Monday Blues

Overview: The markets begin October with some trepidation.  Rumors continue to circulate about the health of a large European bank, cross currency swaps are elevated, suggest dollars are more difficult to access.  The S&P 500 settled on new lows for the year at the end of last week.  China and South Korea on closed for national holidays. Chinese market will not open until next week, and Hong Kong markets are closed tomorrow.  While the Nikkei advanced, the other large bourses in the region fell.  Europe’s Stoxx 600 is giving back the pre-weekend gain of about 1.3%.  US futures look heavy.  The 10-year Treasury yield, which has risen for the past nine weeks (from 2.65% to 3.83% on a closing basis) is off a few basis points to day to 3.78%.  European benchmark yields are mostly a little firmer, but The UK 10-year Gilt yield is softer around 4.06%.  The dollar is mixed.  The dollar-bloc currencies that were beaten up at the end of last week are better bid today as is the Norwegian krone. Sterling is among the advancers, but the euro, Swiss franc, and yen are nursing around quarter-point losses.  Emerging market currencies are mostly heavier, with some exceptions (Russia, Poland, Mexico, and South Africa).  Gold poked above $1675 ahead of the weekend and has been sold back to around $1660 today and could retest $1650.  The prospects that OPEC+ agree to cut 500k-1 mln barrels of production is helping lift December WTI, which is trading above last week’s highs.  Initial resistance now is seen near $83.00.  US natgas is off by about 1.5%, matching the pre-weekend loss to about $6.65.  The 200-day moving average is near $6.53.  Russia stopped gas shipments to Italy over the weekend and Europe’s natgas benchmark has jumped by about 7%.  It fell 8.8% last week, its fifth consecutive drop.  Iron ore fell 2.5% last week and has begun this week with another 2% loss.  December Copper is off 1.4% to give back the lion’s share of last week’s gain.  December wheat is firm, up 1.5% after 10.8% in September. 

Asia Pacific

Japan's Prime Minister Kishida will not be distracted by the stronger-than-expected August industrial production (2.7% month-over-month) and retail sales (1.4%). It may be the fastest growing G7 economy in Q3. Kishida, though, is pressing forward with a sizeable supplemental budget to be readied by the end of the month.  Other data has not been as supportive.  Today's final September manufacturing PMI was shaved to 50.8 from 51.0 preliminary read and 51.5 in August.  The Tankan survey was mixed, with sentiment among large manufacturers unexpectedly declining, but stronger capex intentions (21.5% vs. 18.6%).  Reports suggest it could be as large as JPY30 trillion (~$207 bln), but many think it can be half that size. Caps on energy and wheat may be extended through Q1 23, and there are expected to be additional cash transfers. Earlier this year, Japan's government had a JPY2.7 trillion fiscal support package that followed the JPY56 trillion budget when Kishida first took office a year ago. Separately, the BOJ announced at the end of last week that it would boost the amount of government bonds it buys in its regular operations. The divergence of policy is not just that most other countries are tightening, but the BOJ is also easing. It is sometimes called Abenomics, but easy monetary and fiscal policy is the traditional LDP approach.    

The Reserve Bank of Australia meets first thing tomorrow and is expected to another half-point hike in the cash rate to 2.85% is favored. The futures market has about a 60% chance discounted.  Further hikes are expected, even at a reduced pace, through Q2 23 and a terminal rate between 4.00-4.25%.  The September manufacturing PMI was revised to 53.5 from 53.9 initially and 53.8 in August. Separately, CoreLogic reported house prices fell in September by 1.4%.  It is the fifth consecutive monthly decline.   

