Overview: A simply dreadful flash US PMI stopped the
dollar's four-day rally in its tracks. It followed news that the eurozone,
Japan, and Australia's composite PMIs are below the 50 boom/bust level. However,
the dollar recovered, even if not fully as the market seemed unconvinced that
the data could change Fed Chair Powell's message at Jackson Hole on Friday. A
consolidative tone is evident today. Asia Pacific equities were mixed. China and
Hong Kong fell more than 1% while South Korea, Australia, and India posted
gains. Europe’s Stoxx 600 is off for the fourth consecutive session, the
longest spill in a couple of months. US futures are straddling unchanged levels.
The US 10-year yield is around 3.04%, little changed, while European benchmark
rates are 2-4 bp higher. Japan’s 10-year yield edged up near 0.22% and is once
again drawing close to the cap. Gold is firm near $1750, but unable to build
much on yesterday’s nearly $12 rally. October WTI is extending its rally since
the Saudi’s threatened to reduce supply and Israel is pushing back against the
US-Iran deal. US natgas fell 5% yesterday and is about 1.75% firmer today. The European
natgas benchmark has jumped almost 7% today to recoup fully yesterday’s 6.5%
pullback, which snapped a four-day rally. Iron ore rose 0.5%. It was the third
advancing session, the longest rally this month. September copper is giving
back about half of yesterday’s 1.2% gain. September wheat is up 2% to bring the
gain to 9% since last Thursday.
Asia Pacific
In addition to the usual corporate analysis and credit, ESG ratings and
investment orientation have become increasingly important. However, the
meaning of ESG and ratings are not uniform. Arguably, it is where
"organic" was a couple of decades ago, and it is still evolving. Some are dismissive and suggest it is a "woke” fad. Japan's Government Pension
Investment Fund (GPIF), the largest pension fund in the world, reports that
seven of the eight ESG funds it invests in beat the benchmarks in the fiscal
year that ended in March. Over the past five years, it said that all eight
funds have outperformed.
Since US Pelosi's visit to Taiwan, a few other US elected officials have
visited Taiwan. UK officials and Japanese officials have either visited or
planned to visit Taipei. China has continued its aerial harassment of the
island. and repeatedly crossing the median line in the Taiwan Straits. In a
recent report, the Atlantic Council argued that one of the lessons from
Ukraine, is that the US "strategic ambiguity" is not an effective deterrence,
and that the US should be unequivocal in its support. These developments,
alongside reports that US military advisors have been in Taiwan since before
the 2020 election and the number of "misstatements" by President
Biden that were clear signs of support that were "walked back", all
play into the hardliners in Beijing who think the US is trying to change the
status quo. Congress is considering a bill that would codify some of it. The US
strategic ambiguity is ostensibly not about one-China but on how the US would
respond to Beijing's use of military power to unite the country. This was not
meant to deter China as the military planners would have to game out the US
response no matter its declaratory policy. The chief function is to deter
Taiwan from declaring independence unilaterally and dragging the US into a war
of its making. However, Taiwan, as it stands now, is not a member of
organizations based on state sovereignty, like the UN and IMF. The bill that is
likely to get more attention in Q4 proposes to recognize Taiwan as an important
non-NATO ally and seek to promote Taiwan's membership in international forums. Both
sides are giving the other reason to think that they are trying to change the
status quo.
The dollar is in a narrow range against the Japanese yen today of around
a third of a yen on either side of yesterday's settlement, which was slightly
above JPY136.75. US yields are slightly softer, and the dollar is closer to
session lows (~JPY136.35) in the European morning. The greenback can spend the
North American session on the JPY136-handle. The Australian dollar is also
in a narrow range as the market awaits fresh news. It has spent most of the
local session and the European morning below yesterday's $0.6930 settlement. Meanwhile,
the greenback has edged higher against the Chinese yuan. It made a marginal
two-year high almost at CNY6.8680. In the past two weeks, the yuan has fallen by
a little more than 2% against the dollar, which has risen broadly. The setting
of the PBOC's reference rate today could be the first sign that officials want
the market to go slowly. The dollar fix was at CNY6.8388, a wider than usual
gap and below the market (Bloomberg survey) estimate for CNY6.8511. Of note, the
US dollar did not make a new high against the offshore yuan today. Yesterday's
high of almost CNH6.8850 held.
Europe
On top of the energy crisis, and extreme weather, an economy seemingly
slipping inexorably toward a recession, while inflation is still accelerating,
Italy's national election is a month away. The three-party alliance on the
right continues to dominate drawing about 47% support. The Brothers of Italy
remains the largest, accounting for a little more than half that support. Many
observers assume that the success of the right reflects a shift in the Italian
politics. However, the simpler explanation is the disarray of the center-left. The
Democratic Party draws second highest support, less than half a percentage
point (within the margins of error) of the Brothers of Italy. The problem is
that the center-left has been unable to form a pact like the right has done. The
once populist power, the Five Star Movement, the largest party in the current
parliament, appears to have lost its way, partly the cause and effect of its
fragmentation. There are several other small groupings that would be more at
home with the center-left but have been able to coalesce into an alliance. Still,
it is notable that Brothers of Italy leader Meloni argued for more Europe in
her debate with the Democratic Party leader Letta. Letta sounded like the
nationalist, advocating a temporary price control for gas. Meloni backed an
EU-wide cap, which Draghi supported. As Benjamin Franklin told the thirteen
colonies on the east coast of the North American continent they prepared to
fight against the greatest empire at the time, "hang together or hang
separately."
