USD: tipped to topple?
Today's new headlines:
- ‘China won’t devalue Yuan to boost Exports, Premier Li says’. China won’t devalue its currency in order to make its exports more competitive amid trade wars with the US, Premier Li Keqiang said. (Bloomberg)
- ‘North Korea agrees to shut down missile site, says Moon’. Kim Jong-un has agreed to shut down one of North Korea’s main missile testing and launch sites, says South Korea’s President Moon Jae-in after their meeting in Pyongyang. (BBC)
- ‘Bank of Japan leaves monetary policy settings unchanged, as expected'. (Market News)
- ‘Theresa May exclusive: ”Brexit plan delivers freedoms people voted for”’. The Prime Minister also noted that ‘the withdrawal deal is virtually agreed. Chequers is about the future relationship’. (Daily Express)
- ‘BoE’s Vlieghe says UK pay growth improving “quite slowly”’. Wages in Britain are accelerating 'quite slowly', despite the unemployment rate falling to a more than four-decade low, Bank of England rate-setter Gertjan Vlieghe said. (Reuters)
- ‘Brexit: EU softens Northern Ireland border backstop plan in bid to avoid no-deal’. Most checks could take place away from the border and ports, Michel Barnier, EU chief Brexit negotiator says. (Independent)
The news hit the wires overnight Monday that US President Donald Trump was officially imposing tariffs on USD200bn worth of Chinese imports from September 24th. Trump warned that he would immediately pursue tariffs on a further USD267bn worth of Chinese goods if China retaliates. The FX market reacted in formulaic fashion. Safe-haven assets were snapped up, with the Dollar, Japanese Yen and Swiss Franc all initially higher; commodity and emerging market currencies took a hit. Due to their heavy reliance on China as a market for their exports, the Australian and New Zealand Dollars were once again the biggest losers of the trade war within the G10 complex; until they weren’t.
As the market digested the often threatened and largely expected tariffs, the Dollar reversed its gains, and the CHF and JPY. CAD, NZD and AUD currencies traded higher on the day against the USD, the latter helped by relatively hawkish Reserve Bank of Australia (RBA) minutes. Emerging market currencies did not indiscriminately sell-off but had varied performances against the US Dollar. This came even as China retaliated with USD60bn in tariffs on US goods starting Monday.
In previous updates, we noted extended positioning in both US Dollars and the Treasury market as obstacles to further Dollar upside. However, this risk needed a catalyst to reverse and perhaps one is starting to emerge. The global trade war is increasingly a China-centric one. Mexico has come to the negotiating table, Trump’s truce with the EU is holding, and news Tuesday suggested progress in US-Canada trade talks.
It was not financial or commercial channels that were disrupting emerging markets and risk assets but a re-pricing of disruption to the global trade order that had existed for decades, as well as idiosyncratic factors in emerging markets. A global trade war is one that forces US companies to re-shore manufacturing to the US. However, a US-China trade war means US companies are pressured to relocate operations outside of China. Some EM countries may even benefit. The more the narrative moves away from a global trade war to a China-centric war, the more the Dollar loses a source of support, and extended positioning can unwind. Risk assets such as AUD and NZD will also find support.
The main data release Tuesday was the National Association of Home Builders’ (NAHB) Housing Index, which showed stabilisation in home builders’ sentiment in September. The construction sector has been in a broad downward trend in 2018 as affordability concerns, labour supply shortages and rising mortgage costs take effect. However, Hurricane Florence represents a large exogenous shock for the sector. It is likely that coming months will see rising construction activity levels due to reconstruction demand.
For the day ahead, the UK’s August Consumer Price Inflation (CPI) will be Wednesday’s main release. Both the core and headline indexes are expected to continue to moderate as Sterling’s past devaluation continues to fall out of calculations. However, price pressures are building in the real economy; particularly wage growth. This should prevent CPI inflation from slipping below the Bank of England’s (BoE) 2.0% target.
In the afternoon, the US data releases focus on the housing sector, with the Mortgage Bankers’ Association (MBA) Mortgage Applications index for September 14th, August Housing Starts, and Building Permits. The sector is fighting opposite forces; pay rises and increased personal wealth is supporting demand; however, elevated house prices, higher mortgage rates, increased building costs and a shortage in construction labour is leading to a moderation in the sector. July’s leading
Building Permits suggests we’ll see a boost to August’s Housing Starts. However, we expect the overall housing sector story to be continued moderation.
BoE Chief Economist Andy Haldane will also give a speech at the Bank of Estonia on Wednesday. We can usually count on Haldane to be relatively hawkish but the event, a 100th anniversary celebration, means it may be an academic lecture and not touch on current policy. The European Central Bank’s (ECB) President Mario Draghi will also give the keynote lecture at a conference titled Making Europe’s Economic Union Work. After being publicly rebuked for his comments alluding to Italy’s budget, his remarks could provide some controversy.