In Search of New Incentives

Overview: The global capital markets are subdued. There have been few developments to induce activity. Even President Trump's claims that the talks with China are in the "final throes" failed to excite. Equities are extending their advance. Bonds are little changed, and the dollar is mostly firmer. The MSCI Asia Pacific Index and Europe's Dow Jones Stoxx 600 advanced for the fourth consecutive session. The S&P 500 gapped higher on Monday (~3112.9-3117.4) and has not looked back. It may gap higher today as well. Benchmark 10-year bond yields have edged marginally lower. The dollar is in narrow ranges, but mostly firmer against the major and most emerging market currencies. January WTI is little changed but firm near a two-month high. The API estimate of US oil inventories unexpectedly rose, but the more authoritative EIA estimate is expected to decline by about 880k barrels. Gold is steady but in hugging support around $1450.   

Asia Pacific

The drop in Chinese industrial profits is foreboding. The government reported a 9.9% year-over-year decline in profits in October. It was the third consecutive decline, and at an accelerating pace, and the most in 11 years. Corporate profits have been weak since Q2. After a small rise in July (2.6%), profits fell 2% in August and 5.3% in September. The profit-squeeze is seen as both cause and effect of slower growth. The falling profits and producer prices, reported previously, warns that the second-largest economy has yet to bottom. From an investment point of view, it does not make Chinese stocks attractive, even though one has to expect more action by the PBOC. On the other hand, the sectors sensitive to trade and US tariffs were hit the hardest, while infrastructure-related sectors like mining, railway, ships, aerospace, and transportation equipment did significantly better. Other industries, like beverages, sports and entertainment, and pharma, also reported gains in profitability.  

Consumer confidence in South Korea rose for the third consecutive month in November. It was 92.5 in August and now stands at 100.9, just off the year's highs. The central bank meets tomorrow and is widely expected to stand pat. The ability of many countries in Asia to decouple from China is a subject of much debate.  

If the dollar holds on to today's modest gains against the yen, it would be the sixth consecutive advance and the longest streak of the year. The nearly $1 bln option at JPY109.15 that will be cut in play, while the $790 mln option at JPY109.50 seems out of reach. So far today, the dollar has remained above JPY109.00, where another expiring option for $665 mln is struck. The Australian dollar remains stuck inside Monday's range (~$0.6770-$0.6805) as it was yesterday. When the break comes, the downside is still more likely. Meanwhile, the Chinese yuan as edged higher against the dollar for the third consecutive session but remains in narrow ranges.

Europe

Fresh impulses from Europe are non-existent today. The UK election continues to be monitored, but positions until the actual vote draws nearer positions appear set. Merkel's spirited defense of NATO contrasts with Macron's claim that it is suffering "brain death, and underscores the tension between the two pillars of Europe.  

While the US is on holiday tomorrow, EMU will report money supply and confidence measures. Bank lending to households and non-financial corporations does not appear as weak as the manufacturing sector, which has been hit by reliance on exports amid trade tensions and slowing world economy. Gradually, the business and consumer confidence is beginning to stabilize, but will likely need better real data to support a sustained shift in sentiment. Ahead of the weekend, EMU reports the preliminary November CPI data and a small gain in likely on a year-over-year basis. As we have noted before, the base effect is favorable over the next few months, and this may buy Lagarde and the ECB time before having to make difficult decisions.  

The euro has not been much above $1.1030 this week and so far has held above, even if barely, $1.10. There are options for nearly 2 bln euros struck between $1.0995 and $1.10 that expire today and another one for 770 mln euro at $1.1035. The technical indicators warn a downside break is more likely than a move higher. Sterling is also not going anywhere quickly. Last Friday's range (~$1.2825-$1.2930) continues to confine the price action. Several options in the $1.2845-$1.2870 range expire today and combined have a notional value of about GBP1.12 bln.  

America

The Canadian rail strike ended and without Prime Minister Trudeau forcing the end of it as he did to the postal workers a year ago. With the government's help, a negotiated resolution was reached. This minimizes the economic damage and begins healing Trudeau's relationship with organized labor. Parliament reconvenes on December 5. Trudeau leads a minority government and intends to push for a middle-class tax cut. The Bank of Canada meets on December 4. The signals from Governor Poloz and Deputy Watkins were clearly for staying steady, and the prospect of fiscal stimulus may reinforce the view.

It is not only the US-China phase one trade talks that are said to be nearly over. NAFTA 2.0 is moving forward, albeit slowly. After the Democrats signaled progress with the White House, Lighthizer is due to meet with his counterparts from Canada and Mexico today. A side agreement is sought to strengthen labor and environmental protection enforcement that will win over the Democrat and US union support. Meanwhile, the US is threatening to label the Mexican cartels "terrorists."  

The US economic schedule is jammed today. The most important are the October readings of personal income and consumption, the deflator, which the Fed targets, durable goods orders, and the Fed's Beige Book. The possible revisions to Q3 GDP, pending home sales, Chicago PMI, and weekly jobless claims are less impactful. Income and consumption are both expected to rise by 0.3%. Durable goods orders are expected to have fallen for the second consecutive month in October, and the details are expected to be soft. When everything is said and done, we suspect our back-of-the-envelop estimate for Q4 GDP around 1% is still looking reasonable. The Fed targets the headline PCE deflator (though officials appear to put an emphasis on the core rate). The headline deflator is expected to have ticked up to 1.4% from 1.3%, while the core measure, which strips away food and energy, is forecast to be steady at 1.7%.  

Brazilian officials had indicated by word and temperament that they were comfortable with markets determining the Brazilian real's exchange rate. Economics Minister Guedes, an investor-friendly appointment, said as much 24-hours before the central bank surprised the markets by intervening not once but twice. It was the first intervention in several months. Often, it seems that officials from other countries climb an escalation ladder of intervention, such as words of caution, and verbal intervention before tapping the precious reserves. Before the intervention, the dollar had risen about 6.4% against the real this month alone. The intervention knocked the dollar down from a record high of around BRL4.2770 to about BRL4.2360. There are several pressures on the currency, including the macroeconomic considerations, like the weak economy. There are financial considerations, such as the narrowing rate premium, foreign hedging of equities, and local currency bonds. There are also contagion considerations given the regional instability. The central bank has cut the Selic Rate three times here in H2 by 50 bp a move to 5.0%. It meets again December 11, and if the currency does not recover, a rate cut will be less likely.   

The end of the rail strike in Canada helped the Canadian dollar recover yesterday, and it is firm today. The US dollar settled yesterday below its 200-day moving average (~CAD1.3280) for the first time in five sessions. There has been a little follow-through selling today (to ~CAD1.3265). The technical indicators are turning more positive for the Canadian dollar. Initial support is seen now near CAD1.3230-CAD1.3240. The US dollar set a new high for the month against the Mexican peso yesterday a little above MXN19.59. Sentiment toward the peso has weakened as AMLO seems unable to bolster confidence and the economy. After contracting in three consecutive quarters, the economy stagnated in Q3. Today, the country reports October trade balance (expect sharp deterioration) and unemployment (unchanged on a seasonally-adjusted basis 3.54%). The central bank issues its inflation report. A convincing break of MXN19.60-MXN19.64 could signal a move toward MXN19.78-MXN19.80.  

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