USD: US-China growth divergence lifts USD/CNY close to last year’s high

The US dollar has continued to strengthen overnight resulting USD/CNY moving to within touching of last year’s high at 7.3274. The US dollar has benefitted from the move higher for US yields yesterday triggered by the release of the stronger than expected ISM services survey for August which has reinforced investor confidence over a pick-up in US growth in Q3. The contrast between improving cyclical momentum in the US in comparison to weakening growth momentum in China and Europe has been an important driver behind the US dollar’s current upward momentum. The ISM services survey revealed that business confidence unexpectedly increased by 1.8 point to 54.5 which was the highest reading since February. The employment and prices paid sub-components were also favourable for the US dollar as both increased by 4.0 points and 2.1 points respectively. It has prompted the US rate market to price in a higher probability of one final hike later this year and to scale back rate cut expectations for next year. The probability of one final Fed hike later this year has moved back closer to a 50:50 call, and the amount of cuts priced in by the end of next year has fallen back to around 88bps. Almost one 25 bps rate cut has been priced out since the weak NFP report at the start of the month.                     

The US dollar rally could gain upward momentum more broadly if USD/CNY breaks above last year’s high. As Bloomberg is highlighting today, policymakers in China are continuing to support the renminbi in an attempt to slow the depreciation. The PBoC has set the daily fix at a stronger than expected level for the 54^th consecutive trading day at 7.1986. It is the longest run of stronger than expected daily fixes since Bloomberg started the survey in 2018. However, the measures on their own are unlikely to prevent further upside for USD/CNY while the US dollar is strengthening more broadly and unless there is an improvement in investor sentiment towards the outlook for China’s economy. The release of the latest trade report from China overnight did reveal some modest improvement in August but is not sufficient to materially ease growth concerns in China. The report revealed that the contractions in  annual export and import growth both eased to -8.8% and -7.3%. The trade surplus has been relatively stable over the last year at USD863 billion. Speculation has increased recently that domestic policymakers could eventually allow the renminbi to devalue more significantly to help provide more support for growth from net trade. However, their actions to support the renminbi suggest a gradual depreciation path is favoured as they remain wary of encouraging a sharp pick-up in capital outflows.     

USD/CNY WITHIN TOUCHING DISTANCE OF LAST YEAR’S HIGH

Source: Bloomberg, Macrobond & MUFG GMR

CAD & GBP: BoC policy update & BoE Governor Bailey comments in focus

The other main economic event yesterday was the BoC’s latest policy meeting although the impact on the Canadian dollar has been muted. The BoC delivered a hawkish hold  as the policy rate was left at 5.00%, but the hawkish guidance failed to prevent USD/CAD from hitting a fresh high yesterday at 1.3676. In the accompanying statement, the BoC explained that their decision to leave rates on hold this month was supported by recent evidence that excess demand in the economy is easing and given that they expect past monetary to keep hitting the economy with a lag. The much weaker GDP report released for Q2 including the downward revision to growth in Q1 has given the BoC more confidence that the Canadian economy has entered a period of weaker growth. It should reduce the need for the BoC to hike rates further. However, the BoC continued to provide hawkish guidance signalling that it is prepared to raise rates further. It is clear that there  main concern is the persistence of underlying inflation pressures that have shown little downward momentum recently and are running at about 3.5%. The BoC also flagged that headline inflation is likely to be higher in the near-term on the back of the recent rise in gasoline prices before easing again. Overall, the policy update does not alter our forecast for the BoC to leave rates on hold this year. While the Canadian dollar has continued to weaken against the US dollar, it has been performing better compared to other G10 currencies. Since the dollar index bottomed on 18^th July, the Canadian dollar has been the second best performing G10 currency supported by the improving US cyclical outlook and the higher price of oil.               

Market expectations for monetary policy in Europe were also impacted yesterday by comments from ECB and BoE officials. The comments from BoE Governor Baily have weighed down on the pound resulting in cable back towards the 1.2500-level and EUR/GBP rising up to the 0.8600-level. He stated clearly that rates are probably “near the top of the cycle” with a “definitely a substantial amount of transmission to come” from past rate hikes. He is of the view that there is a longer transmission in this tightening cycle, and that the lags are longer which is something they have to factor in to their policy decision. The comments along with those last week from Chief Economist Pill who favours a leaving rates at a higher level for longer rather than continuing to hike rates support our forecast for one final hike for the BoE this month. The UK rate market had been expecting the BoE to hike the policy rate up to a peak of 6.00%, but is in the process of scaling back those expectations. With around 50bps of further hikes still expected, we see room for disappointment and a weaker pound.