Dollar Rides High into Month-End

The US dollar is firm against the major currencies and nearly all the emerging market currencies as well to close out the week (and month) Participants are clearly focused on next week's events, and in particular, the prospect of additional easing measures by the ECB.  Also, next week's speeches by Yellen and the monthly jobs report is expected to underpin expectations for the Fed's lift-off in the middle of December.  

However, before those events, China is very much center stage.  The Shanghai Composite slumped nearly 5.5%, and the Shenzhen Composite lost 6.1%, the largest losses since August's rout.  The proximate cause appears to be news that the three top brokers are under investigation in part of the larger anti-corruption campaign.    News that corporate profits fell 4.6% in October after a 0.1% decline in September also weighed on investor sentiment. 

The dollar rose to two-month highs against the yuan while the gap between the offshore (CNH) and onshore (CNY) yuan widened to about 0.9%.  This is the widest since early-September.  Although the PBOC is thought to have tried to minimize the gap before it reached this magnitude in the past, its agents have not been seen.  Perhaps some of the tolerance are linked to speculation ahead of Monday's IMF decision.  That the yuan is included seems to be a forgone conclusion.  The issue now is the weight it is given in the basket.  

In a report over the summer, the IMF staff suggested that if just exports are used for the calculation of the yuan's role in the SDR, given that the yuan's share of global reserves is very low (~1.1%), the weighting would be 14%-16%.  However, the use of the yuan is well below the other members of the SDR basket (dollar, euro, sterling and yen).  The market consensus, according to one newswire is for about a 10% weighting.  We suspect that it may be a bit lower.  For Chinese officials getting in is the important thing.  The weighting is less significant.  It can be confident that as the yuan's role in the global economy increases, so will its weight in the SDR.  

Some observers are linking the weakness of the yuan to the anticipation of a smaller weighting, but as we have noted, there is also speculation that after the formal SDR decision is made, Chinese officials will allow the yuan to depreciate.  However, we note that the yuan has been steadily falling since the start of November.  Officials do not appear to be waiting.  We also that this month, the US dollar has risen against all the major currencies, but the Australian dollar and all the emerging market currencies save Brazil and Malaysia.  The same macro-considerations that lift the dollar against other currencies are also operative against the yuan.  

Japanese data was mixed, and those thinking the BOJ will be forced to expand its asset purchases next year are unlikely to be discouraged by today's reports.  For the third consecutive month, Japan's core inflation (excludes fresh food) was -0.1% on a year-over-year basis.  It has not been above zero since June.  Despite this being the formal target measure, the BOJ has looked past the decline in oil prices and finds some comfort in its measure of inflation that excludes food and energy, which it stays was steady at 1.2% though the MOF calculations differ (lower).  

The BOJ may also find solace in the continued tightening of the labor market.  The unemployment unexpectedly fell to 3.1% from 3.4%.  This is the lowest rate in two decades.  The job/applicant ratio remained at 1.24, the highest since mid-1992.   However, it was disconcerting to learn then that household consumption fell 2.4% in October (year-over-year) after a 0.4% decline in September.  It was the poorest report since March.  Since the beginning of last year, household consumption on a year-over-year basis has only been positive for four months.  

This is where Abe's supplemental budget comes.   Reports today suggest a JPY3.5 trillion package, which is a little more than had been suggested previously.  The supplemental budget may include support for poor pensioners and a hike in the government's minimum wage.  Extra budget around this size is relatively common in Japan.  

Turning to Europe, the political tension from the Iberian peninsula may be easing.  This may be helping Spanish, and Portuguese bonds outperform today.  In Spain, the Finance Minister from Catalonia encouraged negotiations with Madrid rather than pushing the secessionist route.  In Portugal, the new government promised to comply with EU rules but remains committed to modifying some of the previous government's austerity measures.  

Separately, Spain reported that its harmonized inflation measure improved to -0.4% from -0.9% in October.  The Bloomberg consensus had expected somewhat less improvement (-0.7%).  Deflationary forces are easing quicker than the year-over-year figures suggest.  In the last three months, the harmonized measure of Spanish inflation has risen at a 3.6% annualized rate.  

This does not impact the outlook for the ECB next week.  The ECB is focused what it sees as too slow of improvement on inflation.  The market expects a deeper push into negative territory with the deposit-rate ( perhaps a two-tier system, which seems to us to punish German and French banks which among the largest depositors at the ECB), increased asset purchases, and a six-month extension of the purchase program.  Although it has been suggested that the ECB could buy sub-sovereign debt or even distressed loans, we are not convinced that an agreement on these can be hammered out.  However, the ECB could increase the agencies that qualify.  

Details of the UK's Q3 GDP, which was left unrevised at 0.5%, are interesting.  The key to growth was government spending, which rose 1.3% in the quarter, added 0.3 percentage points to growth. Government spending increased 0.9% in Q2.  These details come on the back of the Autumn Statement where the government's budget was less austere than expected, given its majority status and rhetoric.  Business investment rose 2.2% after a 1.6% increase in Q2.  This added about 0.2 percentage points to GDP.  Household spending rose 0.8% matching the Q2 increase.  

The net export function was the worst since records began in the late-1970s.  Exports rose 0.9% but were overwhelmed by a 5.5% increase in imports.  This drag too off 1.5 percentage points from GDP.   Part of the problem, economists think, is the growth differential in the UK's favor, which contributes to the trade imbalance.  Sterling's relative strength is also a headwind, and the market continues to take sterling lower.  

Sterling was sold toward $1.5030, nearly matching the low seen earlier this month, which itself was the lowest level since late-April.   Meanwhile, the market is still adjusting its interest rate expectations, and the December 2016 short-sterling futures contract is edging to new highs for the month (new lows in implied yields).  

Lastly, we note that the Swiss franc is the weakest of the major currencies against the dollar today.  It has slipped about 2/3 of a1% amid ideas that the SNB will quickly follow any ECB easing.  Its next scheduled meeting is December 10.  There is some talk of intervention today, but 1) it may be confused with month-end flows and 2) it cannot be confirmed. Today the dollar is trading at new five-year highs against the Swiss franc.  The next immediate target (tough to call levels not seen since 2010 resistance) is CHF1.0360-CHF1.0400.  Since mid-October, speculators have tripled their gross short franc position in the futures market.   

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