Biden-Xi "Summit" Leaves Markets Unmolested, While Bailey Continues to Blame Investors for Misunderstanding Him

Overview: The much-heralded Biden-Xi meeting left little impression on the capital markets.  Equities in the region were mixed, and China's main markets fell, alongside Australia, South Korea, and India.  European equities continue their upward market, with the Stoxx 600 gaining for a fifth consecutive session. US futures are softer.  The bond market is quiet, with the US 10-year yield softer slightly below 1.60%.  European benchmark yields are 1-2 bp lower and the periphery is outperforming the core.  Encouraged by a strong employment report, sterling is the strongest of the majors, gaining about a third of one percent.  Most major currencies are trading with a heavier bias, and the euro is pinned near 19-month lows.  The dollar is gaining against most emerging market currencies.  The Turkish lira is off more than 1.5% as the market prices in a 100 bp cut on Thursday.   Hungary's disappointing Q3 GDP (0.7% vs. 1.0% forecasts) may limit the aggressiveness of the central bank today.  A 30 bp hike after two 15 bp moves was expected.  Gold is extending its rally and has taken out the downtrend drawn off the January and June highs (found ~$1872 today).  The next target is around $1900.  Oil is firm, and the January WTI contract is straddling the $80-level.  European natural gas is rising as new supplies are low, and there is a further delay in the certification process of the Nord Stream 2 pipeline.   Yesterday's 9% advance has been extended by another 8% today.  Iron ore has steadied, while copper is struggling after falling 1% yesterday.  

Asia Pacific

There is not much to say about the Xi-Biden "virtual summit."  The call reportedly lasted three hours.  The one concrete thing to emerge is that US business executives will have an easier/quicker time entering China.  Separately, Hong Kong's Chief Executive used her regular briefing to justify the decision to allow JP Morgan's CEO to skip the city's 21-day hotel quarantine because of the size of the bank's operations.  This speaks to the difference between the rule of law and the rule by law that some observers make.  Returning to regular meetings between the senior officials from both countries seems to be the logical way forward, but both sides appear to draw domestic benefits from demonizing the other.  In the US, the Biden administration uses the threat of China to justify building a 21st-century infrastructure. At the same time, Beijing plays the nationalistic chords to strengthen the loyalty to the Communist Party even as its delivery of improved living standards slows or stalls.  

The minutes from the recent Reserve Bank of Australia meeting contained no surprises.  The exit from the yield curve control policy seems clumsy, but the RBA seems adamant that a rate hike next year is unwarranted.  The market remains convinced officials are wrong.  The swaps market has about 75 bp discounted over the next 12 months, with the hikes and risks increasing beginning in late H1 22. In a speech after the minutes were released, Governor Lowe referred to a hike in 2024 as "still plausible," but this seemed like a slight climb down from it being the "central case."  On the other hand, elevated price pressures and border controls have driven the unemployment rate to 3.4%, its lowest level since 2008, and lifted the participating rate to match record highs. The Reserve Bank of New Zealand will likely hike rates again next week.  The swaps market is pricing in nearly 50 bp of tightening by the RBNZ over the next three months and almost 140 bp in the following nine months.  It is difficult to see a more hawkish outlook. 

The five basis point jump in the US 10-year yield helped lift the greenback to JPY114.30, matching its best level since November 1 (JPY114.45).  There is an option for $1.6 bln at JPY114.30 that expires today.   The four-year high was set on October 20 near JPY114.70.  The Japanese economy is recovering after a larger than expected contraction in Q3.  A large supplemental budget is expected as early as the end of the week but before month-end in any event.  As if confirming the lack of new insight from the RBA minutes, the Australian dollar is trading within yesterday's range (~$0.7320-$0.7370).  A break of the $0.7300 area would weaken the technical tone, while a move above $0.7380 signals a stronger recovery after finishing last month near $0.7550.  The Chinese yuan rose to new five-month highs today before pulling back.  The dollar fell to CNY6.3670 and rebounded to a new session high slightly above yesterday's high near CNY6.3850.  The PBOC set the dollar's reference rate at CNY6.3924, a little above the (Bloomberg survey) median projection of CNY6.3920. Ironically, the yuan's high was recorded as the Biden-Xi call got underway.  It trended lower through the rest of the session.   Separately, the PBOC boosted its liquidity injection via seven-day repos to CNY50 bln from CNY10 bln on Monday and rolled off its full medium-term lending yesterday, easing technical pressure in the money market.  

Europe

The UK's employment data is especially important in light of the BOE concerns about the labor market now that the furlough program has ended.  Around one million workers were on the program when it ended. The BOE surprised the market by not raising rates at the meeting earlier this month. Governor Bailey continues to blame the market for misconstruing his remarks and expressing his unease with the "inflation situation."  He said he wanted to see what happens now that the furlough program ended before hiking, but it is not clear that today's data is sufficient.  However, the preliminary indications suggest the UK labor market is normalizing quickly.  October payrolls rose by 160k. Jobless claims fell by nearly 15k after a revised decline of almost 86k in September (initially estimated at -51.1k).  In the three months through September, the UK employment rose by 247k, and the ILO measure of unemployment fell to 4.3% from 4.5%.  Of note, the next employment report will be issued two days before the next MPC meeting (December 16).    