Italy's 10-year premium over Germany is near 2.35%. It reached a
two-year high in mid-June slightly above 2.40%. In late July, it also tested
2.40%. Italy offers around 100 bp more than Germany for two-year borrowing. The
peak since the Covid panic in March 2020, was set late last month near 1.30%. The
extra that is demanded from Italy is not about inflation. Italy's two-year
breakeven (difference between the conventional yield and inflation-protected
security) is about 4.40% compared with Germany's two-year breakeven near 7.10%.
Italy's 10-year breakeven is slightly below 2.25%. Germany's is near 2.45%. Both
report August's EU harmonized CPI next week. In July, Italy's inflation stood
at 8.4%, just below Germany's 8.5%. Not only is Italian inflation lower than
Germany's and is expected to remain so, but it is also growing faster. On a workday
adjusted basis, the German economy grew 1.4% year-over-year in Q2. Italy
expanded by 4.6%.
The UK's online paper, The Independent, reported that UK imports from
Russia have plummeted by nearly 97% since the invasion. They totaled GBP33
mln in June, it noted, citing data from the Office of National Statistics. The
collapse reflected government sanctions and actions of companies seeking
alternatives to Russian goods beyond the official sanctions. Today is
Ukraine's Independence Day and marks the sixth month since the Russian invasion.
Reports suggest the US will announce a new $3 bln arms package for Kyiv.
The euro was squeezed to almost $1.0020 yesterday after the disappointing
US data, but it was short-lived, and it finished the North Americans session
near $0.9970. The single currency is in about a third of a cent range today
and has not been able to resurface above $1.00, where there are large options
that expire there tomorrow (2 bln euros) and Friday (1 bln euros). An expiry
today for 720 mln euros at $0.9950 has likely been neutralized. Sterling traded
in a broad range yesterday (~$1.1720-$1.1880) and exceeded both sides of
Monday's range. However, the close was neutral, well within Monday's range,
which set the tone for today's quiet session. Sterling has been confined to
less than half a cent range above $1.1800. It settled near $1.1835 and has
spent most of the Asian session and the European morning below it. The next
level of support is seen in the $1.1760-80 band.
America
There can no explaining away the weakest composite US PMI since May 2020
and drop in new home sales five-times more than the median forecast in
Bloomberg's survey. Yet it did not seem to be bipolar as conventional wisdom
has it, swinging between recession and inflation anxiety. The implied yield of
the October Fed funds contract rose two basis points to 2.95%, unchanged on the
week. Another way to look at it, the odds of a 75 bp hike in September stands
at almost 60% compared with 52% at the end of last week and slightly less than
50% the prior week (August 12). Nor did equities recover from Monday's gap
lower opening. Indeed, while the S&P 500 and NASDAQ largely traded within
Monday's range, the Dow Industrials continued to sell off. It is approaching
the (38.2%) retracement of the rally off the mid-July low (~30144) found near
32700. A similar retracement in the S&P 500 is near 4095. The NASDAQ found
support near its retracement around 12350.
The US reports the preliminary estimate of July durable goods orders. The
real sector data has held up better than the survey data. One element of
durable goods orders that may not be appreciated by economists yet is what
appears to be a surge in US arms sales abroad. There seems to be a synchronized
arms build-up and demand for US-made weapons is clear. Separately, today's
report will be flattered by the jump in Boeing orders. The company reported 130
orders last month, the most since June 2021 after 50 orders in June. Of those
orders 27 came from foreign companies up from 20 in June, and the most since
January. On the other hand, its deliveries fell to 26 from 51, the least since
February.
The focus is on the Fed's Jackson Hole symposium that begins tomorrow. Fed
Chair Powell is set to speak Friday (10 am ET). Some observers expect him to
play up the element in the minutes that recognized the risk that the central
bank would tighten too much. However, in the minutes, it was set up in contrast
to the bigger risk that inflation getting embedded into business and household
expectations. We recognize the market's penchant for reading/hearing a dovish
twist to Powell and the Fed even though they are tightening policy faster than
most observers had imagined even a few months ago. The pace of the balance
sheet adjustment is also set to double starting next month. Separate from the
FOMC minutes, the minutes from the discount rate meeting were reported
yesterday, and both the Minneapolis and St. Louis Feds called for 100 bp hike
in the discount rate before the July 26-27 FOMC meeting but did not convince
their colleagues. Nine favored a 75 bp increase, while the KC Fed called for a
50 bp increase. George, the President of the KC Fed supported a 75 bp increases
in the Fed funds target at last month's meeting.
The US dollar posted a big outside down day yesterday against the
Canadian dollar, trading on both sides of Monday's range and settling below
Monday's low. However, there has been no follow-through today and a
consolidative tone is evident. It settled near CAD1.2955 and has spent no time
below it so far today. It has been capped around CAD1.2985. With softer
equities, we are inclined to see the greenback push back above CAD1.3000 and see
resistance near CAD1.3020-30. The US dollar fell yesterday for the second
day against the Mexican peso. Its 0.80% drop was the most in nearly two
weeks. Selling today has extended its loss to around MXN19.9365, a four-day low.
Mexico reports CPI for the first half of August. It is expected have
accelerated, with the year-over-year rate rising to 8.55% form 8.14%. The core
rate is seen slightly above 7.8% from 7.75%. The central bank meets late next
month and another 75 bp hike seems most likely.
Disclaimer
Reviewed by Marc Chandler
on
August 24, 2022
Rating:
