Negative News from Europe Helps Dollar Build on Gains

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Win Thin
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• UK has been confirmed to have the highest death toll in Europe the dollar is getting more traction
• Reports suggest Congress is resisting President Trump’s call for a payroll tax cut; ADP private sector jobs data is expected to come in at -21 mln
• Brazil is expected to cut rates 50 bp; Fitch cut its outlook on Brazil to negative; Chile is expected to keep rates steady
• Sterling remains under pressure as Brexit talks sour; the EC warned that the future of the eurozone is at risk if the pandemic response is badly handled
• Central Bank of Russia will release its quarterly inflation report; reports suggest China policymakers may drop a growth target for this year

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The dollar is mostly firmer against the majors as it continues to build on recent gains. Yen and Aussie are outperforming, while euro and sterling are underperforming. EM currencies are mostly weaker. KRW and PHP are outperforming, while RUB and TRY are underperforming. MSCI Asia Pacific ex-Japan was up 0.6% on the day, with Japan closed until Thursday for the Golden Week holiday. MSCI EM is up 0.5% so far today, with the Shanghai Composite rising 0.6% after returning from holiday. Euro Stoxx 600 is up 0.4% near midday, while US futures are pointing to a higher open. 10-year UST yields are up 2 bp at 0.68%, while the 3-month to 10-year spread is up 1 bp to stand at +58 bp. Цommodity prices are mostly higher, with Brent oil up 2.3%, WTI oil up 3.8%, copper up 0.4%, and gold down 0.2%.

UK has been confirmed to have the highest death toll in Europe, with nearly 29.5K, second only to the US with 72K deaths. We note, however, that international comparisons are complicated by different accounting methods across countries. President Trump is once again pushing hard for a re-opening even if “some people be affected badly,” in what’s being called “phase two.”

The dollar is getting more traction. After five straight down days, DXY is up for the fourth straight day and back above the 100 area again.  A test of the April 24 high near 100.867 seems likely. The euro is trading at the lowest level since April 24 and is likely to test that day’s low near $1.0725. Sterling remains heavy and on track to test the April 21 low near $1.2250, while USD/JPY remains heavy and trading at the lowest level since March 17. We remain constructive on the dollar.

AMERICAS

Reports suggest Congress is resisting President Trump’s call for a payroll tax cut. The resistance is largely bipartisan and so his call is likely to go nowhere.  And that’s a good thing, as a payroll tax cut would do very little when nearly 35 mln Americans have become jobless over the past two months. Тo make matters worse, this tax funds Social Security and Medicare, two social safety nets are likely to be relied on even more during the pandemic.  Rather, Congress so far is taking the right approach by focusing on increased spending over tax cuts in the near-term.

ADP private sector jobs data is expected to come in at -21 mln.  This comes ahead of the April jobs report Friday, where consensus sees -21 mln jobs and the unemployment rate rising to 16.0%.  Yet we already know that things are bad from the weekly claims data and it’s going to get worse in May.  Initial jobless claims tomorrow are expected to come in at a still-high 3 mln.  The only other US report today is weekly mortgage applications.

Brazil COPOM is expected to cut rates 50 bp to 3.25%.  However, a handful of analysts look for a 75 bp cut, and the CDI market is pricing in another 25-50 bp cut at the June 17 meeting.  April IPCA inflation will be reported Friday and is expected to rise 2.49% y/y vs. 3.30% in March.  If so, inflation would be the lowest since August 2017 and below the bottom of the 2.5-5.5% target range.  So far, there has been no inflation pass-through of the weak real but policymakers have been intervening regularly to limit that weakness.

Yesterday, Fitch moved the outlook on Brazil’s BB- rating from stable to negative.  The agency said the move reflects “the deterioration of Brazil’s economic and fiscal outlook, and downside risks to both given renewed political uncertainty, including tensions between the executive and congress, and uncertainty over the duration and intensity of the coronavirus pandemic.”  Our own sovereign ratings model shows Brazil’s implied rating slipping a notch to B+ and so a downgrade by Fitch is warranted.  We find it difficult to argue in favor of Brazilian assets beyond what it can benefit from broad risk appetite trends and an arguably underweight positioning. This has been reflected in Brazil’s CDS performance, which has risen more than for many other EM countries.

Chile central bank is expected to keep rates steady at 0.50%.  The bank has taken rates to the effective lower bound, and so further monetary stimulus will have to come from expanded QE.  April trade will be reported Thursday.  April CPI will be reported Friday and is expected to rise 3.4% y/y vs. 3.7% in March.  If so, inflation would be the lowest since December and further within the 2-4% target range.

EUROPE/MIDDLE EAST/AFRICA

Sterling remains under pressure as Brexit talks sour.  Press reports top EU Negotiator Barnier told leaders in Brussels that the UK was trying to renege on its Withdrawal Agreement commitments.  He expressed doubt that the UK had the ability to carry out trade negotiations with both the EU and the US whilst also struggling with the pandemic.  EU officials believe the UK is adding to an already difficult process by refusing to consider an extension of the transition period.  UK-EU talks resume next week and the mood will not be a good one.  Sterling is down four straight days and traded today at the lowest level since April 24.  A test of the April 21 low near $1.2250 seems likely.

The European Commission warned that the future of the eurozone is at risk if the pandemic response is badly handled.  The EC sees GDP contracting -7.7% this year, but warns that the pain will be uneven and may widen the fissures between the creditor nations in the north and the debtor nations in the south.  Indeed, it warned that without some form of common rescue plan, the stability of the region would be at risk.

The big surprise is that the EC would admit that the European Project is at risk.  Is it meant to be a wakeup call for policymakers to take action?  Perhaps.  But even during the eurozone crisis, there was a “whatever it takes” mentality that Mr. Draghi embodied.  We cannot recall any senior European leaders admitting then that a breakup was possible.

Eurozone final April services and composite PMI readings were reported.  Headline numbers improved a tick or two from the preliminary reading to 12.0 and 13.6, respectively.  France worsened slightly to 10.2 and 11.1, respectively, while Germany improved slightly to 16.2 and 17.4, respectively.  Spain’s services and composite readings came in at 7.1 and 9.2, respectively, while Italy’s were 10.8 and 10.9, respectively.  Elsewhere, March eurozone retail sales fell -11.2% m/m, slightly worse than expected, while German March factory orders came in at a dismal -15.6% m/m, well below the 10.0% expected.

Central Bank of Russia will release its quarterly inflation report.  Governor Nabiullina has signaled further easing lies ahead, but this report should provide some clues to the likely pace of rate cuts in the pipeline.  Elsewhere, reports suggest the central back is considering a bond buying plan that would essentially allow it to monetize the government’s growing budget deficit.  Russian law prevents the bank from direct purchases and so the scheme would reportedly involve state-owned banks.  Next policy meeting is June 19 and another cut then is expected.

ASIA

Reports suggest China policymakers may drop a growth target for this year.  Instead, leaders may unveil a more nuanced outlook at the upcoming National People’s Congress later this month.  While every policymaker is facing the same struggle, China is in a somewhat unique position in that the annual growth targets put pressure on its leaders to deliver.  The targets are a holdover from the days when China was a purely command economy.  As it has moved more towards a market-oriented economy, it certainly makes sense to consider dropping this archaic relic altogether.  The pandemic would provide good cover.

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