Since the plunge following North Korea's latest missile firing, the dollar has rocketed higher on the heels of a collapse in the JPY (BoJ?) and this morning on a dump in the EUR (after leaked jawboning from ECB) for the biggest 3 day swing since December.
Is this the start of a trend reversal in the dollar?
RBC's head of cross-asset strategy, Charlie McElligott, believes the risks of a tactical dollar reversal are growing...
WHAT IS THE OPPOSITE OF A ‘GROWTH SCARE?’
A data ‘triple-whammy,’ as
1) yesterday’s ‘big’ US data (ADP beat and + revision, along with GDP strength especially noted within the ‘Consumption’ sub-index),
2) this morning’s Euro-area CPI beat (highest reading in four-months, largely due to energy prices),
and 3) the overnight ‘strong’ Chinese PMIs (Manufacturing beat with the highest ‘Input Prices’ since Dec ’16, while Service PMI slipped but ‘still expansive’ at 53.4)
...are behind further re-risking overnight.
BUT ‘BEGGAR-THY-NEIGHBOR’ STILL MATTERS MORE
What is remarkable is that this data has been overshadowed via a 6am-ish EST ECB jawboning attempt to weaken the Euro, with Reuters running a ‘sources’ story stating that the strong Euro is “worrying a growing number of ECB policymakers,” which in-turn “increases the chance of a delay in their QE decision, or a more gradual exit from asset purchases.”
And this ‘warning-shot’ at the bottom of the piece is so special that it need-be highlighted - as it not only discusses the potential to ‘loosen’ the ‘capital key,’ but also discussed the potential to buy additional asset classes, including stocks and / or NPLs (!!!):
“It could further relax a requirement to buy bonds in proportion to each country's ECB shareholding, or include new asset classes such as stocks, as raised in July by one policymaker but not given consideration, or non-performing bank loans.”
As such, EURUSD traded down ~70pips from earlier session highs, while periphery spreads to Bunds tightened across boards.
THIS IS A POTENTIALLY HUGE DEAL, AS IT COULD ‘PAUSE’ THE ‘POLICY CONVERGENCE’ MACRO REGIME SHIFT WHICH HAS DRIVEN THE US DOLLAR BREAKDOWN
As the US Dollar bears the brunt of the Euro jawboning selloff, we see US equities futures come off their earlier best levels, while EU equities squeeze back near highs of the day on the currency weakness.
And this crystalizes exactly why this ECB ‘gamesmanship’ is so important…because as the macro regime over the past four months has shown signs of transitioning from ‘Policy Divergence’ (of the past 3+ years) into the recent thinking around ‘Policy Convergence’ (as ‘rest of world’ pivots ‘less dovish’ while Fed stays ‘on message’), the US Dollar has melted-down. If the ECB were to begin ‘backing away’ from the stance that Draghi ‘messaged’ at Sintra in late June, the ‘weak USD’ trade loses its largest input.
DOLLAR REVERSAL RISKS?
And to the point I made in last Friday’s ‘Big Picture,’ a reversal of this 'weak Dollar' trade--which again could really pick-up speed dependent upon today’s and tomorrow's data (core PCE, NFP and AHE)--is a risk to this relatively undisturbed ‘weak USD’ macro trend YTD. This ‘smooth glide-path’ with macro has driven the low cross-asset volatility, with ‘weak Dollar’ having been a key driver behind this perfect ‘momentum’ market (especially QTD) based around a ‘Slow-Flation’ economic worldview.
Case-in-point, 12 month US equities ‘momentum’ is the best-performing traditional ‘factor’ market-neutral strategy QTD and posted its best quarter-return since 2Q16, while in FX, the DB Currency Momentum Excess Return strategy index has posted its best QTD performance in two years as well. ‘Smooth sailing’ indeed for momentum and carry strategies, which means more leverage / allocation into them.
So what else is exposed to a reversal / squeeze higher in USD?
- Obviously, ‘weak US Dollar’ has been the ‘other side’ of Euro (+12.6% YTD vs USD), Cad Dollar (+6.2% YTD), Aud Dollar (+9.4% YTD), Swedish Krona (+13.7% YTD) strength on 'policy convergence;’
- ‘Weak USD’ also critical to 'long US equities’ (size rallies in US exporter / mega-cap heavies Nasdaq / FAANMG / Dow) vs underweight 'tightener equities’ trade (Aus stocks -1.8% since mid-April; German DAX -3.1%; Cad stocks -3.3%; Swe stocks -3.5%);
- ‘Weak Dollar’ too has contributed to the fixed-income / rates rally and enormous ED$ curve flattening (in conjunction with the weak inflation data, of course)—TY has seen its best quarter (+1.2%) since 2Q16;
- ’Weak Dollar has contributed to the explosion move higher in EM equities (EEM +28% YTD, +8.1% QTD alone);
- 'Weak Dollar’ has benefited US ‘Growth’ (‘growth longs’ +19.2% YTD) and ‘Low Vol’ (‘defensive longs’ +13.6% YTD) factor outperformance via ‘slow-flation’ economic view driving lower yields which makes ‘growth’ and ‘low risk’ look like ‘havens’ vs cyclical-heavies ‘Value’ (‘value longs’ only +4.5% YTD) and ‘Size’ (IWM only +2.6% YTD) dynamic;
As noted by my FX colleague Cilline Bain this week, the DXY has now defended its major support band, setting off technical fireworks which produced both a bullish Doji reversal and a Demark 13 count, which produce tactical upside target levels of 94.15 at the 223.6% retracement resistance and from there, 96.28. As I write, DXY is making new session highs and has retraced 61.8% of the 30 day selloff in just 2.5 sessions.
My view has been that in light of the EU data trajectory and prior guidance, the ECB was going to be forced to clarify their tapering plans in the Fall (either Sep or Oct meeting). This in conjunction with the still ‘murky’ US inflation outlook would then continue to perpetuate ‘weak Dollar’ behavior into Q4…which then would ironically act as a (+++) catalyst for long-awaited inflation and / or ‘wages’ beats that in early ’18 would force multiple G10 central banks into a shrinking window to tighten financial conditions (either through tapers or rate hikes). This in turn could then finally introduce sustained volatility into the market place in 1Q / 2Q18.
Without a doubt, this POTENTIAL ‘fall-down’ by the ECB introduces a very significant risk to my above outlined worldview. The start of September’s ECB meeting now takes on even more ‘weight’ with the direction of the global macro trade. In the meantime, we focus on US inflation and wages data to sustain or arrest this nascent Dollar counter-trend rally which is looking increasingly asymmetric.