Overview: Corrective pressures were evident yesterday and they extended today in Asia and Europe but seem to be running their course now. Market participants should view these developments as countertrend and be wary of waning risk appetites in North America today. Most Asia Pacific equities rallied earlier today, save China and Hong Kong. Europe’s Stoxx 600 has retraced most of yesterday’s losses and US futures are trading higher. Benchmark bond yields are softer with the US 10-year note yield off about 3.5 bp to below 3.07%. European yields are mostly 3-5 bp lower, but UK Gilts are pressured by reports that foreign investors were heavy sellers last month. The US dollar surrendered earlier gains yesterday and is mostly lower today. The Australian dollar is leading the charge, despite a much sharper than expected fall in building approvals. Among emerging market currencies, only the Philippine peso and Taiwanese dollar are failing to push higher. Gold is soft, despite the weaker greenback and lower yields. It is nursing losses for the third session. After a sharp 4.25% gain yesterday, October WTI is pulling back by around 1.75% today toward $95. US natgas is off 2%, while Europe’s benchmark has extended yesterday’s 19.5% drop with a further 6.6% slide today. China’s property sector woes are weighing on the steel sector and iron ore prices have fallen 8% over the past two sessions and is below $100 for the first time this month. December copper is off 1% after falling 2.3% yesterday. December wheat is paring yesterday’s 4.6% gain.
Asia Pacific
Japan reported that its unemployment rate was unchanged in July at 2.6%. The
job-to-applicant ratio unexpectedly ticked up to 1.29 from 1.27. The upticks in
the yen, however, are more related to the pullback in US yields than the
developments in the Japanese economy. Tomorrow, Japan reports July industrial
output, and after the 9.2% surge in June, related to the lagged response to re-opening
in Shanghai likely eased a bit. Retail sales offer the opposite trajectory. They
fell a whopping 1.3% in June and likely stabilized in July, allowing for a
small gain. In June apparel and general merchandise purchases were particularly
weak.
Rising interest rates are squeezing Australia's property market more
intensely than expected. Building approvals plunged 17.2% in July,
six-times more than the median forecast in Bloomberg's survey. The drop was
driven by the private sector apartments rather than houses. The number of
private sector approvals was the lowest since January 2012. The disappointment
did prevent the Australian dollar from recovering today, amid the general pullback
in the US dollar, but the odds of a 50 bp hike next week were shaved to around
65% from 70% yesterday.
Rains in Sichuan have eased the energy emergency allowing large-scale
industry to result production this week. The provincial government
downgraded the emergency to level-one from level-two yesterday and several
companies (including Toyota, Honda, and Foxconn) indicated a resumption of
production. Cooler weather was also helping reduce household demand for
electricity. Yet, Sichuan has gone from drought to flood. Reports suggest that
nearly 325 mines, including 60 coal mines, with 5000 workers have been asked to
take shutdown for precautionary reasons. Meanwhile, the zero-Covid policy has
led to lockdowns in parts of Shenzhen.
Softer US rates and a downside correction in the US dollar after reaching
JPY139 yesterday has seen the greenback ease toward JPY138.15. The
JPY137.95 area corresponds to a (38.2%) retracement of the dollar rally since
before Powell spoke at Jackson Hole at the end of last week. We suspect the
corrective pressures have been exhausted or nearly so and expect North American
traders to buy the dollar the on the dip. Yesterday's low was slightly above
JPY137.35. The Australian dollar took out a neckline of what may be a
potential head and shoulder top yesterday but recovered to close above it (~$0.6850).
Follow-through buying today has lifted it to around $0.6955. Here too, we
think the short squeeze has nearly run its course in the European morning. The
$0.6965-70 area may offer the nearby cap. For the fifth consecutive session,
the PBOC set the dollar's reference rate lower than the market (median in
Bloomberg's survey) expected, and the gap today (~249 pips) was the most since
the Bloomberg survey began four years ago (CNY6.8802 vs. CNY6.9051). The
PBOC seemed willing to accept an orderly decline of the yuan, especially given
the divergence of monetary policy, but wants to avoid a vicious cycle. This was
underscored by its announcement of a consultation period as it considers a new policy to require prior approval for companies wishing to sell long-term debt
in offshore markets. At the same time, we read the fixing as a type of
affirmation through negation, i.e., the PBOC's action acknowledges the strength
of the demand for dollars. The dollar rose to a two-year high yesterday, after
rising nearly 2% over the previous two weeks. Today, it slipped less than 0.1%.
Europe
Attention turns to eurozone's August inflation, ahead of tomorrow's
aggregate report. Spain began with a 0.1% month-over-month increase that
saw the harmonized year-over-year pace ease for the first time in four months. It
slipped to 10.3% from 10.7%. However, the core rate rose to 6.4% from 6.1%. German
states have reported, and they all slowed from the year-over-year rate, even as
the month-over-month change moderated to 0.2%-0.4%. The median forecast in
Bloomberg's survey sees a 0.4% increase in the harmonized rate for an 8.8%
year-over-year increase (from 8.5% in July). The risk is on the upside. With
the surge in energy prices, the Bundesbank chief Nagel warned that German inflation could rise to over 10%. The EU is holding an emergency energy
ministers meetings on September 9 to consider efforts to coordinate a response.
