Dollar Heavier to Start Week

The US dollar is trading heavier against most of the major and emerging market currencies. The euro and sterling remain within the ranges seen before the weekend while dollar slipped to JPY107 in a Tokyo-less Asian session. 

Unanticipated strong Chinese imports helped underpin the Australian dollar. Most Asian equities followed the US lower, though the recovery in Europe may have helped lift Indian shares in late dealing. European shares gapped lower but managed to recover by mid-morning. Bond markets were firmer in Asia and weaker in Europe, though UK gilts are notable exception, slipping to new lows (since June 2013) below 2.20%.

Neither French nor Finnish bonds show much reaction to the pre-weekend announcement by S&P.  It took Finland's AAA status away and cut France's outlook to negative from stable.  France's 10-year is flat at 1.25%, and Finland's yield is up less than half a basis point.    Greece's government survived the vote of confidence just before the weekend, but this has not removed the pressure on Greek bonds, where the 10-year yield is up 8 bp to a new three-month high near 6.55%.  

The main news today appears to be about China.  First, it reported strong rise in imports and exports, and a substantial trade surplus that a quarter smaller than expected.  Exports rose 15.3% in September from a year ago.  This follows a 9.4% increase in August, and expectations for a 12.0% increase.  This is the strongest since February 2013, when there was still much suspicion of Chinese companies using exaggerated exports to hide capital flows.  Imports unexpected rose 7% in September.  The consensus was for a 2% decline after a 2.4% decline in August.  Details were sketchy, but electronic imports appeared strong, but commodity imports and autos were soft. 

Second, the ECB indicated that it was considering adding Chinese yuan to its reserves.  We have been skeptical of the talk of the internationalization of the yuan.    While we recognize its increased use, we find much of the reports grossly exaggerated.  For example, Hong Kong is part of China, as the Hong Kong people realize full well, yet when the trade is conducted in yuan, many observers count that as part of the internationalization of the yuan, but is it really?  The network of swap lines it has established are interesting, but they have not been used.  It is as if it is not appreciated the logic of the dollar swap lines and the role of dollar funding in this (we are told) G-Zero world. 

Yet, central banks holding yuan as reserves is indeed the internationalization of the yuan.  However, we caution here too that the exaggerations distort the real developments.  First, there are simply insufficient yuan assets, which is what reserves are kept in, available for the yuan to be a major currency.  Second,a small amount of yuan in reserves is consistent with the broad pattern of some diversification into "other currencies".  Third, it is not a zero-sum game.  As reserve holdings overall increase, the yuan can be accommodated without the sale of another currency.  This also means that an increase in the yuan may come at the expensive of other currencies, not necessarily the dollar.  In the ECB's case, maybe the yen or sterling, for example. 

In any event, recall that China is working to establish a few financial centers, including London and Frankfurt to clear yuan trades.  The UK recently indicated it will sell its first yuan bond for reserves, and the ECB's plan to explore the issue seems broadly consistent with this.  It is not alarming, nor does it signal the imminent demise of the dollar.  

Brent oil continues to trade heavily.  The Saudis and the Iranians have cut prices for Asia.  Oil from Africa, like Nigeria, which was once one of the top five suppliers to the US, has diverted supplies to Asia in the face of weakening US imports.  Kuwaiti officials indicated over the weekend that OPEC was unlikely to agree to cut output to support prices at next month's OPEC meeting.  Note that OPEC's agreement is for 30 mln barrels  a day.  Estimates suggest it produced 30.474 mln bpd.     Kuwait's oil minister was quoted suggesting that $76 a barrel may be the new floor for prices.