Dollar Soft Despite Heightened Geopolitical Risks

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Win Thin
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• The dollar staged a stunning comeback yesterday as risk-off took hold on rising geopolitical risk; those risks remain high
• US-China tensions have risen ahead of trade talks that begin Thursday
• The US abruptly announced that it would withdraw its troops from northeast Syria
• US reports September PPI; German IP came in better than expected
• UK Prime Minister Johnson told Chancellor Merkel that a deal is “essentially impossible”
• Chinese markets re-opened for trading today

The dollar is mostly softer against the majors despite heightened geopolitical risks. Swissie and Kiwi are outperforming, while sterling and Loonie are underperforming. EM currencies are mixed. TWD and KRW are outperforming, while RUB and ZAR are underperforming. MSCI Asia Pacific was up 0.6% on the day, with the Nikkei rising 1%. MSCI EM is up 0.3%, with the Shanghai Composite up 0.3% after China reopened from a week-long holiday. Euro Stoxx 600 is down 0.9% near midday, while US futures are pointing to a lower open. 10-year UST yields are down 3 bp at 1.53%, while the 3-month to 10-year spread has inverted 1 bp and stands at -16 bp. Commodity prices are mostly lower, with Brent oil down 0.4%, copper down 0.2%, and gold up 0.6%.

The dollar staged a stunning comeback yesterday as risk-off took hold on rising geopolitical risk. That bounce stalled during the Asian session but risk-off sentiment is taking hold again as North American markets open. The greenback is likely to remain choppy until the US economic outlook has cleared up. That said, events elsewhere continue to support our long-held view that despite the heightened risks, the US still stands out in an increasingly bleak global landscape. EM FX is mostly firmer today but we would fade any rallies until the trade war ends as rising geopolitical risk in the Middle East is another potential trigger point for deeper risk-off conditions.

NORTH AMERICA

US-China tensions have risen ahead of trade talks that begin Thursday. The US blacklisted eight Chinse tech firms on the basis of human rights violations. This news comes after President Trump earlier warned China that trade negotiations would be impacted if they did anything “bad” against the Hong Kong Protesters. The dynamic is worsening, as China has become more assertive an declared some areas of limit in terms of trade talks. We continue to believe that this week’s trade talks in Washington are unlikely to yield any breakthroughs. That means the next round of tariffs will kick in mid-October, with another round due in mid-December.

US reports September PPI. Headline is expected to rise 1.8% y/y and core by 2.3% y/y, both steady from August. Evans, Powell, and Kashkari speak. WIRP suggests 72% odds of a cut October 30. While inflation readings have been edging up, it will take more than a higher reading today to turn market expectations around in terms of Fed easing.

Canada reports September housing starts and August building permits. For an in-depth look at Canada, please see our recent piece “Canada Election Preview: Trudeau Weathers Brownface Scandal.” We believe USD/CAD is still on track to test the September 3 near 1.3385. The 200-day moving average is currently just below 1.33 and has provided some near-term support. Looking further out, a break of the 1.3355 area would set up a test of the May 31 high near 1.3565.

EUROPE

The US abruptly announced that it would withdraw its troops from northeast Syria. President Trump later threatened to destroy Turkey’s economy if it did anything “off-limits.” Please see our recent piece “Uncertain US-Turkey Relations Add to Geopolitical Risk” for an in-depth look at the situation. Whatever President Trump’s motivation, the move has inflicted serious damage to Turkish assets. The lira has depreciated some 2% over the last two sessions, the Istanbul index is down some 2.2%, and swap rates are up some 50 bps. Aside from the prospect of a military conflict, part of the renewed pessimism towards Turkey is likely also related to higher risk of sanctions and suspension from NATO, as threatened by Republican Senator Lindsey Graham. Also recall that Congress has unfinished business regarding Turkey with respect to purchase of the S-400 missile system from Russia, with sanctions very possible.

German IP came in better than expected for August. IP rose 0.3% m/m vs. flat expected and a revised -0.4% (was -0.6%) in July. However, the bounce will not be enough to move the needle on the pessimistic outlook for the country’s industrial sector and the drag it is having on the broader economy, especially with PMI readings still suggesting hard times ahead. The euro remains stuck below $1.10 and we continue to look for a move to the downside.

On the Brexit front, sterling came off about 0.5% on headlines that UK Prime Minister Johnson told Chancellor Merkel that a deal is “essentially impossible” if the EU insists Northern Ireland stays in the customs unions. Nothing has changed here and nobody is expecting a breakthrough this week. The question seems to be more about the deadline extension and the showdown it will require between Johnson and the UK Parliament. In that regard, Parliament has now been suspended ahead of the Queen’s Speech scheduled for October 14. Sterling is trading at the lowest level since October 2 and a break below $1.22 would set up a test of the September 3 low near $1.1960.

ASIA

Japan reported August cash earnings, household spending, and current account data. Cash earnings and real cash earnings contracted -0.2% y/y and -0.6% y/y, respectively. Whilst right at consensus, July readings were revised down to -1.0% y/y and -1.7% y/y, respectively. Household spending rose 1.0% y/y, as expected, while the adjusted current account surplus came in at JPY1.72 bln vs. JPY1.68 bln expected. USD/JPY remains heavy as the yen benefits from heightened geopolitical risk.

Chinese markets re-opened for trading today with the Shanghai Composite closing 0.3% and the onshore yuan appreciating 0.2%. Markets reopen from an extended holiday, during with tensions with the US have gotten worse. Aside from the blacklisting of Chinese telecommunication companies by the US, China’s CCTV said it would halt broadcasts of the NBA. The move was clearly retaliation for a pro-Hong Kong tweet by the General Manager of the Houston Rockets. The NBA has some 800 million viewers in China, with the Houston team particularly popular due to player and native son Yao Ming.