recession. Although BRICS recovered rapidly in 2010-2011, their decline in tandem with US, UK & Eurozone was notable in 2008-9.
Today, the decoupling idea is being peddled again, based on US diverging away from China & EM. This will prove wrong again as the combination of trade and capital flows is stronger than ever.
EURUSD: more than just unwindingWhile the recent stabilisation in EURUSD has been widely attributed to unwinding of euro shorts linked to escalating risk aversion, don't forget old fashioned fundamentals. The spread on German-US 10-year yields (Germany minus US) continues to improve in tandem with a stabilizing EURUSD rate. The chart below highlights the improving yield spread in favour of the euro, while US core PCE price index (Fed's target) diverges away from the 2.0% target as Eurozone core CPI holds steady at 1.0% --13-month highs.
Draghi is backWe expect ECB president Draghi to re-emphasize his dovish stance in Thursday's press conference, subjecting euro to some pressure, especially if the governing council lowers its growth and CPI projections. Any pullback in EURUSD will be assessed ahead of Friday's release of the US August jobs report, expected at 205K from 210K. But take note that out of the last 15 releases of August NFP reports (due on September), 11 reports had negative surprises. And each of the last four August reports have undershot forecasts.
|51.5||51.9||51.9||Sep 01 8:30|
|PMI Construction (AUG)|
|57.5||57.1||Sep 02 8:30|
|Markit Manufacturing PMI (AUG)|
|53.0||52.9||Sep 01 13:45|
|ISM Manufacturing PMI|
|51.1||52.6||52.7||Sep 01 14:00|
|49.7||49.7||50.0||Sep 01 1:00|
|53.4||53.9||Sep 01 1:00|
|51.5||53.9||53.8||Sep 01 1:45|
|47.3||47.2||47.1||Sep 01 1:45|
|Eurozone Spanish PMI Manufacturing|
|53.2||53.9||53.6||Sep 01 7:15|
|Eurozone Markit PMI Manufacturing (AUG)|
|52.3||52.4||52.4||Sep 01 8:00|
|Germany Markit PMI Manufacturing (AUG)|
|53.3||53.2||53.2||Sep 01 7:55|
1. The Fed likes uncertainty
When more variables are removed, markets function better. The easiest aid for a market in flux would have been for the Fed to signal no rush to hike rates. Instead, top policymakers are comfortable with higher market volatility and uncertainty. If that's what the Fed wants, that's what it will get in September. Don't expect a return to less volatility.
2. China's inexperience is showing
A modest FX devaluation and a rate cut is a logical, normal response for the challenges China faces. They failed, however, in the execution. The devaluation was poorly communicated and undermined confidence. The rate cut was rushed. Meanwhile, the hodge-podge of efforts to stimulate equity markets backfired. The stock market losses and growth can be regained but confidence in Chinese economic leadership will last much longer.
3. Central banks will wait and see
The RBA decision is at 0430 GMT but none of the 27 economists surveyed by Bloomberg is looking for a move on rates. It's a similar story in Japan where the BOJ is edging towards a rate cut but not committing yet. Market participants and central bankers are unsure what is happening with global growth and emerging markets. Ultimately, the divergence between the hawks (Fed & BOE) and doves (BOJ, EM, commodity bloc) will need to close.
4. Correlations aren't dependable
Oil is up 27% in the last week while USD/CAD is exactly where it was last Monday. The risk trade tends to lift the euro on a carry trade unwind but only to a certain point. USD/JPY has tracked risk sentiment but only to a point. When correlations break down it's a severe signal of uncertainty. Eventually they will re-establish but assets can disconnect for months.
5. Selected market performance
The yen led the way with a 2.2% rally against the dollar while the kiwi lagged, down 3.8% (including 1.9% on Monday). The S&P 500 fell 6.3% while the DAX fell 9.3% and Shanghai Composite fell 12.5%. The biggest surprise was crude oil, which finished up 2% on the month after falling as much as 20%.
Central bankers continued with mildly hawkish rhetoric at Jackson Hole and that will ensure elevated volatility into September. In early trading the pound is leading the way while the Australian dollar is the laggard. Japanese industrial production and housing starts highlight a busy start to the week. Over the weekend, Beijing announced it will no longer attempt to boost the stock market through large-scale stock purchases, and will instead focus its efforts to find and punish those suspected of “destabilising the market”, according to the Financial Times.
