Sterling's Losses Lead Dollar Rally

Overview: The US dollar is enjoying broad gains against most major and emerging market currencies.  Sterling, dragged down by Brexit concerns, is leading the way.  With today's losses, sterling has shed nearly 3.7 cents over the last four sessions.  The euro, for its part, is at a new 17-month low (~$1.1250).  Market talks suggest that that large double no-touch option by a large sovereign, which had seen to be defending the $1.13 area may have expired.  Equity markets are mixed.  In Asia, the Nikkei gained, but the Topix did not.  The greater China markets (China, Hong Kong, and Taiwan) moved higher, but most others did not.  In Europe, the Dow Jones Stoxx 600 is off about 0.4% near midday.  The only sectors that are advancing today are energy and materials.  Oil prices are struggling to maintain the upside momentum is seen in Asia in response to the OPEC gathering over the weekend that is expected to lead to less oil supply next month.  Saudi Arabie has indicated it will export 500k barrels a day less starting in December, as it tries to reassert its role as swing producer.  Benchmark 10-year yields are a little lower today, though the rally in Gilts leading the way, with the 10-year yield off four basis points.  The weaker sterling and lower rates are underpinning the internationally-exposed FTSE 100.  

Asia Pacific 

 Last week Japan reported a dreadful core machinery orders report for September.  The 18.3% plunge on the month was more than twice what economists had projected and the largest on record.  Today Japan followed up with a poor October machinery orders data.  The 1.1% year-over-year decline is the first fall in nearly two years. Foreign orders are off 2.5% year-over-year.  A key challenge here is China.  

While the October data does not come with a country breakdown, the September data showed Chinese orders fell 22% and was the seventh consecutive decline.  Chinese orders are at around half of last year's peak. Many observers link it to the rising trade tensions, but the reality may be more complicated.  Japanese projects n China, such as helping build semiconductor plants in China, are nearing completion.  China's capital investment cycle may be an under-appreciated factor.   

For the third consecutive session, the dollar is straddling the JPY114.00 area.  While Asia took the dollar to JPY114.20, the highest level since October 4, Europe took it back down, perhaps related to the drop in equities.  The high for the year so far is about JPY114.55.  Initial support is seen near JPY113.80.  The dollar-yen rate is also sensitive to US bond yields.  The US cash Treasury market is closed today for Veteran's Day.  There are a couple of options expiring today for dollar-yen.  There is a $450 mln option at JPY114.00 and a $365 mln option at JPY114.25 that will be cut today.  

The dollar edged higher against the Chinese yuan.  On November 2, the greenback closed near CNY6.89.  By the end of last week, the dollar had risen to CNY6.9560.  Today's it is pressing CNY6.97.  There continues to be much talk about the CNY7.0 level, which some Chinese officials had previously signaled was an important threshold that they did not want to see crossed.  However, some confuse this with a cap of significance, though we are not convinced it was ever meant to signal a change in the dirty float to a currency floor regime.  The dollar's gains against major currencies cannot be resisted for long.  There is some suspicion that China may be trying to avoid a break of that level ahead of the Trump-Xi meeting later in the month.  

Europe

While some European officials, like EC President Juncker, is still sounding optimistic that an EC-UK deal can be struck in the coming weeks, the market has grown more skeptical.  The resignation of the pro-EU transportation minister  (Jo Johnson) at the end of last week would seem to represent a new challenge for May.  It is not simply the EU skeptics and hard-Brexit camp that are opposed to May, like the transportation minister's more famous brother Boris Johnson.  There is talk of other potential cabinet resignations.  

The key issue is the Irish border, and how long the backstop guarantee must be operative and the problem is that it could be indefinite, which was behind Jo Johnson's comment that May's plan leads to either "vassalage or chaos."   Euroskeptic Rees-Mogg proposed an alternative.  The UK would pay half the divorce bill of GBP20 bln to ensure the most amicable separation that would follow the 21-month transition period, in which everything remains the same.  

The risk is that what would make an agreement with the EU possible would not be acceptable to the UK parliament, even if May is able to jam it through the cabinet.  An exit next March without an agreement means no transition phase either.  Perceptions of the increased risk of this weigh on sterling.  There is little to prevent sterling from returning to the lower end of the recent range in the $1.2660-$1.2700 area.  However, today, an expiring option for GBP656 mln at $1.2810 may slow the descent. 

The prospects of a no-deal separation are negative for the euro as well.  The euro has broken below $1.13 today and is recording new lows since the middle of last year.  There are a couple of other factors today as well, including the expiration of an option structure that had helped make support at $1.13 so formidable.  Germany's SAP has agreed to pay $8 bln in cash for a US software company (Qualtrics) that specializes in surveys and analyzing employee data.  There are also reports suggesting the ECB is concerned about German's Commerzbank, which has been the subject of rumors that have been denied, of a tie-up with Deutsche Bank.   

The euro is approaching our next important technical target, which is found a little below $1.12 and corresponds to the key retracement of the euro's rally last year.  Ahead of it, there is a 1.1 bln euro option expiring today at $1.1250.  The downside momentum stalled as the European morning progressed. We suspect that the old support-$1.13-now becomes resistance and there is another 1.1 bln euro option that is struck there that expires today.  Reports suggesting Italy is preparing to make a couple minor compromises (including lowering its optimistic growth forecast for next year and possibly automatic offset its the 2.4% deficit target is breached) does not look to have persuaded investors and Italian bonds are underperforming today.  

North America

The US Veterans Day holiday means that traders will not have the cash Treasury market to assist in the price discovery process today.  The economic calendar is light for the US and Canada.  San Francisco Fed's President Daly gives a speech late in the session on the US economy.  Many market participants may not be familiar with her views and work and are still trying to locate her on the hawk-dove spectrum.  

The Dollar Index is at new highs for the year (~97.60).  The 97.85 area represents a major retracement of last year's decline.  The cyclical peak recorded in January 2017 was near 103.80.   The greenback is trading in a narrow range near CAD1.32.  The pre-weekend close above there was the first since July.    Typically in a strong US dollar environment, the Canadian dollar gains on the crosses.  

The Mexican peso is under pressure.  Although the President-elect AMLO has played down the effort by his allies in the Senate to ban certain bank fees, like on ATM transactions, has hit local bank shares and European banks with a significant presence in Mexico.  The strength of the US dollar added to the pressure on the peso.  The central bank meets later this week, and a 25 bp hike in the overnight rate to 8.0% is likely.  It may not be sufficient to prevent another test on the MXN20.50 area that held last week.  

Disclaimer