At the end of last week, South Korea's figures showed record intervention to support the won in Q2 of about $15.5 after around $8.3 bln in Q1. A few weeks ago, South Korea seemed interested in new swap lines with the Federal Reserve. Nothing really came of it, and the won remained under pressure. However, a call between South Korea's Deputy Prime Minister and US Treasury Secretary over the weekend seemed more promising. Press accounts suggested that the US could offer new liquidity facilities if the financial instability worsens. This seems like a more practical and efficient approach than for the Fed to adjust its monetary policy, as some economists, including some that previously worked for the Fed itself, advocated for a Plaza-type accord that some others have played up.  Separately, South Korea reported its largest trade deficit over the weekend since 1997 ($3.77 bln).  Exports slowed to 2.8% year-over-year from 6.6% and were a bit weaker than expected.  Imports were stronger than expected though they slowed to 18.6% growth year-over-year from 28.2%.  Exports to China were off 6.5% and to the fell 0.7% to the EU, while shipments to the US rose 16% and 2.5% to Japan.  Semiconductor exports were off 5.7% year-over-year, while auto exports were up almost 35%.  

The dollar has edged over JPY145 for the first time since BOJ intervention on September 22.  The market is treading cautiously, and the greenback reached JPY145.30.  Initial support is seen near JPY144.80.  There is an option for nearly $1.25 bln that expires Thursday at JPY145.50.  After poor price action ahead of the weekend, the Australian dollar held above $0.6400 and tested $0.6460.  The consolidative tone is helpful, but the Aussie needs to rise above the $0.6520-30 area to be anything of note. China and South Korea are closed for national holidays.  South Korea will re-open tomorrow, China not until next week.  The dollar settled near CNH7.1420 against the offshore yuan at the end of last week.  It rose to CNH7.1560 before slipping back to about CNH7.12.  

Europe

Before the weekend, S&P cut its UK sovereign outlook to negative from stable. The rating of AA is a step above Moody's (Aa3) and Fitch (AA-). S&P cited the rising fiscal costs associated with the tax cuts and the rise in borrowing. The widening fiscal imbalance will complicate the challenge of taming price pressures. We think that the communication channel is under-appreciated by some policymakers and many market observers. Despite some claims by a few observers, it still does not look as if the PBOC intervened materially last week, but the impact of its open-mouth policy generated near instant success. The BOE did buy Gilts last week, but a fraction of what it could have done. The BOE's emergency purchases (not for monetary policy but to guard against systemic risk could be for as much as GBP5 bln a day. In three days last week, it could have purchased GBP15 bln but bought a little less than GBP3.7 bln.  Lastly, note that the UK government did pullback from plans to cut the tax on top earners as a compromise the Tory members of parliament.  Lastly, the UK manufacturing PMI was revised to 48.4 from 48.5.  The contraction is happening at a slower pace than in August, when the manufacturing PMI stood at 47.3. 

The eurozone final manufacturing PMI slipped to 48.4 from 48.5 flash reading and 49.6 in August.  German and French final reports were weaker than the preliminary reports. Germany's manufacturing PMI stands at 47.8 from 48.3 flash and 49.1 in August.  France was shaved from 47.8 to 47.7.  It was at 50.6 in August.  Spain was a bit weaker than expected at 49.0, down from 49.9.  Italy's readings were a bit better than expected.  Italy's ticked up to 48.3 from 48.0.  The median forecast (Bloomberg's survey) saw 47.5.  The data does little to expectations that the eurozone has entered a recession.  

There seem to be two crosscurrents. On the one hand, there have been reports of European companies selling assets in the US, with the exchange rate helping to boost returns. On the other hand, there has been talk of European businesses increasing output in US subsidiaries to take advantage of the cheaper energy. RWE, Germany's largest utility, showed another approach this weekend with its $6.8 bln purchase of Consolidated Edison's (NY/NJ) renewable assets. The acquisition doubles RWE's renewable presence in the US.   There has been domestic criticism of RWE's foreign acquisition when the energy crisis has hobbled the German economy. Separately, sometimes cross-border acquisitions are fodder in the foreign exchange market. However, reports suggest the funding will initially be a bridge loan. Given that the dollar is rich by most measures and is taking on a significant dollar asset, it would seem worth considering borrowing the dollars (offsetting the purchase with a liability) rather than buying them.  

