Overview: The euro traded below parity for the second time this year and sterling extended last week’s 2.5% slide. While the dollar is higher against nearly all the emerging market currencies, it is more mixed against the majors. The European currencies have suffered the most, except the Norwegian krone. The dollar-bloc and yen are also slightly firmer. The week has begun off with a risk-off bias. Nearly all the large Asia Pacific equity markets were sold. Chinese indices were a notable exception following a cut in the loan prime rates. Europe’s Stoxx 600 is off by around 1.20%, the most in a month. US futures are more than 1% lower. The Asia Pacific yields rose partly in catch-up to the pre-weekend advance in US yields, while today, US and European benchmark 10-year yields are slightly lower. The UK Gilt stands out with a small gain. Gold is being sold for the sixth consecutive session and has approached the (61.8%) retracement of the rally from last month’s low (~$1680) that is found near $1730. October WTI is soft below $90, but still inside the previous session’s range. US natgas is up 2.4% to build on the 1.6% gain seen before the weekend. It could set a new closing high for the year. Gazprom’s announcement of another shutdown of its Nord Stream 1 for maintenance sent the European benchmark up over 15% today. It rose almost 20.3% last week. Iron ore rose for the first time in six sessions, while September copper is giving back most of the gains scored over the past two sessions. September wheat rallied almost 3% before the weekend and is off almost 1% now.
Asia Pacific
Following the 10 bp
reduction in benchmark one-year Medium-Term Lending Facility Rate at the start
of last week, most observers expected Chinese banks to follow-up with a cut in
the loan prime rates today. They delivered but in a way that was still surprising. The
one-year loan prime rate was shaved by five basis points to 3.65%, not even
matching the MLF reduction. On the other hand, the five-year loan prime rate
was cut 15 bp to 4.30%. This seems to signal the emphasis on the property
market, as mortgages are tied to the five-year rate, while short-term corporate
loans are linked to the shorter tenor. The five-year rate was last cut in May and
also by 15 bp. Still, these are small moves, and given continued pressures on
the property sector, further action is likely, even if not immediately.
In addition to the
challenges from the property market and the ongoing zero-Covid policy, the
extreme weather is a new headwind to the economy. The focus is on Sichuan, one of the most
populous provinces and a key hub for manufacturing, especially EV batteries and
solar panels. It appears that the aluminum smelters (one million tons of
capacity) have been completed halted. The drought is exacerbating a local power
shortage. Rainfall along the Yangtze River is nearly half of what is normally
expected. Hydropower accounts for a little more than 80% of Sichuan power
generation and the output has been halved. Officials have extended the power
cuts that were to have ended on August 20 to August 25. Factories in Jiangsu
and Chongqing are also facing outages. According to reports, Shanghai's Bund
District turned off its light along the waterfront.
Europe
Gazprom gave notice at the
end of last week that gas shipments through the Nord Stream 1 pipeline would be
stopped for three days (August 31-September 2) for maintenance. The European benchmark rose nearly 20.3%
last week and 27% this month. It rose 35.2% last month and 65.5% in June. The
year-to-date surge has been almost 380%. The energy shock seems sure to drive
Europe into a recession. The flash August PMI out tomorrow is expected to see
the composite falling further below the 50 boom/bust level. Bundesbank President
Nagel, who will be attending the Jackson Hole symposium at the end of this week
recognized the risk of recession but still argued for the ECB rate increases to
anchor inflation expectations. The record from last month's ECB meeting will be
published on Thursday. There are two keys here. First, is the color than can be
gleaned from the threshold for using the new Transmission Protection Instrument.
Second, the ECB lifted its forward guidance, which we argue is itself a type of
forward guidance. Is there any insight into how it is leaning? The swaps market
prices in another 50 bp hike, but a slight chance of a 75 bp move.
The German 10-year breakeven
(difference between the yield of the inflation linked bond and the conventional
security) has been rising since last July and approached 2.50% last week. It has peaked in early May near 3% before
dropping to almost 2% by the end of June. It is notable that Italy's 10-year
breakeven, which has begun rising again since the third week of July, is almost
25 bp less than Germany. Several European countries, including
Germany and Italy, have offered subsidies or VAT tax cut on gasoline that have
offset some of the inflation pressures. Nagel, like Fed Chair Powell, BOE
Governor Bailey, and BOJ Governor Kuroda place much emphasis on lowering wages
to bring inflation down. Yet wages are rising less than inflation, and the
cost-of-living squeeze is serious. They take for granted that business are
simply passing on rising input costs, including labor costs, but if that were
true, corporate earnings would not be rising, which they have. Costs are being
passed through.
