Date: September 21, 2018
Biggest U.S. Premium Over Europe Since ’80s Fails to Help Dollar
Not since the 1980s have U.S. Treasuries had such handsome yield premiums over their German counterparts. Yet none of that widening advantage in recent weeks has helped the dollar, in a disconnect that’s catching analysts’ attention. Prospects for central bank tightening, emergent inflation and solid growth have boosted government bond yields across developed markets this month — but particularly in the U.S., where the 10-year spread over German bunds now exceeds 2.6 percentage points. Wider gaps were only seen in the late 1970s and 1980s, when American inflation averaged 3 percentage points higher than in Germany (versus little difference now), Commerzbank AG says. Part of the dollar’s recent weakness has been explained by a resumption of demand for risky assets, with China declaring that it won’t devalue the yuan and some fund managers saying it’s time to dive back into the likes of Argentina and Turkey. The risk-on sentiment has undermined demand for the greenback as a haven. That could also explain why the yen, another haven asset, has been the only major currency to drop against the dollar this month. But when it comes to the dollar’s retreat against the rest of the key developed-market currencies, some are reading a deeper underlying challenge: diminished appetite for U.S. assets as American fiscal and current-account deficits widen. “Widening dollar-supportive yield differentials should be seen in the context of rising capital import needs. We believe the current yield compensation offered by the U.S. is no longer adequate to attract sufficient foreign funds to cover U.S. capital-import needs,” Morgan Stanley currency strategists led by Hans Redeker wrote in a Sept. 20 note. “The dollar has to decline to attract international funds to the U.S.” Indeed, private domestic investors have had to take up a bigger share of U.S. debt as the Federal Reserve draws down its holdings through the unwinding of quantitative easing. U.S. Treasury data show the smallest share of overseas holdings since 2003.
U.K. Heatwave Lifts Brexit Gloom as Economy Beats Expectations
The U.K.’s scorching summer has pushed the economy’s performance well beyond expectations. Citigroup Inc.’s Economic Surprise index for the U.K., which measures whether economic data have exceeded or fallen short of analysts’ estimates, climbed to 25.5 on Thursday, the highest since January. The gauge has been boosted by a string of reports that have painted a positive picture of the nation’s economy as the summer heatwave boosts consumer spending and business activity following a winter freeze. That better weather is underpinning growth even as a lack of progress in the U.K. Brexit’s talks leaves businesses complaining about uncertainty and economists downgrading their outlooks. This month alone, the Office for National Statistics has reported faster-than-predicted overall expansion, a surprise pick-up in wages and unexpected jump in retail sales. On Thursday the ONS highlighted that the U.K. had seen its hottest summer on record, which has encouraged shoppers to splash out. As the nation heads in autumn, the outlook may turn gloomier. The impact of the heatwave is likely to prove transient, while the bigger question of the U.K.’s future relationship with the European Union remains unresolved.
China Plans Broad Import Tax Cut as Soon as October
China is planning to cut average tariff rates on imports from the majority of its trading partners as soon as next month, two people familiar with the matter said, in a move that would lower costs for consumers as a trade war with the U.S. deepens. The two people asked not to be named because the matter isn’t public yet. Premier Li Keqiang said Wednesday that China would reduce tariffs, though he didn’t elaborate. It’s not yet clear how the planned reduction would affect imports from the U.S., if at all, including Chinese retaliatory tariffs on American products amid the trade war. Those details may only emerge once the government outlines which products will enjoy lower tariffs. Any reduction of tariffs usually must be offered to all countries equally under World Trade Organization rules. The move comes as the nation is trying to stimulate domestic consumption to support a slowing economy, and follows similar cuts to tariffs in July on a wide range of consumer goods. It’s also in step with China’s pledge to support more imports. “This is in line with China’s longstanding strategy of opening,” said Nicholas Lardy, a China expert at the Peterson Institute for International Economics in Washington. “It has the additional advantage that it will make U.S. firms complain more loudly that Trump’s strategy is blocking their access to the China market.” Government ministers have said they will proceed with their own reform agenda, regardless of developments in the trade standoff with the U.S.