Dollar firm on rate hike fears as global FX markets tumble

Stronger US retail sales data spooked traders this morning, suggesting that the Fed’s rate hikes might need to persist to slow the economy. Against this backdrop, the US dollar was a bulwark amidst a rising currency troubles in China, Japan, Russia and Argentina – a developing story which raises global risk, and one which makes dollar assets more attractive. Of these, weakness in the Argentine Peso and Russian Ruble are perhaps the most worrying, allowing cheaper exports notably of oil and agricultural commodities and undercutting global prices. Our technical analyst James Stanley has focused on the dollar index, DXY, as the best gauge for dollar strength, and we agree that this has become a key indicator for US financial markets.

Bottom-line: risk-off.

TODAY’S MAJOR NEWS

Stronger retail sales data raises risk of another Fed rate hike

The initial market response was that today’s stronger than expected retail sales data will cause the Fed to push interest rates higher for longer, with Fed fund futures currently trading roughly 40% odds of another rate hike by the end of the year. Current interest rates are doing little to slow the US consumer, with the risk that inflation will remain sticky.

• Retail sales rose 0.7% month-on-month in July, ahead of the forecast 0.4%, while the June data was also revised higher to 0.3% gains, up from the 0.2% originally reported
• Retail sales excluding vehicles rose 1.0% month-on-month in July, ahead of the forecast 0.4% growth, and up dramatically from 0.2% growth seen in June
• Fears of another rate hike quickly turned into a focus on problems in the manufacturing sector, with the Empire State manufacturing index falling to -19.0, down from +1.1 the previous month

Dollar’s technical position looks strong

One measure of the attraction of dollar assets is the dollar index, DXY, which rose to 113 a year ago James Stanley has written: “At this stage, resistance has held in DXY at the 103.45 level and this keeps an open door for bulls to continue topside trends, but just as we had looked at with the breakdown in July, the big test here is whether buyers come into hold the move by showing higher-low support.”

China’s economy needs stimulus, but it weakens the Yuan

China’s slowing economy is seriously in need of stimulus but doing so during a time of monetary tightening in the US and elsewhere puts downward pressure on the yuan – precisely when China wants the world to see its currency as an attractive alternative to the dollar as a global currency. The Fed’s longer window between policy meetings provides an opportunity for China’s central bank to cut rates, although doubts remain about its effectiveness given the modest reductions so far.

China’s retail sales grew just 2.5% in July, the lowest increase of the year and below expectations of 4.5%. The entire social sales sector was down 8% month-on-month in July, reflecting sluggish domestic consumption. Sales of clothing, cosmetics, jewelry, telecommunication devices, and autos were down by 22.4%, 45%, 18%, 43%, and 15% respectively month-on-month in July. Furthermore, China quit publishing the unemployment rate for the 16-24 age group when it topped 21% in June, raising fears that it is much higher than that, further slowing consumer spending.

Chinese Yuan tumbles further

• The Chinese yuan fell to 7.29 yuan to the dollar, a fresh nine-month low
• China’s central bank cut its key benchmark rate by another 15 basis points to 2.5%, responding to this week’s poor economic data
• The Shanghai Composite Index fell 1% today, before recovering to close the session near unchanged

Ruble trouble hits commodity markets

The rubles decline to 100 rubles to the dollar was too much for Russian President Putin, who “requested” Russia’s central bank to hike its benchmark interest rate to 12%, up from 8.5%. The ruble was trading near 60 a year ago today, but it pressed above 102 yesterday. The ruble tumbled to 92 on today’s move, before trading back near 98. A weak ruble allows Russia to sell wheat and crude oil at cheaper prices on the world market, hitting commodity prices, but it also makes it very expensive to import items needed to sustain its economy, as well as sustain its war effort.

Russia sets its wheat price at whatever level is needed to undercut the rest of the world, so today’s move isn’t likely to change the volume of wheat coming out of Russia, or crude oil either for that matter. However, Russia has been working with other OPEC+ members to reduce the overall supply of crude oil to prop its cash price prospects to aid in funding its war effort.

It’s usually the case that rate hikes do little to defend a structurally weak currency, and the ruble is no different. The massive interest rate hike has not yet been enough to attract investor interest in a country that is slowly deteriorating under Putin’s war with Ukraine that seems to linger on and on with no end. If anything, the war continues to escalate, draining Russia’s economy in the process.

TODAY’S MAJOR MARKETS

Equity markets sell off, led by Russell 2000

• Equity markets rallied in morning trade, with the Russell 2000 down 1.1%, the S&P 500 off 0.8%, and the Nasdaq off 0.6%
• Global markets were generally weaker, with the Nikkei 225 up 0.6%, while the DAX was down 0.9%, and the FTSE100 off by 1.6%
• The VIX, Wall Street’s fear index, rose back to 16

Dollar and bonds modestly stronger

• The dollar index was up by 0.1% against a basket of currencies to 103.1
• Sterling and the Euro were up 0.4% and 0.1%, respectively, while the Yen was unchanged
• Bonds were stronger, with 2-year and 10-year Treasuries yields at 4.95% and 4.20%

Commodities weak across the board, led by oil

• Gold and Silver prices both fell by 0.3%, to $1,938 per ounce and $22.7 per ounce
• Crude oil prices saw marked profit-taking, falling 2.4% to $80.5 per barrel

• Wheat leads the grain and oilseed sector lower with more than 2% losses
• December corn is poised for a possible test of the July low, while Chicago wheat fell to its lowest level since May
• Additional pressure comes from larger-than-expected increases in the corn and soybean crop ratings released by the USDA

Analysis by Arlan Suderman, Chief Commodities Economist: Arlan.Suderman@StoneX.com

Market outlook by Paul Walton, Financial Writer: Paul.Walton@StoneX.com