The Yen and Yuan Continue to Weaken

Overview: While the US dollar appears to be consolidating its recent gains, the Japanese yen and Chinese yuan remain under pressure. Officials seem more concerned about the pace of the move than the level it has reached. New and large fiscal initiatives that the new UK government has floated has failed to change sentiment toward sterling, which is the second weakest major currency today after the Japanese yen. The yen’s weakness did not prevent new losses in Japanese equities, and most equities in the Asia Pacific region fell, except China. Europe’s Stoxx 600 is lower, giving back yesterday’s 0.25% gain and more. US futures are steady to firm. Meanwhile, benchmark 10-year yields played catch-up in Asia, while they have come back softer in Europe and are 6-8 bp lower. The 10-year US Treasury is off nearly four basis points to 3.31%. Emerging market currencies are mixed. Central European currencies and the Mexican peso lead the advancers. The Polish zloty is bid ahead of what is expected to a be 25 bp rate hike later today. Gold held $1690 and is recovering to $1706 in the European morning. Yesterday’s high was almost $1727. October WTI is recovering after slipping to almost $85, a new six-month low earlier today. Record production is weighing on US natgas prices. It fell 5.1% before the weekend and 7.3% yesterday. Today, it is fractionally lower and at its lowest level in a month. Europe’s natgas benchmark is also trading heavily. Between yesterday and today, it is off 6%. Iron ore slipped lower for the second day after rising nearly 3.6% on Monday. December copper is paring yesterday’s 1.4% gain. December wheat is up 3.4% after a 0.75% gain yesterday. It rose 4.4% last week amid concerns about weather and war limiting new supply. 

Asia Pacific

Japanese official expressions of concern about the yen's slide escalated. Finance Minister Suzuki cautioned that it is not desirable for such rapid movements, while Cabinet Secretary Matsuno threatened "action" if one-sided moves continued. The market barely flinched at the news. The threat of intervention is not seen as particularly credible. Even if Japanese officials wanted to intervene, it seems clear that it would be alone and fighting not simply a weak yen but a strong dollar. The last time the Ministry of Finance ordered intervention to support the yen was in 1998. The dollar reached about JPY147.65 before then. This area is best seen as a target now and the dollar reached nearly JPY144.40 today. Separately, but not totally unrelated, the 10-year JGB approached the 0.25% cap. The BOJ announced it would increase its monthly set purchases to JPY550 bln from JPY500 bln. 

China reported a smaller than expected August trade surplus. The $79.4 bln surplus compares with July's $101.3 bln and forecasts (median Bloomberg survey) of $92.7 bln. Exports stalled. After rising 18% year-over-year in July, they slowed to 7.1% in August, a little more than half the projected pace. It is the weakest shipments since April. Imports slowed to 0.3% year-over-year from 2.3% in July and weaker than the 1.1% projection. Energy imports (oil, coal, and natural gas) fell. Exports volumes of cellphones home appliances and semiconductors fell by about a tenth in the Jan-Aug period. Auto exports remain strong but flattered by higher prices. The geographic mix was notable. Exports to the US fell 3.8% year-over-year, the first decline since May 2020. Exports to EU fared better and are up 11% from a year ago. Given the cost of energy, it is not surprising that the EU imported energy-intensive products, like aluminum. Still, the pace of growth was halved from July. Exports to Russia jumped 26.5%. Exports to Taiwan fell for the first time since January 2020 as Beijing punished Taiwan after US Pelosi's visit. Note that another group from the US Congress is visiting Taipei today. 

Australia, where the central bank delivered its fourth consecutive 50 bp hike yesterday (bringing the cash rate target to 2.35%) reported that the economy expanded by 0.9% in Q2, which was in line with expectations. It has grown by 0.7% in Q1. The year-over-year pace accelerated to 3.6% from 3.3%. Its July trade figures are out first thing tomorrow and RBA Governor Lowe will provide more color on the outlook for monetary policy. Next week' s labor market report may be the next key data point for rate expectations. The futures market sees about an 80% chance that it hikes by 25 bp instead of 50 bp when it meets early next month.

The dollar settled last week at JPY140.20 and reached nearly JPY144.40 in the first part of the local session before consolidating. The market seems to be calling the Japanese officials’ bluff. Note that there has been a dramatic bout of short covering in the currency futures market. In April, the next speculative position reached 112k contracts (JPY12.5 mln per contract) and had fallen to about 25k by mid-August. It increased for the past three reporting periods to stand at roughly 41.5k contracts on August 30. Support now is seen in JPY142.70-JPY143.00 area. The RBA's rate hike did not prevent the Australian dollar's sell-off. A big, bearish outside day was recorded yesterday and follow-through selling today pushed the Aussie briefly below $0.6700. While this is the first technical target we suggested based on the head and shoulders pattern, it held the mid-July two-year low set closer to $0.6680. It bounced to almost $0.6735 and met new offers. Like the BOJ, the PBOC is resisting market forces that are taking the yuan lower. Today's reference rate was set at CNY6.9160 compared with the Bloomberg survey median of CNY6.9614. The gap is the largest since the Bloomberg survey began. Like the BOJ, the PBOC seems more concerned about the pace than the level. The greenback reached almost CNY6.98.

Europe

UK rates are jumping. Over the past 16 sessions, the 10-year yield has risen in all but two. The surge has lifted the yield from about 2.02% to 3.10% yesterday. Some of this increase was due to increased inflation expectations. The 10-year breakeven has risen from around 3.90% to about 4.30%. Part of the increase in the nominal 10-year yield reflect the anticipation of a higher overnight rate. Indeed, the terminal rate in the swaps market has risen from around 3.20% to over 4.5%. There is some thought that if PM Truss goes ahead with the freezing over current household energy rates, with the government borrowing funds to keep the power companies whole, then inflation may have peaked, but this seems a bit incomplete analysis. The BOE meets next week, and the swaps market continues to see the target rate doubling from 1.75% now to over 3.50% by year-end. The market is pricing in about a 65% chance of a 75 bp hike next week's meeting. Later today, BOE officials, including Governor Bailey are speaking before Parliament.