Later this week, the UK
regulator will announce the new gas cap for three months starting in October. Some reports warn of as much as an
80% increase. It is behind the Bank of England's warning that CPI could hit 13%
then. The UK's wholesale benchmark has soared 47.5% this month after an 83.7%
surge last month. Gas prices in the UK have nearly tripled this year. The UK's
10-year breakeven rose by 38 bp last week to 4.29%, a new three-month high.
Although the UK economy shrank slightly in Q2 (0.1%), the BOE warned earlier
this month that a five-quarter recession will likely begin in the fourth
quarter. Unlike the eurozone, the UK's composite PMI has held above the 50
boom/bust level. Still, it is expected to have slowed for the fourth month in
the past five when the August preliminary figures are presented tomorrow.
The euro and sterling
extended their pre-weekend declines. The euro slipped below parity to $0.9990. The multiyear low set
last month was near $0.9950. The break of parity came in the early European
turnover. Only a recovery of the $1.0050-60 area helps stabilizes the tone. Speculators
in the futures market extended their next short euro position in the week
through August 16 to a new two-year extreme and this was before the euro's
breakdown in the second half of last week. The eurozone's preliminary August
composite PMI due tomorrow is expected to show the contraction in output deepened
while the market is expecting the Fed's Powell to reinforce a hawkish message
on US rates. After falling to almost $1.1790 before the weekend, sterling
made a marginal new low today, closer to $1.1780. The two-year low set last
month was near $1.1760. The $1.1850-60 area offers an initial cap. Strike activity
that hobbled the trains and underground spread to the UK's largest container
port, Felixstowe, which handles about half of the country's containers. An
eight-day strike began yesterday. Industrial activity is poised to spread, and
this is prompting Truss and Sunak who are locked in a leadership challenge,
to toughen their rhetoric against labor.
America
This is a busy week for the
US. First, there is
supply. Today features $96 bln in bills. Tomorrow sees a $60 bln three-week
cash management bill and $44 bln 2-year notes. On Wednesday, the government
sell another $22 bln of an existing two-year floating rate note, and $45 bln
five-year note. Thursdays sale includes four- and eight-week bills and $37 bln
seven-year notes. There are no long maturities being sold until mid-September.
The economic data highlights
include the preliminary PMI, where the estimate for services is forecast
(median in Bloomberg's survey) to recover from the drop below the 50 boom/bust
level. In the middle of
the week, the preliminary estimate of July durable goods is expected. Shipments,
which feed into GDP models is expected to rise by 0.3%. The revision of Q2 GDP
the following day tends not to be a `big market movers. Friday is the big day. July
merchandise trade and personal income and consumption measures are featured. Like
we saw with the CPI, the headline PCE deflator is likely to ease while the core
measure proves a bit stickier. Shortly after they are released, Powell addresses the Jackson Hole gathering.
Canada has a light economic
diary this week, but Mexico's a bit busier. The highlight for Mexico will be the biweekly CPI on
Wednesday. Price pressures are likely to have increased and this will encourage
views that Banxico will likely hike by another 75 bp when it meets late next
month (September 29). The July trade balance is due at the end of the week. It
has been deteriorating sharply since February and likely continued.
The US dollar rose more than
1% against the Canadian dollar over the past three sessions. It edged a little higher today but stopped
shy of the CAD1.3035 retracement objective. Initial support is seen near
CAD1.2975-80. With sharp opening losses expected for US equities, it may
discourage buying of the Canadian dollar in the early North American activity. The
greenback is rising against the Mexican peso for the fifth consecutive session.
However, it has not taken out the pre-weekend high near MXN20.2670. Still,
the next important upside technical target is closer to MXN20.3230, which
corresponds to the middle of this month's range. Support is now seen near
MXN20.12.
Disclaimer
Reviewed by Marc Chandler
on
August 22, 2022
Rating:
