Consolidative Tuesday

Overview: The yen and sterling are trading quietly after the recent drama, but with the Party Congress ending, the Chinese yuan has been permitted to fall faster. It approached the 2% band today and its loss of about 0.65% today makes it the weakest among the emerging market currencies. Most of the major currencies seem to be consolidating. Chinese stocks pared earlier losses as foreign buying via the Hong Kong link returned after large sales yesterday. Asia Pacific equities were mixed, while Europe’s Stoxx 600 is slightly firmer after yesterday’s 1.4% gain. US futures are softer. Benchmark 10-year yields are mostly 5-8 bp lower in Europe. The 10-year Gilt is off about 3 bp and the 30-year yield is down four basis points bringing both to about 3.70%. The 10-year US Treasury yield is about six basis points lower near 4.18%. Gold was turned back yesterday after briefly trading above its 20-day moving average (~$1667) and settled slightly below $1650. It is straddling $1640 in the European morning. December WTI is soft at the lower end of yesterday’s range. It is now changing hands around $83.40. Last week’s low was closer to $81.30. Bargain hunting helped lift US natgas prices yesterday to snap a six-day sharp drop. Today it is flat. Europe’s natgas benchmark is up 2.5% today after dropping by around a quarter in the past two sessions. EU energy ministers meet today, and capping gas prices still seems quite difficult without encouraging demand and giving others a free ride. Iron ore fell 2% today, while December copper is off 1.7%. Lastly, December wheat is off 1% after falling 1.4% yesterday. It is at new lows for the month near $8.30 a bushel. 

Asia Pacific

While the BOJ's intervention and its policy meeting at the end of the week is the main focus, do not forget about fiscal policy. Capital might have struck the UK, protesting the unfunded deficit that Truss was pursuing, but Japan is different. Prime Minister Kishida's new spending bill is expected to be announced toward the end of the week. The package is expected to be between JPY20-JPY30 trillion (or roughly $134-$200 bln). It will include some local government spending as well, and may use some unspent funds from earlier budgets, especially last year, when tax revenues were stronger than expected. It is an awkward time for the Economic Minister Yamagiwa to resign (over ties to the Unification Church). He will be replaced by former health minister Goto.

Foreign investors have been net sellers of Japanese stocks and bonds this year (weekly average of JPY113.4 bln and JPY51 bln, respectively or ~$870 mln and ~$400 mln). Last year, through mid-October, foreigners were net buyers of Japanese bonds and stocks (JPY117 bln and JPY51 bln, respectively. For their part, Japanese investors have been sellers of foreign bonds this year (~JPY436 bln weekly average) and buyers of foreign stocks (~JPY88.5 bln weekly average). During this period last year, Japanese investors for buyers of foreign bonds (~JPY145.5 bln weekly average) and small sellers of foreign equities (~JPY98 bln weekly average).

The dollar has been confined to half a yen range today above JPY148.60. The volatility of the past two sessions has evaporated. There are options for around $1.3 bln at JPY150 that expire today but we suspect that the hedging helped the dollar rise to nearly JPY152 at the end of last week. The market will likely probe for a new range, and it could be JPY148-JPY150. News that the Australian government projects the fiscal deficit to be half of what it had been projected in the year ending in June appears to have had little impact on the Australian dollar. It too is consolidating after two sessions of dramatic swings that saw it traded roughly $0.6200-$0.6400. It is trading quietly today between $0.6300 and $0.6340. The Chinese yuan slumped even though officials tweaked the rules to make it allow companies to repatriate more funds raises offshore. The dollar gapped higher and reached nearly CNY7.31, the upper end of 2% band. The reference rate, which had been set around CNY before and during the Congress, was set at CNY7.1668 (median in Bloomberg's survey was CNY7.2198). Against the offshore yuan, the dollar traded to nearly CNH7.37.

Europe

Here is a narrative of the UK events. After numerous miscues and petty scandals, Johnson resigned. A party leadership contest began and under the rules in the early 2000s, the Tory MPs would narrow the field to two and let the members of the party decide. Sunak led among the MPs and Truss came in second. Sunak lost the vote among the party members. Truss campaigned on pro-growth, tax cut platform. It should hardly be surprising that she was implementing her strategy, which shunned by capital, and reflected in a sharp sell-off in sterling and dramatic rise in rates. Large, levered pools of capital, especially pension funds and insurance companies faced destabilizing margin calls and the central bank had to step in buying what amounted to be relatively small amounts of Gilts. The Tory MPs threatened to fire Truss (vote of no confidence) and she resigned. A new leadership contest ensued. There was no credible opposition so Sunak became the head of the party, yet the party is anything but united. He is the third prime minister in about seven weeks.

By overturning the rank-and-file decision, the Tories have jumped from one horn of the problem to the other. From a Prime Minister that carried the Tory voters but not the MPs to a Prime Minister who has the support of the MPs but not necessarily of the Tory voters. The UK economy already headed for a recession, if not in it already, will have another dose of austerity. The Bank of England threatened a sizable rate hike. In the turmoil in late September, the swaps market thought this could be as much as a 150 bp rate hike. The swing back toward orthodoxy has seen expectations roughly halved. The market seems comfortable with a 75 bp hike and has about a 25% chance of a 100 bp move next week. 

