The Storm Continues, Dollar Stabilizes

The global markets are struggling to regain some semblance of stability.  The US dollar is consolidating yesterday's losses and is modestly firmer.   US 10-year Treasury yields have slipped back to near 2.0%, while the 10-year German bund yield has slipped to new record lows, below 75 bp.  Peripheral bond yields are sharply higher 14-18 bp, though Greek bonds remain under sharp pressure, and the 10-year yield has jumped another 85 bp, which brings the five-session increase to almost 200 bp.  

Of note, French bonds are not being dragged higher by the rally in bunds, but instead yields are up six basis points.  Given the logic of the German-French link, this divergence can be a more worrisome sign.  On the other hand, the two-three basis point backing up in 10-year gilts seems to be more of consolidation after yesterday's large move.  The 10-year gilt yield is off 28 bp over the past five sessions, which is the same as the US.  

Equities in Asia continued to fall after sizable losses in the US yesterday.  The MSCI Asia Pacific Index lost about 1.3%, and European bourses are mostly lower.  The Dow Jones Stoxx 600 is off nearly 0.5%.  There main exceptions are the German, UK, and Swedish equity markets, where small gains are being posted.  

Oil prices continue to slide.  The market is focused on two main stories here.  The first is the global slowdown, and the poor US data--retail sales and Empire survey--fed into such anxiety.  The second is the reluctance of Saudi Arabia to assume its traditional role as the swing producer.  Instead, it has cut prices and increased output.   By doing so, Saudi Arabia could be going to next month's OPEC meeting with bargaining chits to re-establish discipline in the cartel.  Saudi Arabia is also delivering a powerful blow to its non-OPEC rivals, which are not just in Russia, and also includes US shale producers.  

The actual news stream is light.  There are two main stories.  The first is the US Treasury report on the foreign exchange market and the international economy.  The big take away is the softening of the US language about the Chinese yuan.  Since its last report back in the spring, the yuan has appreciated, and the US Treasury recognized this.  It still says that the yuan is significantly under-valued, but it acknowledged the new willingness to allow it to appreciate.  Today's the PBOC fixed the yuan at 6.1395, the lowest since March.  

The US Treasury report did not seem to focus on the yen per se, but urged Japanese officials to be cautious about fiscal consolidation (sales tax increase), and discussed the need to boost growth.  South Korea came under continued pressure, and the US Treasury called upon it to accept more currency appreciation.  In Europe, Germany and the Netherlands external surpluses were cited.  It was noted that eurozone surplus exceeds China's a percentage of world GDP.  The German surplus was cited as evidence that more pro-growth policies can be taken.  The US Treasury recognized the recent introduction of minimum wage in Germany, and called for additional measures to boost domestic demand.  

The second main story comes from China.  New yuan loans increased by CNY857.2 bln, which is the most in three-months, and was about 15% larger than expected.  However, aggregate financing was about 10% less than expected at CNY1.050 trillion.  It was, though, the second consecutive month of improvement.  It suggests Chinese officials have made important strides in reining in the shadow banking.  

However, the more interesting element of China's financial news was that reserves unexpected fell by $103 bln in Q3.  It is the first quarterly decline in reserves in two years and is a record decline.  In comparing the change in reserves to the current account surplus, there does appear to have been capital outflows during the period, but not as much as the change in reserves suggest.  The reserves are measured in dollars, and the euro component of China's reserves, lost almost 8% of their value over the course of the quarter.  A conservative estimate would put capital outflows from China in the $25-$30 bln area.  

There are a few other developments to briefly note.  One of the dissenters from the Bank of England, Weale seemed to defend his stance, though said he would take into account the weakness of the euro area.  He continued, though to press with his case that the unemployment rate is the best guide to anticipate wage inflation.  It will be interesting to see if the hawks at the Federal Reserve, like Plosser and Bullard who speak today have modified their position in light of the breakdown in US inflation expectations and softer economic data.  

Italy's cabinet has approved Prime Minister Renzi's 2015 budget, which includes an increase in the deficit to 2.9% from 2.2%.  Reports suggest the European Commission may seek changes.   France is thought in a similar position, but with a larger deficit.  In addition, following Fitch's recent decision to put France's AA+ credit rating on review, it announced it will review ESM (AAA) and EFSF (AA+) ratings as well.  A decision is expected in mid-December on France and the ESM/EFSF. 

The US session features the weekly initial jobless claims, industrial output, the TIC report, the Philly Fed, and several other Fed officials (including Lockhart and Kocherlakota).   The risk is on the downside of the industrial production, though the market is looking for some bounce back (0.4%) after the weakness in August (-0.1%).  We are not as sanguine.  Weakness may come from autos and steel output.  The disappointment with the Empire Survey and the fact that US economy has lost some momentum points to downside risk of the Philly Fed survey as well.