Governor Bailey acknowledged that his decision not to hike rates earlier this month was close.  The swaps market has a little more than a 55% chance of a hike in December and has it fully priced it in for the first meeting next year (February 3). The central bank's chief economist, Pill, said there was no evidence yet that higher inflation was seeping into general pay levels.  Starting salaries appear to be increasing, but it may not be lifting the pay for existing workers.  Separately, a technical glitch with an internet-based order system caused the BOE to postpone a bond purchases operation until Thursday.  The QE operations take place three times a week at a pace of slightly more than GBP3 bln a week, with an eye toward finishing them by year-end.  

There is another twist to the saga of the controversial Nord Stream 2 pipeline.  Hopes that the completed pipeline could become operational soon were dealt a fresh blow by the German regulator, who suspended the certification process.  The technical issue was a change in the legal form of the operating company.  Nord Stream 2 AG established a subsidiary that would own and operator the German section of the pipeline.  There is some thought that after this delay, the corporate reorganization could expedite the eventual approval.  

Coronavirus deaths spiked in Germany to the six-month highs, and the government is debating how to control the fourth pandemic wave. Ironically, Japan now has the highest inoculation rates among the G7. It reported the lowest number of new infections in 18 months. The euro was sold below $1.1400 yesterday and has been unable to resurface above there.  Since the $1.15 level broke, we have suggested the next target is near $1.1290-$1.1300. The ECB's dovish rhetoric contrasts with the prospect of a more hawkish posture by the Federal Reserve.   We continue to see an acceleration of the Fed's tapering as the most likely outcome of the December FOMC meeting, while next month's ECB meeting is more about extending the bond-buying after the Pandemic Emergency Purchases Program ends next March.  The prospects of a rate hike next month lifted sterling to four-day highs near $1.3475, but there does not look like there is the interest to test the $1.35 area, which holds a GBP407 mln option that expires today.  Initial support is now seen in the $1.3400-$1.3420 area. The euro is sliding for the third consecutive session against steering and looks poised to test the year's low near GBP0.8400 in the coming days. The UK reports October CPI figures tomorrow, and they are expected to have accelerated.   

America

The US economic growth is improving this quarter after the disappointing 2% annualized pace in Q3.  It will be reflected in the consumption and production data.  Today sees October retail sales, a little more than 40% of overall consumption, and industrial production, including factories and utilities, mining, and drilling.  Headline retail sales will likely be lifted by the first increase in auto sales in six months.  The core components, which exclude autos, gasoline, building materials, and food services, are forecast (Bloomberg, median) to rise a solid 0.9%.  It would be the third consecutive monthly gain, the first since Q3 20.  Consumer spending rose 2% at an annualized rate in Q3 and is expected to grow closer to 5% this year, having peaked in Q2 at 6.7%.  Industrial production fell in August and September but is expected to have snapped back in October as the recovery from Hurricane Ida took hold.  The median forecast (Bloomberg survey) is for a 0.8% gain.  The rig count rose by 23, matching the most since January.  According to the recent jobs report, manufacturing employment rose by 60k in October.  Few have noted it, but if confirmed, it would be the largest monthly increase since August 1998.  That said, the Markit manufacturing PMI and ISM manufacturing index fell.  

The Biden administration's $1.75 trillion "Build Back Better" bill is in the balance.  Some argue that the surge in inflation has been spurred by the government's spending and transfer payments and are opposed to new large-scale spending.  However, the bill's defenders argue that it has been scaled back, and much of the expenditures will be covered by new revenue.  The non-partisan Congressional Budget Office, the arbiter of such scoring, will publish its full cost estimate on Friday.  Meanwhile, expectations that an announcement will be made shortly on the Fed's leadership were fanned by comments from the Senate Banking Chairman (Brown), who said he was told a decision was "imminent."  It was widely expected before the end of next week.  Reports suggest that Treasury Secretary Yellen has opined that Brainard would be a credible pick, but she is recommending Powell, emphasizing continuity and avoiding the politicization of the post.   Meanwhile, the Fed's Bullard, Barkin, and Daly speak today.  Note that Daly was interviewed for a Board of Governor slot but appears to have turned it down.

Canada reports October housing starts today ahead of the October CPI figures tomorrow.  The headline rate is expected to approach 5% though the underlying measures are lower.  The market is positioned for a hike in the March-April period next year.  Recall that the jump in US CPI sent the greenback up from just below CAD1.2400 to slightly above CAD1.2600 at the end of last week.  It reversed lower before the weekend and slipped briefly below CAD1.2500 today, roughly the (50%) retracement of the CPI-inspired gains, before rebounding. Initial resistance is seen in the CAD1.2535-CAD1.2560 area.  Mexico's economic diary is light, and the movement of the peso may reflect broader forces.  For the past three sessions, the dollar has been consolidating in a broad range against the peso (~MXN20.45-MXN20.72). Within that range, initial support may be in the MXN20.55 area.  

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