USD: A bigger rates drop with equities required to hurt dollar

The S&P 500 declined yesterday for the third consecutive day with the tech sector hit by the news that China will broaden its ban on the use of Apple iPhones in certain government departments in government agencies or state-owned companies. Apple’s share price fell 3.0% yesterday and the S&P 500 closed down 0.3% and has fallen 1.5% in the last three trading days. The move helped push yields lower but the scale of the drop in the 2yr UST note yield was modest – down 8bps in two days. The US dollar continued to grind higher despite the drop in US yields with yields falling elsewhere too. The euro-zone GDP revised data provided more bad news with a revision in the Q/Q Q2 gain from 0.3% to 0.1%. Recessionary conditions are close at hand in the euro-zone. The 2yr yield in the UK plunged 10bps with the 3mth decision-maker inflation expectations reading slowing more than expected from 5.2% to 4.9%.

The worsening global backdrop in circumstances of these declines in equity market only reinforce support for the dollar. Our one-month rolling negative correlation of daily percentage changes in the S&P 500 and DXY is strengthening and has reached -0.50 – the strongest correlation since January before the US regional banking sector turmoil when the dollar actually weakened as equity markets fell due to the US-centric nature of that episode. While a larger tech sell-off now would hurt US equities more than elsewhere, the dollar is likely to remain on a strengthening path given the US economy’s stronger position to weather a bout of risk-off.
When you have a scenario of the dollar seeming to perform well in risk-on and risk-off conditions it only adds to the short-term appeal and demand fuelled by the positive momentum. This type of scenario won’t last and certainly a more pronounced risk-off episode (unlikely triggered by this China tech story) would then see yields start to fall more notably in the US and that could then undermine USD demand. But we are far from that scenario and in current circumstances, the likely conclusion is that the US dollar is the best alternative at least until euro-zone growth can stabilise and shows signs of recovery (unlikely) or the US economy starts to show clearer signs of weakness (more likely but not imminent).
The greatest risk now for the dollar is more technical than fundamental. The Bloomberg USD index is set to close this week stronger, which would be the eight consecutive week of gains – the longest run since the index was created in 2005. The DXY weekly run of gains is set to be the longest in nine years. The DXY RSI has just broken the 70-level on the weekly chart, for the first time since September last year when the dollar reached its cyclical peak before correcting sharply lower. Is the long USD trade perhaps becoming crowded?

S&P / DXY NEGATIVE CORRELATION THE STRONGEST SINCE JANUARY

Source: Bloomberg, Macrobond & MUFG Research calculations

JPY: Japan posts record current account surplus

The yen remains close to lows and at levels where the Japan authorities intervened last year to stem the depreciation of the yen. Positive US dollar momentum could well see the market test the resolve of the authorities in Tokyo especially now with USD/CNY breaking more decisively above the 7.3000-level.

But data released today in Japan should serve as a reminder that the outlook over the medium term is not pointing to a sustained move weaker for the yen from here. While we are back close to the highs recorded in September/October last year, Japan’s external position is dramatically different. Today, the seasonally adjusted current account surplus surged to JPY 2,767bn, the largest on record. On an annualised basis, the July surplus equates to 5.8% of GDP over the four quarters to Q2 2023. Looking at the breakdown of the non-seasonally adjusted data, Japan recorded a goods and services deficit and it was the investment income surplus that helped lift the overall balance.
Japan also released labour market cash earnings data which remains a key component in the decision-making for the BoJ on whether Japan can achieve its price stability goal on a sustainable basis. The data was not as weak as the headline reading which revealed a slowdown in cash earnings growth on an annual basis from 2.3% in June to just 1.3%. Some of this slowdown reflects overall pay volatility in overtime and bonuses. What we track and we know what is important for the BoJ is scheduled pay and scheduled pay for full-time employees actually accelerated from 1.7% in June to 1.9% in July – just below the recent but still at levels not seen since 1997.
None of this will really matter from an FX perspective until we see evidence of the US slowing and US yields moving lower. But even without that development, the move higher for USD/JPY will continue to be challenging and surely at these levels, with the fundamental backdrop improving and with Tokyo resistance to JPY weakness building investors will see better long US dollar opportunities elsewhere.