Calmer Capital Markets...for the Moment

Overview:  The capital markets are quiet today. Equity markets and bond yields have a slight upside bias, while the dollar is little changed. Despite reports that the lockdown in Chengdu is easing, Chinese equities underperformed in the Asia Pacific region. Japan, Hong Kong, Taiwan, and Australia eked out modest gains. After sliding around 2.4% over the past two sessions, the Stoxx 600 is up fractionally. US futures have edged slightly higher. The US 10-year yield is firmer by around three basis points near 3.44%, while European benchmark yields are mostly 1-2 bp firmer. Most of the major currencies are +/- 0.2% changed on the day. A similar picture is evident among emerging market currencies. Gold settled below $1700 yesterday and has continued to retreat today. It has tested the $1685 area to approach the year’s low set in late July near $1680. The next key chart area may be closer to $1676, the 200-day moving average, which the yellow metal has not traded below since late 2018. December WTI has cut yesterday’s 1.3% gain in half and is trading below $87. Rail disruption in the US ahead of the potential strike starting Saturday helped lift the US natgas price over 10% yesterday. It is off 3.3% today. The EC’s reluctance to support a cap on gas prices has seen the European benchmark climb higher. It is up 4.5% today after gaining 8.2% yesterday. Iron ore was practically flat today. It fell almost 2.5% yesterday. December copper has steadied after falling 2.5% over the past two days. December wheat has come back offed after yesterday’s 1.4% advance.  

Asia Pacific

In unadjusted terms, Japan's trade deficit doubled in August to JPY2.82 trillion (~$19.7 bln) from JPY1.43 trillion in July. This is a record shortfall and is the 13th consecutive month in deficit. Consider that this year's average shortfall is JPY1.53 trillion a month. Last year, the monthly average through August was a JPY73.5 bln surplus. Prior to the pandemic, Japan recorded an average monthly deficit in the first eight months of 2018 of about JPY163 bln. The weak yen helped boost imports by nearly 50% from a year ago. Japan imports most of its energy. Exports rose an impressive 22.1%, slightly less than expected but better than July's 19.0% increase from a year ago. On a month-over-month basis, imports rose 1.5% whiles exports slipped by about 0.7%.

Australia's August jobs report was mixed. After losing almost 41k jobs in July, Australia grew 33.5k in August, which was near expectations. The details were even better, with an increase of nearly 59k full-time positions (it lost ~87k in July). Part-time positions fell by a little more than 25k (gained 46k in July). The participation rate increased to 66.6% from 66.4%. The record was set in June at 66.8%. However, the increase in the participation rate saw the unemployment rate tick up to 3.5% from 3.4%. The data did not change the market's assessment of the outlook for the central bank meeting on October 4. The market sees a downshift from 50 bp to 25 bp as most likely. The futures market has about a 35% chance of a 50 bp move discounted, virtually unchanged from yesterday. However, it settled last week at less than a 15% chance. Separately, the Melbourne Institute of Consumer Inflation Expectations eased to a four-month low of 5.4%, down from 5.9% previously. A year ago, the reading was at 4.4%. Lastly, we note that New Zealand report Q2 GDP rose 1.7% quarter-over-quarter, well above median forecasts (Bloomberg's survey) for 1.0% and follows the 0.2% contraction in Q1. The RBNZ meets on October 4. The swaps market is comfortable with another 50 bp hike.

The dollar is consolidating in a JPY142.80-JPY143.80 range today. It is trading within yesterday's range. The 10-year JGB yield is a whisker below the 0.25% cap, which is another front in the tension between the market and officials. After having been large buyers of Japanese bonds in July and August, foreign investors reversed course and sold JPY2.57 trillion last week. To put last week's sales in perspective, it offset the August purchases in full. Soft demand at today's 20-year bond auction did not help matters. The Australian dollar extended yesterday's recovery but found sellers lurking around $0.6770 that capped it. The consolidative tone looks set to continue through North America today. The dollar gapped higher against the Chinese yuan yesterday and reached a new high for the move today, slightly above CNY6.98. Reuters reports that five large Chinese banks cut the personal deposit rates by 10-15 bp even though the one-year medium-term lending facility was unchanged at 2.75%. Some observers link it to last month's cut in the loan prime rate. Meanwhile, the PBOC continues to manage the yuan's leg lower by continuing to set the dollar's reference rate well below market expectations (CNY6.9101 vs. CNY6.9631). The dollar can move only 2% from the reference rate.

Europe

The EC shied away from recommending a cap on natural gas prices and this disappointment seems helping lift prices today. Instead, a cap on profits on low-cost producers and a level on fossil fuel producers is intended to raise 140 bln euros to be used to help blunt the impact of higher energy prices. The EC will begin formal talks with Norway in hopes to negotiate a lower price for natural gas. It proposed a 5% mandatory cut in consumption in peak hours. To address the liquidity squeeze of margin calls, it proposes to boost the threshold for clearing to 4 bln euros from 3 bln. It also wants bank guarantees to be accepted for margin calls. The formal heating season begins next month and there is much negotiation needed before then. This is still very much a work in progress. It will likely require the EU Council where the heads of state can make these decisions.

