Dollar Firm Ahead of Jackson Hole

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Win Thin
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• FOMC minutes were not as dovish as many had hoped; bond and equity markets are set up for a big reset
• Today sees the start of the annual Fed symposium in Jackson Hole; the US reports a slew of data
• Markit flash eurozone August PMI readings were reported; ECB publishes the account of its July 25 meeting
• Japan-Korea relations continue to deteriorate 
• Indonesia delivered a dovish surprise; Mexico and Brazil report mid-August inflation data

The dollar is broadly firmer against the majors ahead of the Fed’s Jackson Hole Symposium.  The yen and Loonie are outperforming, while Stockie and Kiwi are underperforming.  EM currencies are mostly weaker.  IDR and RUB are outperforming, while TRY and PLN are underperforming.  MSCI Asia Pacific was down 0.3%, with the Nikkei rising 0.1%.  MSCI EM is down 0.5% so far today, with the Shanghai Composite rising 0.1%.  Euro Stoxx 600 is down 0.3% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 1 bp at 1.58%, while the 3-month to 10-year spread is unchanged to stand at -38 bp.  Commodity prices are mixed, with Brent oil up 0.7%, copper down 1.1%, and gold down 0.4%.

FOMC minutes released yesterday were not as dovish as many had hoped.  Most viewed the July cut as a “mid-cycle adjustment” and stressed the need for “flexibility” and “optionality.”  These are just fancy ways of saying policy remains data-dependent going forward.

We totally agree with this balanced view.  There is no need to pre-commit to more cuts, as the Fed can wait and see how the data come in.  By the time of the next FOMC meeting September 18, the Fed will have seen most of the major US data for August (jobs, inflation, retail sales).  Simply put, we do not think a September cut is a done deal.

The choice of the phrase “mid-cycle adjustment” is noteworthy.  It suggests that Powell and the Fed explicitly worded their messaging to dissuade markets from looking for a series of cuts.  And yet, here we are with 75 bp priced in for this year and 50 bp more for next year.  Note that several Fed officials favored steady rates, while a couple favored a 50 bp cut.

We continue to believe that bond and equity markets are set up for a big reset.  Both are pricing in a very dovish Fed and we see disappointment ahead.  The position skew in both markets is extreme, and so we see scope for some very disruptive moves ahead.  WIRP suggests 100% odds of a Fed cut next month, but odds of a 50 bp move have fallen to 9%.

We do not think FX markets are as skewed, as the low US rate view has not really fed into significant short dollar positions.  Indeed, we feel that the skew here is on the long side and so we are uncertain if the dollar rally will get that much juice when bond and equity markets reset.  That said, we remain dollar bulls and EM FX will likely get crushed further.

Today sees the start of the annual Fed symposium in Jackson Hole.  It will run through Saturday and will feature senior policymakers and academics from around the world.  The subject is “Challenges for Monetary Policy.”  As of this writing, the agenda still has not yet been released to the public, but we do know Fed Chair Powell will speak Friday.

During the North American session, the US reports a slew of data.  Weekly jobless claims (216k expected), August Kansas City manufacturing survey (1 expected), Markit flash PMI readings, and July leading index (0.3% m/m expected) will be reported.  The claims data will be closely watched since they are for the August BLS survey week that contains the 12th of the month.  Minneapolis Fed President Kashkari speaks, while Canada reports June wholesale trade sales (-0.2% m/m expected).

President Trump walked back reports that he would pursue either a payroll tax cut or capital gains tax indexation.  On the latter, he said it would likely be perceived as “elitist,” since the wealthy would benefit disproportionately.  We doubt that this is the last we’ve heard of these options, as growth concerns are clearly building ahead of the 2020 elections.

The Congressional Budget Office (CBO) just released its updated 10-year outlook and it wasn’t pretty.  It sees the budget deficit hitting -$1 trln in FY2020, two years earlier than previously anticipated.  That’s up from an estimated -$960 bln for FY2019 that end September 30.  The cumulative deficit over the next ten years is expected to be $809 bln higher than previously forecast.

What’s really worrisome is that the budget deficit is expanding even as the economy grows robustly.  The CBO actually raising its 2020 growth forecast from 1.7% to 2.1%.  However, the CBO singled out the trade war for weighing on the economy.

Markit flash eurozone August PMI readings were reported.  Headline manufacturing and services PMIs unexpectedly rose to 47.0 and 53.4, respectively.  This dragged the composite reading up to 51.8 vs. 51.2 expected and 51.5 in July.  Germany and France both saw their composite PMIs improve to 51.4 and 52.7, respectively.  However, manufacturing PMIs were a mixed bag as France’s moved back above 50 to 51.0 while Germany remained below 50 at 43.6.

ECB publishes the account of its July 25 meeting.  At this point, easing seems pretty much a done deal at the September 12 meeting and so the account probably won’t add much to the debate.  WIRP suggests 80% odds of a cut then, down from 100% at the start of the week.  Furthermore, odds of a larger 20 bp move have fallen to 0% from 56% at the start of the week.

Japan-Korea relations continue to deteriorate.  Seoul announced that it is withdrawing from its intelligence sharing agreement with Japan.  This is a continuation of the feud arising from colonial era reparations and comes despite the urging of the US to continue working together.  Korean officials said it can review this withdrawal if Japan ends its trade restrictions.  Tensions here are another headwind to global trade and growth.

Bank Indonesia delivered a dovish surprise and cut rates 25 bp to 5.5%.  The market was a bit split.  Of the 34 analysts polled by Blomberg, 21 saw steady rates and 13 saw a 25 bp cut.  We thought the weak rupiah was problematic and looked for no cut.  However, like Mexico last week, it appears that policymakers are more concerned about boosting growth.  Governor Warjiyo said the cut was consistent with the bank’s low inflation forecasts and was a “preemptive measure to push economic growth momentum in the future.”

Mexico mid-August CPI is expected to rise 3.5% y/y vs. 3.84% in mid-July.  If so, inflation would be the lowest since December 2016 and would move further into the 2-4% target band.  Banco de Mexico just delivered a dovish surprise last week and cut rates 25 bp to 8.0%.  Next policy meeting is September 26.  While the bank would probably like to follow up with another cut, we think much will depend on global conditions.

Brazil reports mid-August IPCA inflation Thursday, which is expected to rise 3.33% y/y vs. 3.27% in mid-July.  If so, inflation would remain in the bottom half of the 2.75-5.75% target range.  COPOM cut rates 50 bp last month but may find it difficult to repeat this at the September 18 meeting if BRL remains under pressure.