The euro reached its best level against the Swiss franc in three months today (~CHF0.9900). It has now met the (38.2%) retracement objective of its losses from the year's high set in February slightly above CHF1.06. What is counter-intuitive about the euro's gain (~4.5%) since late September's 7-year low (~CHF0.9410) is that Russia threatens the use of nuclear weapons and the new Italian government was bickering as the government was being formed. On a trade-weighted basis, the franc is trading at three-month lows. Moreover, sight deposits are collapsing in Switzerland as the SNB mops up extra liquidity. Total sight deposits have fallen 11% already this month after an 11% decline last month. They have fallen by more than CHF150 bln over the past five weeks. Meanwhile, for the past four week, banks have borrowed dollars from the SNB's swap line with the Fed. At last week's auction, the banks took about $11.1 bln after roughly $6.3 bln the previous week. Last week 17 banks took dollars, and in the previous week 15 did. While there could be a systemic issue here, we continue to think the more likely explanation is a type of financial arbitrage, where the dollars are swapped for the Swiss franc and put in the SNB's repo facility or on deposit with the SNB.

The euro has drawn little comfort from the German IFO survey that held up better than expected. The overall business climate was little changed at 84.3 (from a revised 84.4 in September). While the current assessment is softer slightly (94.1 vs. 94.5, but better than the 92.5 expected), the expectations component rose (to 75.6 from a revised 75.3). The euro held just below $0.9900 and found support near $0.9850. The intraday momentum indicators suggest another try at $0.9900 is likely today. Sterling is firm but unable to scale the heights that saw it test the $1.1400 area yesterday. It appears that support is being tentatively formed around $1.1250-$1.1275. The push to session highs in the European morning near $1.1330 is stretching the momentum indicators.

America

The disappointingly weak flash PMI played into talk that after next month's 75 bp hike, the Federal Reserve will slow the pace of its hikes. The US economy has been losing momentum if that makes sense after it contracted in the first two quarters. It was the fourth consecutive month that the composite was below the 50 boom/bust levels. New orders in manufacturing and new business in services are both below 50. The employment sub-index of the services PMI fell to 49.4, the lowest level since the early days of the pandemic. Manufacturing prices (input/output) fell but in services prices (input/charged) ticked up. The pipeline also thinned, with backlogs falling in manufacturing and services.

Today the US reports August house prices. The FHFA purchase price index is expected to have fallen for the second consecutive month for the first time since 2011. The S&P Corelogic Case-Shiller 20-city price metric is also expected to have fallen for the second month in a row. Given the slowdown in activity, spurred primarily by higher rates and less confidence, the weakening of prices will not surprise. When the Fed tightens financial conditions, among other things, it means downward pressure on asset prices, including houses.

There was some suggestion that Saudi Arabia would consider selling its Treasury holdings if the US went forward with its bill that would allow OPEC to be challenged in US courts for being a cartel. US Treasury figures suggest that it held a little less than $120 bln of Treasuries at the end of June, which might understate the case a bit. Is this much of a threat?  Probably not. First, Saudi Arabia's chief export is denominated in US dollar, and the Saudi currency is pegged to the dollar, which among other things, means that when the Fed hikes next week, so will the Saudi Monetary Authority. Second, to sell US Treasuries means to give up yield, liquidity, and security. Third, the amount is modest. Consider that the BOJ's recent intervention (last month and this month's operation) may be close to $60 bln and the impact on the Treasury market has been minimal. The same could be said when Russia reduced its Treasury holdings by around $90 bln. The NOPEC bill may not be a good idea, but not because the Saudi's Treasury holdings give it leverage on US policy. 

Mexico's CPI for the first half of October was mixed. The headline and core rates rose by a little more than 0.4% from 8.5% and 8.4% year-over-year readings, respectively. That was less than expected for the headline and a little more for the core, however, not sufficiently to signal anything new. Today, Mexico reports the IGAE economic activity report, which is a bit like a monthly GDP proxy. The median forecast of the 11 economists in Bloomberg's survey is for a flat number, though the average is for a small decline. Net-net it has been flat for the May-July period. The week's highlights include the September jobs report on Thursday and the trade figures on Friday.

Meanwhile, Brazil reported a larger than expected September current account deficit ($5.68 bln vs. $5.43 bln in August and median forecasts for $3.04 bln). However, the current account is being more than covered by long-term capital flows, direct investment. The current account deficit has averaged $3.29 bln a month this year, while direct investment has averaged more than twice that (~$7.85 bln). Tensions are rising ahead of this weekend's presidential run-off contest. Both Bolsonaro and Lula were critical of former lower house deputy Jefferson who shot at police who tried to arrest him. The latest polls show Lula with a few percentage-point lead. The dollar fell 3% against the Brazilian real last week and rose almost 2.5% yesterday. The dollar tested the BRL5.30 area. This month's high was set on October 13 near BRL5.38. The monetary policy committee of the central bank (COPOM) meets on Wednesday and is expected to keep the Selic rate steady at 13.75%. 

The US dollar is trading quietly against the Canadian dollar in a 20-25 tick range on either side of the CAD1.3705 settlement. The intraday momentum indicators are stretched, suggesting, the greenback may pullback in the North American session, ahead of tomorrow Bank of Canada meeting. The pendulum of market sentiment has swung from not even fully discounting a 50 bp hike earlier this month to now when the swaps market has about a 1-in-3 chance of a 100 bp move, which seems a bit much. The greenback fell and recorded the month's low against the Mexican peso before the weekend near MXN19.8860. Yesterday's bounce stalled slightly above MXN20.00 and it is back near its lows today. If last week's low is taken out today, we suspect it will be minimal.

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