Greenback Firms

Overview:  The US dollar is firmer against all the major currencies and most emerging market currencies, extending the recovery seen after the Federal Reserve's rate hike.  Despite the poor finish for US equities yesterday and declines in Japanese and Chinese shares today, the MSCI Asia Pacific Index eked out a small gain.  European bourses were on the defensive, the Dow Jones Stoxx 600 off almost 0.5% in late morning turnover.  Core bond yields are softer after, though budget uncertainty in Italy is weighing on the country's assets, and pushing peripheral yields higher.  

Central Banks:  Following the Fed's hike, Hong Kong as widely expected matched suit with a 25 bp increase.  A couple of large banks in Hong Kong lifted their prime rates by 12.5 bp.  The PBOC, which on occasion this year has followed Fed hikes with a small token move, refrained from action today.  The Reserve Bank of New Zealand kept policy steady, as had been anticipated.  The Philippines central bank and Taiwan held monetary policy, while Indonesia delivered a 25 bp rate hike (seven-day reverse repo rate to 5.75%.  The rate hike did not prevent the rupiah from edging lower.  

Euro:  The single currency had poked through $1.18 at the end of last week and earlier this week.  However, no follow-through buying materialized and except for a week ago (September 20), the euro has been unable to close above $1.1750.  The inability to rally left late longs vulnerable and some were washed out on the move to $1.1685 today, a five day low.   There are a 1.2 bln euro $1.1700 option and a 1.7 bln euro $1.1750 option that is expiring today.   

Italy: The Italian budget is turning into a cliffhanger and investors do not like it. The outcome may not be known until well into the US afternoon.   Italy's two-year note yield is up 12 bp today, and the 10-year yield is up eight.  Italian stocks are underperforming and the 1.5% loss near midday is the largest in a month.  Bank shares are 3% lower,  The issue comes down to this:  the Five-Star Movement and the League made campaign promises for a new transfer program for the poor and elderly and lower flatter tax, but centrists, like the president, prime minister, and finance minister want to avoid antagonizing investors, like seen in May--and submit a budget deficit of 2% or less of GDP.  Separately, Italy raised 5.25 bln euro in debt instruments today, and the bid-cover looked solid.  Over the remainder of the year, it reportedly needs to raise another 34 bln euros while nearly 55 bln euros in debt is maturing, providing positive dynamics unless there is a dramatic loss of investor confidence.  

Germany: German states reported September  CPI figures, and the firm readings warn of upside risks to the median forecast (Bloomberg) of the national figures that will be reported late in the local session.  The median forecast was for a 0.1% increase in the harmonized measure for a 1.9% year-over-year pace.  Instead, a reading of 2.0%-2.1% seems likely.  Moreover,  it does not look like it is only energy prices, as Saxony reported a small acceleration of the core rate as well.  

Eurozone Money Supply:  The ECB reported a more dramatic slowing in money supply (M3) growth to 3.5% from 4.0%.  It is the weakest pace of M3 growth since November 2014.  However, the ECB officials will likely find comfort in the fact that the lending to non-financial businesses rose (4.2% from 4.0%) and households (3.1% from 3.0%).  Separately, economic, industrial, and service sentiment softened.   

Trade:  The US and Japan have reached an agreement to hold bilateral trade talks.  President Trump has said that any agreement will be better than the current one.  Trump wants to focus on autos and agriculture.  Japan, which is in other trade agreements, cannot give the US better terms than it has given under these agreements.  The other large trade issue is NAFTA.  At a press conference, yesterday said he rejected a request for a meeting by Canada's Prime Minister Trudeau.  Canada denies that such a request was made.   The point, however, is that the Trump Administration is going forward with a bilateral agreement with Mexico, setting up a showdown with Congress.  Trump continues to threaten to levy on a tax on car and car parts that are exported from Canada, largely by US companies.

Canadian Dollar and Yen:  The US dollar dipped below CAD1.29 at the end of last week and is now probing last week's highs near CAD1.3060.  The next area of resistance is seen near CAD1.31.  The dollar posted a potential key reversal yesterday against the Japanese yen by 1) making new highs for the move, and 2) selling off and closing below the previous day's low.  The greenback was unable to resurface above JPY112.90 in Tokyo and fell to almost JPY112.55 in early European turnover.   There are about $1.28 bln in options struck at JPY112.40-JPY112.50 that expire today and $950 mln at JPY113.00.  

Sterling:  The pound is trading heavier against the US dollar for the second session, and its three-day advance against the euro is in jeopardy.  It takes a break of the $1.3050 area to be of much technical significance.  Nearby resistance is seen near $1.3100. The euro ran into offers at the end of last week and start of this week near GBP0.9000.  It retreated to GBP0.8900, where some bids have been found.   May delivers a key speech at the Tory Party Conference next week which is seen at the next important Brexit event.  There continues to be talk of a leadership challenge.  

FOMC Recap:  The Fed may have provided little fresh information yesterday.  However, it may have boosted investors' confidence in what they already knew or thought they knew.  According to the CME's model, the market has discounted almost an 80% chance of a hike in December and Fed's dots show 12 of the 16 officials see a hike as likely appropriate then as well.  The Fed thinks it will raise rates into 2020, peaking in around 3.25%-3.50%.  The market is less sanguine.  It appears that many are expecting rates to peak around the middle of next year.  Consider that implied yield of the June 2019 Eurodollar futures contract is 3.0% and the implied yield of the June 2020 contract is 3.175%.  The difference is less than the cost of funding. 

Accommodating:  For several years the FOMC statement has characterized the Fed's stance as accommodative.  This was dropped in yesterdays statement.  The significance should not be exaggerated.  Powell himself said at the press conference that monetary policy was still accommodative.  And he gave a clear, pragmatic definition.  If the Fed funds target is below what the Fed regards as the long-run rate (the median of which rose to 3.0% from a little below 2.90%), then the monetary setting is accommodative.  By that metric, policy will become neutral to toward the middle of next year. 

US data: The FOMC meeting steals the thunder of the high-frequency economic data the US will report today.  The August merchandise trade report, durable goods orders, and inventory data will help sharpen Q3 GDP forecast.  Tomorrow consumption data will be more important still.   Although Q2 GDP revisions may be too historical for investors' tastes but is a useful reminder of the economic optimism at the Fed.  The median forecast is for the economy to grow by 3.1% year-over-year.  To achieve this, the growth has to accelerate from the 2.75% pace in H1. 

Strategic Oil Reserves:  There had been speculation that OPEC's decision not to boost oil output more than it had previously agreed despite US demands would encourage the Trump Administration to tap into the strategic reserves.  Energy Secretary Perry said this was not going to happen shortly after the North American oil trading had ended for the session, but immediately WTI jump. It is trading 1% higher today, while Brent is 0.6% stronger.   WTI  had recorded session lows around the time of the Fed's announcement after the EIA showed an unexpected rise in oil inventories (1.85 mln barrels).  It is the first increase since early August.  On the continuation futures contract, the key level is near $76.55, which is the 61.8% retracement of the decline from the 2014 high.  The high for the year was set in July near $75.25. 

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