Big Dollar Squeeze Remains In Effect

Wednesday August 3: Five things the markets are talking about

The dollar has fallen to its lowest level since the U.K.’s vote to leave the European Union due to the markets growing scepticism about policy makers’ efforts to boost growth and as oil prices hover around their three-month lows.

Investors are worried that last Friday’s weak GDP figure makes it less likely that the Fed will raise interest rates before the end of the year. Federal-funds futures are pricing in a +37% chance of an interest-rate increase at the Fed’s December meeting and only a +12% probability of a hike in September.

Both U.S. growth and the prospect of low interest rates continue to provide investors a good excuse to sell the dollar, at least until the market sees some strong economic numbers. Perhaps this Friday’s non-farm payroll (NFP) will be the dollars catalyst?

Currently, worries about the U.S. economy have been overshadowed by fresh stimulus efforts from the Reserve Bank of Australia (RBA) and the Bank of Japan (BoJ) over the past week. The day’s that the domestic currency underperforms after a policy change seems to have gone. The USD remains down against both the AUD and JPY even as the RBA cut interest rates in a bid to spur job creation and increase inflation, while the BoJ underwhelmed capital markets with modest stimulus measures.

Next up is the Bank of England (BoE) tomorrow. Will the pound continue to its stride higher despite Governor Carney delivering what’s expected, a -25bp interest rate cut and £50B of additional QE? One gets the feeling that the market remains very short sterling, with little love for those positions, a disappointing BoE could encourage a further unwind in the short term.

1. Japanese officials keep verbal intervention active

As an export dominated economy, Japan has always relied on a weak domestic currency for growth. However, the latest modest fiscal and monetary package from PM Abe’s government and the Bank of Japan (BoJ) is surely confounding Japanese authorities – yen has rallied nearly +2% outright this week (¥101.00).

Japan’s MoF, BoJ and FSA officials met overnight to discuss the markets. Vice-Finance Minister of International Affairs (currency chief) Asakawa stated that they were “seeing one-sided movements in currency markets and that they continued to watch markets carefully.” It has been five years since Japan actually intervened in the FX market and authorities are concerned about being labeled a ‘currency manipulator’ if they did so.

Dealers believe that its only a matter of time before the USD breaks again below the psychological ¥100 barrier – it last briefly slipped following the U.K’s vote to leave the EU on June 23.

That was an extraordinary move, todays yen move higher is gaining steadily on fundamental factors, like Japan’s improving current account balance and the fading impact of BoJ’s multi-dimensional easing – Japanese authorities upped the amount of its exchange-traded fund purchases, but underwhelmed the markets by holding off from increasing the amount of government bonds its buys every month.

2. Global bourses see red

Global stocks are on the back foot for a third consecutive day this week, depressed by growing nervousness surrounding central bank policy and the recent spike in world bond yields.

Yesterday, Japan announced a fresh stimulus package that included +¥13.5T in fiscal measures. It’s a headline package that has disappointed Asian investors. Japanese equities are leading the way this week, pushed down nearly -2% overnight by the recent surge in Japanese government yields (10-year JGB’s near flat) and the strength of the yen (¥101.00).

Already in Europe, generally positive earnings releases from the financial sector pre-market are providing some support to the Eurostoxx, but is failing to lift the broader Euro indexes. Commodity and mining stocks are again weighing on the FTSE 100 – front month WTI contract maintains its stance below the psychological $40 a barrel handle.

Note, a loss for Dow industrials today would add to a string of seven straight losses, the longest losing streak in about a year.

Indices: Stoxx50 -0.2% at 2,903, FTSE -0.1% at 6,636, DAX -0.2% at 10,120, CAC-40 -0.6% at 4,303, IBEX-35 flat at 8,280, FTSE MIB +0.3% at 16,139, SMI -0.3% at 7,987, S&P 500 Futures -0.2%

3. Central Banks credibility test

Global sovereign yields are little changed today (U.S 10’s +1.533%, Gilt 10’s +0.80%, Bunds -0.40%), but still well up from their recent lows following the shakeout in debt markets globally since the BoJ’s policy meeting last week. Investors now turn their attention to the BoE rate decision tomorrow.

The aggressive back up in global yields suggests that investors are losing confidence in central banks monetary policy. Is the multi-year ‘bull run’ in prices finally coming to an end? Just look at JGB’s, they have suffered the worst sell-off in over three-years as investors fear that the BoJ is running out of easing ammunition.

Bond bulls are now worried that the BoE might also under-deliver at its policy meeting tomorrow, and just like the BoJ, and put the onus on debt-funded government spending to support growth.

The BoE should cut rates, because not doing it would have an adverse effect on its credibility. But where does sterling go to from here? Record ‘short’ positions would indicate that the pound (£1.3362) would have difficulties depreciating if Carney does not go deep enough.

4. Commodities

Crude prices looked to be gathering a head of steam in early Asia trade on the prospect of a drawdown in U.S. crude stockpiles, but not so fast, prices continue to gravitate to their three-month lows on a global supply glut.

Brent crude has rallied +$0.26 to $42.07 a barrel, while WTI has gained +$0.34 to $39.74.

Week to date, U.S. oil prices have fallen -5.15%, as domestic stocks of gasoline have been usually high for this time of the year. Investors will look towards today’s EIA report (10:30 EDT) for market direction. The release is expected to show a small decline in inventories (-1.6m), but after last week’s build broke a run of nine consecutive weekly falls, a similar result would be bearish for crude prices.

5. Fed speaker and U.S data to dominate proceedings

Chicago Fed President Charles Evans is expected to speak to news outlets at 1 p.m. EDT.

This morning’s ADP data could offer some insight into last months labor market performance – the reading of “private sector” hiring in July is due at 8:15 a.m. EDT. Market consensus estimates an addition of +170k jobs.

At 9:45 a.m. EDT, Markit will release its final reading on activity in the services sector in July. The preliminary reading showed the PMI print a five-month low of 50.9. The ISM services sector index is due at 10 a.m. EDT – consensus expects a reading of 56.

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