Meanwhile, in what is one of the most seemingly diversified cabinet in UK history, many seen it as among the most conservative governments. Still, ironically, it looks set to launch among the largest fiscal initiatives outside of the Great Financial Crisis and pandemic and could boost the UK's debt by 10%. Separately, we note reports suggesting that rather than an immediate confrontation with the EU over the Northern Ireland protocol, PM Truss may seek an extension of the current workaround.

After Germany reported a larger-than-expected drop in July factory orders, the fear was an outsized falling industrial output figures today. However, the 0.3% decline was half as large as the median forecast in Bloomberg's survey and revisions doubled the June increase to 0.8%. Separately, the Lufthansa pilot strike that was planned for today and tomorrow was called off as a new wage offer was made. The full details are not yet available, but the pilots were seeking a 5.5% pay increase retroactive to July 1 and an 8.2% increase next year. Separately, Italy reported a 1.3% jump in July retail sales, well above the 0.2% expected (median in Bloomberg's survey). The ECB meets tomorrow. The swaps market is pricing in about a 63% chance of a 75 bp hike.

The euro has mostly traded in a quarter-cent range on either side of $0.9900. The low was set in Asia, as the dollar peaked against the yen, and the euro's high was set in early European turnover. The single currency is consolidating within yesterday's range. While it still looks fragile, the proximity of the ECB meeting may be deterring interest today. Sterling failed to sustain the upside momentum that had lifted it to almost $1.1610 and it recorded session lows as Europe was closing yesterday below $1.15. Follow-through selling today took it to almost $1.1450, just above the 2.5-year lows set on Monday near $1.1440. Today's high, slightly below $1.1525 was seen in early Europe and is better offered ahead of the North American open.

America

The US reports the July trade balance, and later in the say, the Fed releases its Beige Book ahead of the September 20-21 FOMC meeting. Several Fed officials speak today as well:  Barkin, Mester, Brainard, and Barr. Powell speaks tomorrow. We suspect the takeaway is that the reaching what the Summary of Economic Projections (dot plot) regarded as neutral is not sufficient and there is a consensus that policy needs to be restrictive. The Fed funds futures are discounting a 70% chance of a 75 bp hike. The recent string of data has shown the resilience of the economy including the labor market. Note that the Atlanta Fed's GDPNow tracker will be updated later today for the first time since September 1, when it was Q3 was lifted to 2.6%.

The US goods balance drives the overall trade balance. The advance report on the goods balance showed the smallest deficit since last October. Despite the greenback's strength, monthly goods exports reached a record of $181.3 bln in June and slipped slightly in July ($180.98 bln). Yes, some companies said that the translation of foreign earnings back into dollars weighed on earnings, but in aggregate US earnings growth was strong as price increases more than covered rising input costs. Typically, the strong dollar, especially against the yen spurs protectionist noises form some parts of US industry. However, now, there is hardly anything. Imports declined for the fourth consecutive month in July. At $270 bln, they are off by about 8.3% since the March peak. The 10% decline in consumer goods imports in July was the largest drop in 30 years, which is not typically what one expects in a strong dollar environment. The soft imports are often a symptom of weaker domestic demand, but retailer ae struggling to manage inventories. In July, retail inventories rose 1.1% to a record of nearly $731 bln. Wholesale inventories edged up by 0.8%, to almost $903 bln. The overall July trade deficit is expected to fall toward $70 bln from $79.6 bln in June. In July 2021, the imbalance was $69.4 bln. The change in net exports, in real terms, may contribute to Q3 GDP.

Canada will report is July merchandise trade figures ninety minutes before the Bank of Canada's rate decision. As is widely recognized, Canada is experiencing a positive terms-of-trade shock. Canada was running a deficit before Covid and now is reporting the largest merchandise surplus since 2008. Since the start of 2020, the Canadian dollar is the strongest of the major currencies, falling only 1.25% against the dollar. The Japanese yen is on the other extreme, depreciating by almost 24% against the greenback. Canada's economic outperformance has seen its better days. Like in the US, the interest rate sensitive housing market is contracting. The August manufacturing PMI fell below 50 (48.7), its lowest since June 2020. The labor market improvement is stalling. It has lost full-time jobs in both June and July. The August report is due at the end of the week. The Bank of Canada's surprise 100 bp hike in July has kept the swaps market jumpy about a repeat. We have consistently suggested 75 bp was more likely now. That would lift the target rate to 3.25%. The swaps market sees the terminal rate close to 3.75%.

The US dollar continues to absorb offers around CAD1.3200. It has probed this area but has not closed above it. There are options there that expire tomorrow for about $540 mln. Initial support is seen around CAD1.3160. The two-year high was set in mid-July near CAD1.3225. The next key chart area above there is seen around CAD1.3300-40. The greenback remains in a broad sideways range against the Mexican peso. Trendline support is seen near MXN19.92, while the upper end is in the MXN20.26-MXN20.29 area. Mexico reports August CPI figures tomorrow. The central bank meets on September 29 and is expected to match the Fed's move. Chile surprised the markets yesterday by delivering a 100 bp hike instead of 75 bp. Its overnight target rate is now 10.75%. August CPI will be reported tomorrow. It is expected to rise to 13.8% from 13.1%. After rallying ahead of last weekend's referendum, which the government lost (and a cabinet reshuffle was announced), the peso is off almost 2% this week. 

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