Global Macro & FX: Intervention to weaken the dollar unlikely, but cannot be ruled out – US exchange rate policy has been in the spotlight recently, and US Treasury Secretary Mnuchin was quizzed on the topic in a post-G7 finance minister meeting press briefing this afternoon. In his remarks, Mr Mnuchin confirmed that there is no change to the US administration’s dollar policy ‘as of now’, although he did not rule anything out either, stating ‘this is something we could consider in the future’. This followed a tweet by President Trump on 3 July hinting at currency intervention, when he said the US should ‘match’ China and Europe who he accused of ‘playing [a] big currency manipulation game’. We judge that unilateral intervention to weaken the dollar by the US authorities is unlikely, as that there is little chance of it being effective, but given the erratic moves of the administration it is not something we would dismiss outright.
Why we think intervention is unlikely – First, the liquidity of the dollar market is immense, and so it would take enormous firepower for any FX intervention to be effective. Second, the unilateral interventions are typically ineffective beyond the immediate short-term, and in the past it has taken globally coordinated interventions (for instance that resulting from the Plaza Accord in 1985) to have a lasting impact on markets. Given the US dollar is not especially overvalued (it is strong by historic standards, but nowhere near extremes), and given President Trump’s combative rhetoric on the topic, it looks unlikely that the US would be able to persuade key trading partners of the need to intervene in weakening the dollar. Taken together, the case for intervention is hardly a strong one. With that said, the same argument could be made about the effectiveness of trade tariffs, and yet tariffs were nonetheless imposed. We cannot therefore rule out the possibility that the administration goes down this path.
What is the legal framework for currency intervention? The US Department of the Treasury is primarily responsible for exchange rate policy, in consultation with the Federal Reserve (and with the New York Fed executing currency interventions). This is in contrast to the eurozone, where the ECB is primarily responsible for exchange rate policy (although there are as-yet unused provisions for the ECOFIN to direct policy). As such, the US administration is legally within its right to change policy on the dollar and to direct interventions, though there would likely be considerable pushback from the Federal Reserve (and before that, from within Treasury itself) given that intervention would likely be ineffective. (Bill Diviney & Georgette Boele)
Corporate Credit IG: Trade war-exposed corporates disappoint in first weeks of earnings season – We performed a quick analysis on how the second quarter earnings season has been panning out so far. Granted, it is still early days, since only 33 entities within the S&P500 have reported their second quarter, while 39 entities from the European Stoxx 600 have reported. Overall, we see a decent showing by US corporates with roughly 70% beating consensus while 30% missed, whereas Europe looks mixed with nearly 49% missing the earnings mark. The contrast in beats versus misses between Europe and the US does not come as a surprise, since we saw a similar pattern at the end of last year, with Europe clearly lagging the US at a similar rate. Staying with Europe and looking at full year 2019 company guidance, out of the 27 Stoxx 50 constituents which are non-financial and have given earnings guidance in at least the last three months, 20 corporates remain confident in a rise in earnings, 2 expect a flattish trend and 5 expect a decline in earnings (all compared to 2018 actuals).
We are still early into earnings season, and the overall analyst consensus for the second quarter 2019 compared to a year ago still calls for a 4% rise in EPS at the S&P 500 level, and an ambitious 13% rise in EPS at the Stoxx 600 level. We note that since the start of the year earnings expectations have come down in line with leading economic indicators. Therefore, with respect to index level credit spreads, we doubt there will be material downside surprises to corporate earnings.
What also stands out from the first read into earnings season is that industries affected by the trade war (such as machinery makers and companies engaged in transportation of goods) are coming under pressure. Out of the 11 relevant entities from the US and Western Europe, only two companies managed to beat consensus. Obviously it is still early days to judge the earnings outcome for trade war-affected sectors as a whole. Indeed, big names such as Caterpillar, General Electric, Dow Inc and various car makers have yet to report. Still, with bellwether BASF recently issuing a warning shot and citing the trade war as a key driver behind its expected profit slump, we would be surprised to see a change in trend from what we have seen so far. Despite the expected support from the next round of the corporate sector purchase program by the ECB, even in credit a defensive stance to names exposed to the trade war seems warranted.
By Bill Diviney, Georgette Boele, Shanawaz Bhimji
18 JULY 2019.
Source: ABN AMRO