The euro is in a half-cent range today above $0.9785.  The pre-weekend high was closer to $0.9855.  The 20-day moving average is slightly below $0.9890, and the euro has not closed above this moving average for two weeks.  Also, the $0.9865 area corresponds to the halfway mark of the leg down since the September 12 high near $1.02.  Sterling extended its recovery off last week's record low near $1.0350.  It recorded the week's high ahead of the weekend around $1.1235 and rose to $1.1280 today.  The 20-day moving average is slightly higher (~$1.1290). It has not closed above the 20-day moving average since August 12.  During last week's panic, several banks issued calls for sterling to fall through parity here in Q4.  We suspect some late shorts are still vulnerable to a squeeze. The momentum indicators on the daily bar charts have more room to run.  That said, the high for the session may be in place, and some backing and filling can see it test the $1.1120-30 area.  

America

There are various measures of inflation expectations. They can be divided into two main groups. The first is survey-based, like the University of Michigan's final September reading at the end of last week. The one-year expectation slipped to 4.7% from 4.8%.  It is still elevated, of course, by has fallen for three months and stands its lowest since last September. The 5–10-year expectation eased to 2.7% from 2.8%, matching its lowest since the end of 2020.  The other measure of inflation expectation comes from the markets themselves. The difference between the inflation-protected security and the conventional instrument is the breakeven rate. The two-year breakeven slipped below 2% ahead of the weekend for the first time since December 2020 and is now below 1.95%. The 10-year breakeven stands at 2.14%, its lowest since February 2021. Many critics claim that Fed has lost its credibility. The breakevens seem to offer a counter.  

The Atlanta Fed's GDPNow is tracking 2.4% Q3 GDP, and today's US reports are unlikely to challenge it.  On tap are the final manufacturing PMI (51.8 flash after 51.5 in August and was the first gain since April), the manufacturing ISM (expected to soften to 52.1 from 52.8) and construction spending, which is expected to have fallen for the third consecutive month.  During the day, September auto sales will be reported, and modest acceleration is expected toward 13.55 mln vehicles (SAAR) from 13.18 mln.  The highlight of the week is the employment report. The median forecast (Bloomberg) is for a 250k increase, which includes 300k from the private sector.  

In addition to a discussion of a liquidity provision by the US, South Korea also reportedly again expressed concern about the Inflation Reduction Act. It offers a tax break on domestically produced EVs to the disadvantage of South Korean (and other foreign) producers. Now the Biden administration is reportedly pressing some of the largest US gasoline producers to limit exports so as not to leave the US vulnerable to a shortage of some fuels. The stock of diesel is particularly low, now about 20% of the five-year average.   In many ways, nationalism marred a stronger and more coordinated response to Covid. Now the world confronts an energy crisis, and while there are some examples of coordination, national actions are dominating. These include Germany's new 200 bln euro "protective shield." It includes an emergency gas and electricity cap and will be financed by borrowing through an off-budget facility (Economic Stabilization Fund). Even though there has been a more unified response to Russia's invasion, the US has been critical that Europe has not done more.  

The US dollar closed at its highest level against the Canadian dollar since mid-2020 before the weekend near CAD1.3830.  It chopped dramatically between CAD1.3600 and CAD1.3840 last week.  It is trading lethargically today between CAD1.3730 and CAD1.3815.  The intraday momentum indicators warn of the risk of test on the highs in the North American session. Canada sees its September manufacturing PMI (from 48.7 in August) but is not typically a market-movers.  The highlight of the week is the trade figures on Wednesday and the employment data on Friday.  The Mexican peso's resilience continues to be impressive.  The greenback spiked to MXN20.58 in the middle of last week and reversed lower to MXN20.1185. It fell to MXN20.05 ahead of the weekend to record the week's low.  Today is slipped fractionally further but appears to be consolidating.  Initial resistance is seen in the MXN20.14-5 area.  Lastly, even though Lula received the most votes in Brazil, he did not receive 50% of the vote and a run-off will be held on October 30.  The dollar rose almost 3% against the Brazilian real last week, its third consecutive weekly advance.  In September, the greenback rose nearly 4.5% against the real, trimming the year-to-date gain to almost 3%.  

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