Although Italy holds its general election in 10 days, Prime Minister Draghi is pushing for a new 13.5 bln euro energy assistance package, to include extra tax breaks and the possibility of paying utility bills in installments. Earlier this month, the German government announced a new 65 bln euro initiative and earlier this week, the French government announced a 15% cap on increase of energy prices to households starting next year. It is also considering a one-off payment of 200 euros for the poorest households. The new UK government is going to cap prices to households about 25% above current levels and next week is expected to provide plans to help businesses, though Parliament is on recess from September 22.

Meanwhile, Sweden's Prime Minister Andersson will resign today following the close election over the weekend that has seen the center-right win the slimmest of majorities. Law-and-order and immigration appears to have played a strong role in boosting the Swedish Democrats. Although it became the second-largest party after the Social Democrats, the head of the Moderate Party is likely the next prime minister. The head of Swedish Democrats is not acceptable to the center-right coalition that is needed in the fragmented political system. It may take some time to put together the new government and it will be recognized as fragile unless it proves otherwise.

After traveling in a two-cent range on Tuesday, the euro trading in a 3/4 of a cent range yesterday, and today is in less than half-of-a-cent range today below $1.00. There are 1.3 bln euros in options at parity that expire today. We would have thought that these have been offset. Above there, another set of options for 1.15 bln euros at $1.0050 will also be cut today. The euro is trading near session highs late in the European morning, which is stretching the intraday momentum indicators. In the bigger picture the euro is consolidating in its trough following the US CPI surprise on Tuesday. Sterling is also trading quietly, confined to a little less than half-of-a-cent range too, above $1.1500. However, it is on session lows late morning turnover. Yesterday's low was near $1.1480. The intraday momentum indicators are not quite stretched, seeming to allow for a test on yesterday's low, but we would not look for much more than that today.

America

After the inflation reports over the past two sessions, real sector data is in the spotlight today, with August retail sales and industrial production. Falling gasoline prices likely dragged headline retail sales, but excluding autos and gas, sales are expected to increase by 0.5%. That would match the 2019 average but would be the slowest since last November. Industrial output looks softer. Manufacturing output is the culprit. It rose for the first time in three months. The 0.7% gain drove the 0.6% rise in the overall measure of industrial production. The manufacturing surveys warn of weakness and the median forecast in Bloomberg's survey forecasts a 0.1% decline in manufacturing output. Manufacturing employment has risen by an average of 37k this year through August, 50% more than the average in the first eight months of 2021. July business inventories will be reported. In addition, weekly jobless claims, the import/export prices, and the September Empire State manufacturing survey and the Philadelphia Fed surveys are due. Taken together, economists will update their GDP forecasts. That Atlanta Fed's GDPNow tracker will be updated from it 1.3% estimate from September 9. 

It is not just that monetary policy is tightening in the US, but fiscal policy is tightening more than many seem to appreciate. The deficit will fall this year from almost 11% of GDP last year to close to 4% this year. It took several years after the Great Financial Crisis to reduce the deficit as much. In Canada it is even more pronounced. The OECD projects it to fall from 13.2% last year to about 2.5% this year. Earlier this week, Canada's government offered targeted aid to low-income families (doubling the sales tax rebate for six months), housing benefit (tops up an existing program for low-income renters) and fund a dental care plan (for children under the age of 12 who do not have access). Some of the funds have previously been allocated. Estimates suggest, the measures will boost borrowing by C$3.1 bln. This seems too small for the C$1.7 trillion economy to make much of a difference in terms of inflation or growth. The Bank of Canada sees the neutral rate between two and three percent. The target rate is currently 3.25%. The swaps market favors a 50 bp hike in October and a 25 bp hike in December. It has begun considering a hike in Q1 23 (~38% chance).  

The US dollar briefly poked above CAD1.32 yesterday. It was the fourth time in the past two months, but it has not closed above it once. It is consolidating quietly in a narrow range roughly between CAD1.3155 and CAD1.3185. Yesterday's low was near CAD1.3140 and this looks safe. The intraday technicals seem to favor the greenback, which may mean weaker US stocks. The US dollar is hovering around MXN20.00, the middle of the MXN19.80-MXN20.20 range that has dominated for the past month. The range looks to have narrowed lately to MXN19.90-MXN20.10. When the dollar is offered, the peso is among the market's favorites. Note the leaving aside the Russian rouble for obvious reasons, the next three best performing emerging market currencies are from Latam this year:  Brazil (~8%), Peru (~3%) and Mexico (~2.7%). 

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