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Brown Brothers Harriman & Co.

09/17/2021 | News release | Distributed by Public on 09/17/2021 06:09

Dollar Retains Gains as Eventful Week Winds Down

  • August retail sales data are worth discussing; University of Michigan consumer confidence ties into this question about consumption; regional Fed manufacturing surveys for September are starting off strong
  • ECB denied hawkish comments attributed to Chief Economist Lane; new forecasts from last week's ECB meeting are not consistent with the FT story; U.K. reported weak August retail sales; recent weak data should lead the BOE to deliver a dovish hold September 23
  • Lower iron ore prices will impact Australia significantly; Chinese authorities started countermeasures against the Evergrande-led financial stress; energy prices are receding a bit today but the energy crisis in Europe continues; in crypto land, both BTC and ETH are off their recent highs but up 6% on the week, with fundamentals still looking supportive

The dollar is holding on to its recent gains ahead of the weekend. DXY is trading near 92.81 after making a new high for this move yesterday near 93. A break above 93.048 is needed to set up a test of the August 20 high near 93.729. The euro found some support near $1.1750 on reports of a hawkish ECB (see below) but we would fade this bounce. A clean break below $1.1760 is needed set up a test of the August 20 low near $1.1665. Sterling continues to find support near $1.38 despite weak data (see below), while USD/JPY has recovered to test the 110 area after trading this week at the lowest level since August 17 near 109.10. We remain positive on the dollar and are heartened that the economic data this week have supported this view. Next week, we believe the Fed will help keep this rally going.

AMERICAS

August retail sales data are worth discussing. Headline sales were expected to fall -0.7% m/m but instead rose 0.75 vs. a revised -1.8% (was -1.1%) in July, while ex-autos were expected flat m/m but instead rose 1.8% m/m vs. a revised -1.0% (was -0.4%) in July. The so-called control group used for GDP calculations was also expected flat m/m but instead jumped 2.5% vs. a revised -1.9% (was -1.0%) in July. This was an extremely strong report, though downward revisions to July take a little of the shine off. Still, the death of the US consumer has been greatly exaggerated, it would seem. In terms of absolute levels, retail sales ex-autos and control group are at new all-time highs. Bottom line is that despite the runoff of stimulus and softer job numbers and consumer confidence, the US consumer remains very strong. This should give the Fed more confidence to taper before year-end.

University of Michigan consumer confidence ties into this question about consumption. Preliminary September reading will be reported today and is expected at 72.0 vs. 70.3 in August. In light of the strong retail sales and regional Fed surveys (see below), we suspect there are upside risks here. That August reading was the lowest since April 2020 and so some recovery would b welcome. Confidence has clearly suffered from the spread of the delta variant, but also but rising inflation and uncertainty about the economic outlook. Yet despite that, consumption continues to hold up well.

Regional Fed manufacturing surveys for September are starting off strong and will continue to roll out next week. Empire survey came in at 34.3 vs. 17.9 expected and 18.3 in August, while Philly Fed came in at 30.7 vs. 19.0 expected and 19.4 in August. The August Fed surveys were mostly softer but down from historically high levels. Some moderation is to be expected but we see underlying strength continuing in the U.S. manufacturing sector.

EUROPE/MIDDLE EAST/AFRICA

ECB denied hawkish comments attributed to Chief Economist Lane. The FT reported that Lane had told analysts privately that the ECB expects to reach its 2% inflation target by 2025. Official ECB statement said 'The FT story is not accurate. Mr. Lane didn't say in any conversation with analysts that the euro area will reach 2% inflation soon after the end of the ECB's projection horizon.' The FT also cited unpublished internal models that suggest the ECB is on course for lift-off in just over two years. The ECB stressed the that notion 'that a lift-off of interest rates could come already in 2023 is not consistent with our forward guidance.'

We note that new forecasts from last week's ECB meeting are not consistent with the FT story. Inflation is seen falling further below the 2% target in 2022 and 2023. 2024 will be added at the December 16 meeting but we would be shocked if they showed inflation moving back above target. If so, the new forward guidance would suggest no lift-off until 2025 at the earliest!