The focus appears capping gas prices and/or decoupling electricity prices from
gas prices. EU countries have already "spent" and estimated 280 bln
euros on tax cuts or subsidies for energy.
Quietly, the German two-year yield has doubled in the past two weeks from
0.53% on August 15 to 1.10% yesterday. The German yield has risen faster
than the comparable US yield. As a consequence, the US 2-year premium has fallen
below 240 bp for the first time since early July. It recorded a three-year peak
on August 5 a little more than 277 bp. One of the spurs to the more than 22 bp
increase in the German two-yield over the past two sessions has been the push
from some of the hawks for a 75 bp move at next week's ECB meeting. While it is
noteworthy that it was not done via leaks to the press this time, as sometimes has appeared in the past, the market seems to think it is likely. The
swaps market shows it be a little more than a 60% chance of materializing, up
from about a 20% chance a week ago. Our own subjective assessment is that a
steady series of 50 bp hikes is more likely to achieve a consensus than a jump
to 75 bp and a return to 50 bp or even 25 bp. Given the fragile economic
condition, and with little to gain from a larger move than cannot be achieved
through the ECB's forward guidance, a stable, predictable course is likely
preferable. That said, the provocative tactics of the hawks seems to be an
attempt to deliver a fait accompli to the ECB. If they deliver a 50 bp hike,
they will appear as dovish versus expectations and could pressure the euro
lower in disappointment.
The short-covering bounce in the euro began yesterday when the $0.9900 area held. There are a little more than 3 bln euros in options struck there that roll-off today. The gains maybe spurring demand related to 1.55 bln in options struck at $1.00 that expire tomorrow. The euro is at its best level since Powell spoke. Just prior to the Fed Chair's speech last week, the euro spiked to $1.0090. This area should provide a cap now. Sterling's recovery off yesterday's two-year low (~$1.1650) seems less inspired and has not been able to push above yesterday's high (~$1.1785). And even if it does, the upticks will likely be limited to the $1.18 area, which is the (61.8%) retracement of the decline since the high set before Powell spoke (($1.1900). The intraday momentum indicators are stretched by the gains of a little more than half a cent in the European morning. Separately, the decision by the Hungarian central bank is awaited. It is expected to hike the base rate by 100 bp today after hiking by 300 bp last month. This move will bring the base rate to 11.75%. It was at 2.4% at the end of last year.
America
The two-year breakeven has now fallen slightly more than 25 bp over the
past three sessions to about 2.70%. Over the three sessions, the nominal two-year
yield has risen by a grand total of three basis points to 3.42%. The odds of a
75 bp hike next month has edged to about 75% from about 66% before Powell spoke at
Jackson Hole and gave no signal besides saying it could be 50 bp or 75 bp move.
The difference, the 25 bp is coming in addition to the other anticipated moves.
What this means is the market now sees the year-end Fed funds target closer to
3.75% rather than 3.50%. The implied yield of the March 2023 Fed funds futures
is pricing in about an 80% chance of a hike in Q1, unchanged for the third
consecutive session. The market also continues to price in 7-9 bp of easing by
the end of next year as it has for the past five sessions.
Ahead of the US jobs data, which are the highlight of the week, with the
ADP estimate tomorrow, house prices, the Conference Board's consumer
confidence, and the JOLTS report on job openings are featured today. While
the Fed's Kashkari's comments about the stock market and the Fed's objective of
tightening of financial conditions aren't really revealing anything new, the
undiplomatic expression seemed to set the chins wagging. Equity prices are part
of the financial conditions but so are interest rates, ease of credit, and
asset prices more generally. House price inflation appears to be slowing and
this alongside weaker financial asset prices are part of the process.
Canada reports its Q2 current account surplus, which is reflecting the
positive terms-of-trade shock. Consider that in 2019, before Covid, Canada
recorded a C$47 bln current account deficit. With a Q2 surplus of C$6.8 bln
expected, it would mean Canada has recorded a nearly C$11 bln current account
surplus in H1 22. Tomorrow, Canada reports Q2 GDP and it is expected to have
accelerated to around 4.4% form 3.1% in Q1. Still, even with today's modest
gain, the Canadian dollar is off about 2.7% this year against the US dollar. The
broader risk environment is a more important driver of the exchange rate. Mexico
reports its July unemployment rate. It is expected to have ticked up to 3.53%
from 3.35%. The market does not appear sensitive to this time series. Tomorrow,
the central bank's inflation report is due, but it’s unlikely to impact
expectations for a 75 bp hike late September.
The US dollar set a new high for August near CAD1.3075 before pulling
back toward CAD1.2990. Follow-through selling today has been limited
to the CAD1.2970 area, just above CAD1.2965 retracement objective. The momentum
indicators suggest that losses below that will be limited and instead the
greenback could recover toward CAD1.3025. The Mexican peso's resilience is
evident. It continues to trade well within this month's range. The dollar has
built a base around MXN19.81 and has not closed above the 20-day moving average
(~MXN20.0735) since August 2. However, further dollar losses today look limited.
Disclaimer
Reviewed by Marc Chandler
on
August 30, 2022
Rating:
