RBA Surprises

Overview: US Treasury yields were slipping, but the weaker than expected manufacturing ISM, which included the slowest rise in price paid since March, sent the 10-year yield below 1.15% and the 30-year below 1.83%.  The yen appears to be the most sensitive of the major currencies to US yields, and the drop in yields saw the dollar trade down to  JPY109.20 and post its lowest close since early June.   US equities pared early gains, which had lifted the Dow to new record highs before reversing lower, and both the Dow and S&P 500 finished lower.  Asia Pacific shares were mixed, with Taiwan, South Korea, and India (Nifty 50 closed at a record high), among the large markets advanced, while Japan, China, and Australia slipped.  Europe's Dow Jones Stoxx 600 is extending its gains into record territory, led by energy and health care.  US futures point to a higher opening, while US bonds are consolidating, and the 10-year yield is hovering below 1.20%.  European bonds are snapping their rally with a 1-2 bp gain today.  That said, Greek bonds are extending their advance today, with the 10-year benchmark yield off for the ninth consecutive session.  The Norwegian krone and the Antipodean currencies are leading the move against the dollar, though near midday in Europe, the yen, euro, and Canadian dollar are less than 0.2% changed on the day.  Most emerging market currencies are mostly firmer against the dollar.  Gold is consolidating in a narrow band within yesterday's range, stuck between the 200-day moving average (~$1820) and the recent lows ($1805).  Crude oil prices are stabilizing after yesterday's retreat.  Near $71.80, WTI for September delivery is about 0.80% higher after dropping 3.6% yesterday, the most in two weeks.  Copper is trading off for the third consecutive session and the fifth in the past six.  The CRB Index fell by more than 1% yesterday for the second consecutive session.  

Asia Pacific

The Reserve Bank of Australia surprised investors by sticking to its plan to reduce its bond purchases next month.  Starting next month, the RBA will buy A$4 bln a week of bonds, down from A$5 bln currently.  Governor Lowe argued that once the virus is contained, the economy responds quickly.  The slower pace of bond buying will continue through mid-November before another opportunity to taper opens.  The RBA will update its economic forecasts at the end of the week.  Still, Sydney, which accounts for a quarter of the country's GDP and a little more than a fifth of employment, has been in lockdown for the past five weeks and has reported a record number of cases.  Lowe was adamant, though, that the conditions that would allow a rate hike are not anticipated until 2024.  The market appears to be discounting a hike in 2023.  

Tokyo's core CPI, which excludes fresh food, rose to 0.1% in July, its first positive reading since last July.  However, the gain seems to reflect higher energy prices, and without fresh food or energy, Tokyo's CPI remained at zero year-over-year.  The headline rate actually slipped to minus 0.1% from zero in June, which was the highest since last September.   Japan has not escaped deflation, but officials seem to have stopped doing more to turn it around. 

Chinese officials took another swipe today, calling gaming a "spiritual opium," and companies in that ecosystem, including Tencent, fell. Subsequently, the South China Morning Post reported that the reference has been deleted "because its attack against the industry does not represent Beijing's official stance." Ironically, investors using the "connect" links reportedly bought about $3 bln of Chinese shares in the four sessions through yesterday.  On another front, Beijing announced an investigation into the possible price manipulation of makers of semiconductor chips for autos.  The State Administration for Market Regulation is focused on prices but also on companies "hoarding" chips.

More than any other single factor, the drop in US yields seems to explain why the dollar is back near JPY109.00.  It has not traded below there since late May.  The expiring option at JPY109.25 today, about $330 mln, offered little support. A convincing break of JPY109 targets the JPY108.50 area. The unexpected decision by the RBA to reduce its bond purchases briefly lifted the Australian dollar above the cap at $0.7400.  The Aussie stopped a little short of last week's high, near $0.7415, and it has not closed above $0.7400 since mid-July.  The 20-day moving average, which it has not closed above since June 10, is found at $0.7400 today.  Support is seen in the $0.7350-$0.7360 area.  The Chinese yuan remains in a narrow range today, with a slightly heavier bias.  It eased today for the third consecutive session.  The price action reinforces the lower end of the dollar's range near CNY6.45.  The PBOC set the reference rate at CNY6.4610, near the median projection in the Bloomberg survey (CNY6.4609).    

Europe

The US 10-year yield fell by nearly 25 bp last month, the most since Q1 20. The German 10-year yield also fell 25 bp last month to minus 46 bp.  The yield has fallen for the last five sessions coming into today, where the yield is about two basis points higher.  Germany's 30-year yield fell back below zero for the first time in six months, but with today's gain is ever so slightly positive. At the short end of the coupon curve, the German two-year yield fell 10 bp in June to minus 77 bp (the US 2-year yield fell by about 6.5 bp to almost 18 bp).  It has fallen for the past 12 sessions coming into today, and the streak is at risk.  Italy's 10-year yield fell by 20 bp in July and fell another five basis points yesterday, at 57 bp it is at its lowest level since February.  The quest for yield and reduced perceptions of "redenomination risk"  (leaving monetary union) has seen an impressive rally of Greek bonds.  Since May, Greece's 10-year yield has traded through (below) Italy.  The yield fell by 22 bp in July and started August with a 3.5 bp decline to 56 bp. It is extending its drop for the ninth consecutive session today.   

The eurozone's June PPI rose 1.4%, in line with expectations, which lifted the year-over-year rate to 10.2% from 9.6% in May.  The acceleration may have taken some of the wind for the bond sails, but it is typically not a market mover.  Tomorrow, the eurozone sees the final service and composite PMI readings and the June retail sales report.  Growth in the region still appears to be accelerating. 

Two other developments are notable.  First, Hungary's finance minister, a moderate, warned that the country whose relationship with Brussels is strained could reconsider its EU membership when it becomes a net contributor of funds.  The EC is threatening to hold back funds and possibly even fine Hungary for breaking the rules regarding the independence of the judiciary and media and social rights.  Second, Turkey reported an acceleration in July's CPI, which puts the central bank in an awkward position when it meets next week. President Erdogan wants lower rates, but the 1.80% monthly rise in CPI lifted the year-over-year rate to 18.95% (from 17.53% in June).  The one-week repo rate stands at 19.00%.  A politically pressured rate cut may preserve Governor Kavcioglu's job, but it could spur new lira sales, which feeds through to domestic inflation.  

The euro is moving sideways in a narrow range.  In fact, the euro remains within the range set last Friday (~$1.1850-$1.1910).  There is an option at the lower end of the range for around 840 mln euros that expires today.  The market appears to be waiting for fresh incentives, which do not seem likely to materialize today.  Sterling had approached $1.40 at the end of last week, but it too has not been able to sustain the momentum. Instead, it has carved out a shelf in the $1.3875-$1.3880 area.  It faces an initial cap near yesterday's high, around $1.3935. 

America

News that Republican Senator Graham, one of the ten Republican senators to support the material infrastructure compromise, has contracted Covid, and this could see a delay in the Senate vote.  In any case, the House is not going to take it up until it returns from its recess next month.  Before the recess began, the House failed to extend the moratorium on evictions. Treasury Secretary Yellen will meet with Democrat legislators today to see what can be done to expedite the distribution of the $46.5 bln in federal rental assistance.  Most of the funds are not believed to have been distributed, and the bottleneck looks to be at the state and local government levels.  

The US reports June factory orders and durable goods orders today, but with Q2 GDP out last week, outside of some knee-jerk headline risk, the market is unlikely to take much notice.  July auto sales will be reported through the day.  There is risk that auto sales slowed for the third consecutive month.  Auto sales peaked in April at a 18.51 mln seasonally adjusted annual pace. They fell to 15.36 mln in June, and the median forecast in Bloomberg's survey is for a 15.25 mln unit pace last month.  It would be the slowest pace since last August.  The slowdown reflects the shortage of supply due to chips and other parts.  

Part of the rally in Treasuries may reflect the likely reduction of supply going forward.  Yesterday, the Treasury's announced its anticipated borrowing in H2, and it was almost $150 bln less than it projected in May.  Plus, the Federal Reserve is buying $240 bln a quarter in Treasury bonds, which is expected to continue through at least the next several months.  Tomorrow, Treasury announces the details of its quarterly refunding.  The newest Federal Reserve Governor Waller suggested yesterday that a couple more employment reports like the 850k reported in June could get the Fed to begin tapering in October.  Moreover, Waller suggests the pace of tapering could be considerably faster than the $10 bln a month seen after the Great Financial Crisis.  

Canada sees the July manufacturing PMI today.  The recovery peak so far was set in March at 58.5 but fell to 56.5 in June, slipping each month in Q2.  Still, the Canadian economy seems to be recovering again, and this should be reflected in today's report.  Canada reports June trade figures on Thursday ahead of the employment report on Friday, where the median forecast (Bloomberg survey) now sees 165k jobs growth after a nearly 231k increase in June.    Mexico reported stronger than expected worker remittances yesterday at $4.44 bln, underscoring its importance as a source of capital inflows.  The Markit manufacturing PMI remained below the 50 boom/bust level as it has been since last February. The next significant report is the July CPI due next Monday, but barring a significant surprise, Banxico is expected to hike rates when it meets again on August 12.  Yesterday, Brazil reported an uptick in its manufacturing PMI (56.7 vs. 56.4) and a smaller than projected July trade surplus as imports rose and exports fell.  June industrial production figures are on tap today ahead of tomorrow's central bank meeting that is expected to result in a 100 bp hike in the Selic rate (to 5.25%). 

The Canadian dollar is slipping for the third consecutive session.  The greenback found support at the end of last week near CAD1.2420 and tested the CAD1.2525 area in late Asian turnover.  Several expiring option strikes today include about $310 mln at CAD1.2505 and almost $470 mln at CAD1.2540.  The big one, for $1.28 bln, is struck at CAD1.2480.  Meanwhile, the greenback remains confined to the recent range against the Mexican peso of roughly MXN19.80 and MXN19.94.  The intraday momentum indicators seem to pave a probe higher in North America today after the dollar found bids in the European morning near MXN19.83.   

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