U.K. reported weak August retail sales. Headline sales were expected to rise 0.5% m/m but instead fell -0.9%. July was revised lower to -2.8% m/m vs. -2.5% previously. Ex-auto fuel, sales were even worse at -1.2% m/m vs. 0.8% expected and a revised -3.2% (was -2.4%) in July. This was the fourth straight month of lower sales and is very disappointing as weakness comes despite the reopening of the economy in July. Last week's data for July was very disappointing and so the August sales data suggest that overall weakness could continue as we move into Q4. Adding to the headwinds will be the expiry of the jobs furlough program this month.

Recent weak data should lead the Bank of England to deliver a dovish hold September 23. Some are looking for a hawkish hold in light of the higher than expected CPI readings, but the bank has been warning that inflation could spike higher before returning close to the 2% target. The spike has been well -anticipated and suggests no hurry to hike and no need to hike aggressively. Updated BOE forecasts won't be made until the November 4 decision. 2024 will be added to the forecast horizon then and will be very important components of the bank's forward guidance. We continue to believe that market pricing for Q1 22 lift-off and two hikes next year is way too aggressive. This should continue to weight on sterling. Cable is on track to test last week's low near $1.3725 and a break below that would set up a test of the August 20 low near $1.36.

ASIA

Lower iron ore prices will impact Australia significantly. The price has tumbled over 50% over the last two months after peaking around $205 per ton in mid-July. At $101 today, this is the lowest since last November and looks set to continue falling as China seems likely to maintain its price controls and reduced steel production. While the May budget assumed iron ore prices would fall to $55 per ton over the next 18 months, the recent plunge (if sustained) has come much quicker than that. A deficit of -AUD106.6 bln is the current forecast for this fiscal year that begin July 1, or -5% of GDP vs. -7.8% last year. The deficit is seen narrowing to -4.6% for next fiscal year but this now seems unlikely. Higher coal prices will help offset lower iron ore prices but it won't be enough. Lastly, this represents a significant terms of trade shock that implied a sizable adjustment in the exchange rate. AUD is down only about 3% since mid-July and that number should probably be higher.

Lower iron ore prices will be a big hit to growth and will also worsen the external accounts. The current account surplus is forecast by the IMF at around 1% of GDP in 2022 and 0.3% in 2023 but a sustained drop in iron ore prices could unexpectedly push Australian into deficit, which is negative for AUD. The potential hit to growth should also keep the RBA in dovish mode, with current forward guidance of lift-off in 2024 at the earliest likely to be maintained for the now.

As expected, Chinese authorities started countermeasures against the Evergrande-led financial stress. The PBOC added some RMB90 bln ($14 bln) in short-term liquidity, the first add over $10 bln this month and the largest injection since February. Note, however, that aside from the Evergrande story, it wouldn't be unusual for the PBOC to boost liquidity ahead of the October holiday and quarter end. We expect a lot more activity from China's policymakers and still believe lowering RRR again is amongst them. Chinese equity markets were mostly higher and the yuan little changed.

COMMODITIES AND ALTERNATIVE INVESTMENTS

Energy prices are receding a bit today but the energy crisis in Europe continues. Major European companies such as BASF and Airbus as well as the UK fertilizer industry are facing increasing problems due to the energy supply shock. CPI will surely see some impact from higher prices, but we are also facing the risk of blackouts as the weather gets colder. Brent is up over 3% on the week and natural gas up 7.2% in the U.S. and far more in Europe.

In crypto land, both BTC and ETH are off their recent highs but up 6% on the week, with fundamentals still looking supportive. There are a few different forces at play, including an estimated $200 mln of BTC options expiries today, so higher volatility around here is expected. Under the hood, markets are seeing a steady rise in stable coins moving into the system, implying inflows that could be deployed into active positions soon. Moreover, ETH burns (supply reduction) remains strong with over 300k ETH ($1.1 bln) tokens burned since the EIP-1559 launch. There has been some cooldown in NFT activity and a lot of discussion about insider trading at the big platform Opensea, but this seems unlikely to dramatically change the NFT growth cycle.