What's clear from Jackson Hole is that central bankers 'want' to hike, they're just waiting for the right opportunity. If the Fed or BOE was genuinely on the fence, the round of market volatility would have spooked them towards waiting.
Ultimately, we believe policymakers will wait but the undeniable bias toward rate hikes adds fresh risks. On Saturday, BOE Gov Carney continued to stress year-end as the time when he will begin to seriously debate a hike. Carney noted downside risks from China but said recent events hadn't changed the BOE's thinking.
Fischer underscored a positive outlook, saying there is “good reason” to believe inflation will rise toward 2% and then Fed can't wait until it gets there before hiking. The current statement says the Fed wants to be “reasonably confident” about rising inflation. So the question is, how close is “good reason” to “reasonably confident”?
Fed funds futures now price a 38% chance of a Sept hike, up 12 percentage points since Wednesday. So long as it remains a close decision, we struggle to see how risk assets can continue to recover.
In the shorter term the focus will be on Chinese stocks to open the week. However, a series of eco releases will also jar the FX market. The first is Japanese July industrial production at 2350 GMT. It's expected up 0.8% y/y.
Australia is also in focus ahead of tomorrow's RBA decision. Three final data points include TD Securities inflation, HIA new home sales and private sector credit.
Finally, Japanese July housing starts are expected up 11.0% in a report at 0500 GMT.
Remember that Monday is a holiday in the UK so volumes will be thin in European trading. Note that it's also month end so flows will be a major factor.
Commitments of Traders
Speculative net futures trader positions as of the close on Tuesday. Net short denoted by - long by +.
EUR -96K vs -93K prior JPY -39K vs -90K prior GBP +4K vs -4K prior AUD -47K vs -50K prior CAD -59K vs -67K prior CHF -12K vs -10K prior
Yen shorts were chased out in the huge rally on Monday but we expect they've slowly been rebuilding positions since.
|Industrial Production (JUL) (m/m) [P]|
|0.1%||1.1%||Aug 30 23:50|
|Industrial Production (JUL) (y/y) [P]|
|2.3%||Aug 30 23:50|
|Housing Starts (JUL)|
|1.033M||Aug 31 5:00|
|Housing Starts (JUL) (y/y)|
|11.0%||16.3%||Aug 31 5:00|
|TD Securities Inflation (AUG) (y/y)|
|1.6%||Aug 31 0:30|
|TD Securities Inflation (AUG) (m/m)|
|0.2%||Aug 31 0:30|
|HIA New Home Sales (JUL) (m/m)|
|0.5%||Aug 31 1:00|
|Private Sector Credit (JUL) (m/m)|
|0.5%||0.4%||Aug 31 1:30|
|Private Sector Credit (JUL) (y/y)|
|5.9%||Aug 31 1:30|
The Fed remains strangely open to the idea of hiking rates in September despite turmoil in markets. The US dollar climbed and stocks fell late Friday after the Fed's Fischer left liftoff on the table. On the week, the yen was the top performer while the kiwi lagged.
Risk assets and the US dollar face a conundrum in the coming weeks: If sentiment improves it makes a rate hike more likely, but as a rate hike grows more likely, market risks mount. The Fed's Fischer partially brushed aside the market rout this week in surprisingly hawkish comments Friday.
Fisher's Keeps September SuspenseFischer said the case for a hike was “pretty strong” before the recent round of volatility and also indicated that markets could settle quickly. He also said China was the trigger for the market moves, which shows a belief that markets aren't concerned about US growth. Overall, he emphasized that no decision was made but his comments perhaps suggest he believes the probability is higher than the 30% implied in markets. That gave the US dollar a boost and weighed on stock markets. The risks are skewed toward more of the same. Another thing that Fisched added was that the Fed doesn't fully understand market volatility anf that it volatility does affect the timing of rate hike.
We will be carefully watching the final hour of trading today. Massive volatility has been the case every day this week and month-end flows are factor now as well.
Another standout factor Friday is oil. WTI crude climbed another $3 to bring the cumulative gain from this week's lows to 21% in a remarkable bounce. What's less remarkable is how the Canadian dollar has failed to respond. USD/CAD is poised to finish the week 50 pips higher despite oil. If CAD can't rebound on oil, can it rally at all?