Dollar Firm as Two-Day FOMC Meeting Begins

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Win Thin
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• The dollar continues to gain traction as the two-day FOMC begins; US political uncertainty has entered a new phase
• Yesterday marked the third time that UK Prime Minister Johnson lost a vote for elections; he will try again today
• Weak South Africa data support our call for imminent easing; the threat of sanctions against Turkey are back on the table
• Lower than expected Tokyo October CPI was reported

The dollar is mostly firmer against the majors as the FOMC’s two-day meeting begins. Aussie and yen are outperforming, while sterling and Nokkie are underperforming. EM currencies are mostly weaker. KRW and TWD are outperforming, while ZAR and HUF are underperforming. MSCI Asia Pacific was up 0.5% on the day, with the Nikkei rising 0.5%. MSCI EM is flat so far today, with the Shanghai Composite falling 0.9%. Euro Stoxx 600 is down 0.4% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 2 bp at 1.83%, while the 3-month to 10-year spread has risen 1 bp to stand at +23 bp. Commodity prices are mixed, with Brent oil down 0.9%, copper up 0.1%, and gold flat.

The dollar continues to gain traction, reinforcing our decision to maintain our strong dollar call. DXY has risen in five of the past seven days and has retraced nearly a third of its October swoon. The major retracement objectives from the drop come in near 98.10, 98.40, and 98.70. On the other hand, EM is holding up better as MSCI EM FX just made a new high for this move today near 1641. It retraced nearly three quarters of its July-September drop before turning lower, while DXY has retraced less than half its move.

The US 3-month to 10-year curve is now +23 bp, the highest since March 6. It seems that much of the UST bid for the last few months has come from haven flows due to dual risks of the trade war and Brexit. The same goes for the dollar in general and so as those two risks are ebbing, we are seeing both USTs and USD being offered. We think the higher US yields should give further support to the dollar, but we’re not quite there yet. Perhaps we shall see that after the FOMC meeting, when markets hopefully have a better idea of what the Fed has in store for us in 2020.

AMERICAS

The two-day FOMC begins today. The decision comes out tomorrow at 2 PM ET, followed by Powell’s press conference at 230 PM ET. Another 25 bp cut is widely expected, but what’s next?  We will be putting out a Fed preview later today. US data reports today include S&P CoreLogic September house price data, October Conference Board consumer sentiments, and September pending home sales. There are no Fed speakers until Powell’s post-decision press conference.

US political uncertainty has entered a new phase. The Democratic leadership announced plans to hold the first formal House vote Thursday to affirm the existing probe and to lay out the impeachment timeline and procedures to hold nationally televised hearings. A successful vote by the full House is widely expected and would strengthen their bid to force the Trump administration to comply with document requests and subpoenas. The base case is that the House will vote to impeach and the Senate will vote not to convict.  However, with the hearings moving into the public eye, there are clear risks to this base case. For now, we see limited market impact but the developments reinforce our view that the added domestic risks will lead the administration to limit external risks. That means the odds of a US-China deal should continue to rise going forward.

EUROPE/MIDDLE EAST/AFRICA

Yesterday marked the third time that UK Prime Minister Johnson lost a vote for elections in his short time as PM. He will try again today through a different legislative route that requires a simple majority and is expected to succeed in setting the vote in mid-December, most likely on the twelfth. None of this should come as a surprise as the strategy has been well telegraphed. This means that the furious campaigning will begin soon, but the elections is Johnson’s to lose. According to Politico’s aggregate poll, the Conservatives have 37% support compared to 24% for Labour, 17% for the Liberal Democrats, and 11% for the Brexit Party. Meanwhile, the implied betting odds of a no-deal Brexit this year has fallen to just 2%, while 1-week and 1-month implied volatility has collapsed to around 9%.

Sterling remains heavy as uncertainty hangs over the UK. The $1.30 area has so far proven hard to crack and until we get some Brexit closure, we suspect any bounces towards that level will be sold into. The $1.28 area has offered some support.  If that breaks, the 200-day moving average near $1.2715 is the next likely area of support. Elsewhere, the euro is also heavy and has retraced over a third of its October bounce. Break below the $1.10 area would set up a test of the October 1 low near $1.0880.

Weak South Africa data support our call for imminent easing. M3 and private sector credit growth both slowed sharply from August, while Q3 unemployment rose a tick to a record high 29.1%. SARB next meets November 21 and we expect a 25 bp cut to 6.25%. It has stood pat since the July cut to 6.5% despite falling inflation.

The threat of sanctions against Turkey are back on the table. Despite President Trump’s efforts and the deal brokered by Vice President Pence, the US House is set to move ahead with bi-partisan action to punish Turkey for its actions in Syria. In addition, lawmakers also want to impose sanctions relating to Turkey’s purchase of the Russian S-400 missile-defense system. Any bill still must go through the Senate, where we have seen pushback against the administration’s decision to exit Syria. Markets are unfazed by this, perhaps in line with our view that President Trump will act as a buffer against congressional aggression as both sides fight to assert control over the Middle East agenda policy agenda. In any case, the worst seems to be over for Turkish assets. Despite the country’s well-documented weaknesses, we expect local markets to re-couple back onto the high-beta EM cycle—for now, at least.

ASIA

Lower than expected Tokyo October CPI was reported. Headline inflation was seen rising 0.8% y/y but instead remained steady at 0.4%. Ex-fresh food was also seen rising 0.7% y/y but it too remained steady at 0.5%. Acceleration was expected due to the impact of the consumption tax hike that took effect October 1, but instead, price pressures remain weak. Bank of Japan meets Thursday and is expected to keep rates steady at -0.1%. WIRP suggests 43% odds of a move this week vs. 100% seen at the beginning of the month. Those odds rise to 63% in December and 76% in January.

USD/JPY has traded above 109 for the first time since August 1. That day’s high near 109.30 lies near but the pair must first break above the 200-day moving average near 109.05.  After the 109.30 level, the next upside target is the May 21 high near 110.65.  Looking further out, the April 24 high near 112.40 beckons.