Dollar index falls to new 10-month low as this year’s downside correction continues
U.S. import prices expected to contribute to tepid U.S. inflation outlook
NAHB housing index expected to remain strong
China’s domestic stocks sink on prospects for tighter regulation and deleveraging
Dollar index falls to new 10-month low as this year’s downside correction continues — The dollar index on Monday fell to a new 10-month low and has now fallen sharply by -8.5% from the 14-1/2 year high posted in early January. The dollar index rallied sharply after the November 2016 election but then topped out in January and has since been on a downward slope. Despite this year’s sell-off, however, the dollar index is still up by a hefty +20% from the mid-2014 level.
In the bigger picture, we view the -8.5% sell-off in the dollar index from January’s 14-1/2 year high as a large downside correction in the context of a continuing secular bull market that began in 2011. The dollar rally began in earnest in 2014 when the Fed started tapering QE3 and the dollar has since gained further underlying support from the Fed’s overall 100 bp rate hike seen since late 2015.
Bearish factors that have caused the dollar index to correct lower this year include (1) disappointment that the Republican growth agenda has not yet translated into tangible results, (2) reduced expectations for Fed rate hikes in coming quarters due to tepid U.S. economic growth and inflation, (3) reluctance by some foreign investors to put money to work in the U.S. due to the White House political uncertainty, and (4) underlying strength in the euro tied to the improved Eurozone economy and the likely end of the ECB’s QE program in 2018.
The euro may well see further strength this year because of the market’s anticipation that the ECB by September or October will announce the tapering of the QE program during the first 6-9 months of 2018. The market is also discounting two 10 bp ECB rate hikes in the second half of 2018. The dollar saw the bulk of its rally as the Fed was tapering QE3, which illustrated how a currency can rally sharply in anticipation of ending QE programs and eventual rate hikes.
However, the Fed remains well ahead of the ECB in its tightening monetary policy cycle, which means the dollar should eventually resume its bull market as the Fed’s tighter policy takes hold. The ECB still has its QE program in progress and has its main refinancing rate pegged at zero, whereas the Fed is on the verge of reducing its balance sheet and has already raised its funds rate target by 100 bp to 1.00-1.25%. The ECB won’t be at that point in its monetary policy cycle for at least several years, giving the dollar plenty of underlying firepower.
U.S. import prices expected to contribute to tepid U.S. inflation outlook — The market is expecting today’s June U.S. import price index to ease to +1.3% y/y from May’s +2.1%. Meanwhile, the June import price index ex-petroleum is expected to move a bit higher to +1.4% y/y from May’s +1.0%.
Today’s expected report of +1.3% y/y headline and +1.4% y/y ex-petroleum would indicate that import prices are still helping to dampen the overall U.S. inflation outlook. However, import prices in theory should be seeing upward pressure from this year’s -6.9% year-to-date decline in the dollar index as importers boost their prices to make up for the weaker dollar.
Inflation is obviously a key topic ahead of next week’s FOMC meeting. The recent decline in the U.S. inflation statistics has thrown the Fed off balance about the outlook for U.S. inflation and whether it should nevertheless charge ahead with its three-rate-hike per year regime. On a 3-month annualized basis, the June CPI was up by only +0.1% headline and +1.0% core, while the May PCE deflator was very weak at -0.5% headline and +0.3% core.
NAHB housing index expected to remain strong — The market consensus is for today’s July NAHB housing market index to be unchanged at 67 following June’s report of -2 to 67. The housing index remains in very strong shape at only -4 points below the 12-year high of 71 posted in March. The strong confidence among U.S. home builders is linked to (1) strong new home sales (only -5.3% below March’s 9-1/2 year high), (2) a record high in new May new home prices ($345,800), (3) a mildly tight supply of new homes on the market (5.3 months vs the long-term average of 6.1 months), and (4) continued low mortgage rates.
China’s domestic stocks sink on prospects for tighter regulation and deleveraging — Chinese mainland stocks on Monday fell sharply after news of the weekend high-level government meeting on financial risk. The meeting produced a new cabinet level committee designed to coordinate financial regulation and the Chinese central bank is also likely to end up with expanded regulatory powers. Chinese President Xi Jinping said after the meeting that “Deleveraging at state-owned enterprises (SOEs) is of the utmost importance.” The meeting focused on reducing risk in the corporate world and in the financial system.
Mainland Chinese stocks on Monday fell sharply on fears that the weekend meeting means that the government might step-up its deleveraging campaign in general and also crack down more on stock trading and wealth management products. The Shanghai Composite index was down -2.6% on Monday’s low, but was then able to partially recover and closed -1.4% after the stronger than expected Chinese economic data was released of Q2 GDP (+6.9%), June industrial production (+7.6% y/y), and June retail sales (+11.0% y/y).
In some good news for the overall Chinese stock picture, however, Hong Kong stocks saw little impact from the regulatory meeting. In fact, the Hang Seng index on Monday rallied to a new record high and closed +0.16% due to the strong Chinese economic data. Hong Kong stocks were partially insulated from the mainland worries because the Hong Kong stock market has tighter regulation, lower valuations, and larger companies.