Calm Markets with Japan on Holiday Today and the US Tomorrow

Overview: The capital markets are quiet today with Japan on holiday and the US on holiday tomorrow. Asia Pacific equities were mostly firmer after yesterday’s rally on Wall Street. Europe’s Stoxx 600 is about 0.25% higher and at its best level in three months. US futures are steady to slightly higher. Benchmark 10-year yields are little changed. The dollar is narrowly mixed against the major currencies, with Scandis leading the way. Sweden is expected to raise rates tomorrow. Emerging market currencies are also mixed today. The Philippine peso is the strongest with a 0.75% gain, while the Thai baht is the softest, with a 0.50% decline. Gold was capped near $1750 yesterday and is near the week’s low set Monday around $1732.50. January WTI is pushing below $80 a barrel after testing a three-day high yesterday around $82.35. US natgas is jumping 7% today. It was little changed yesterday after a 7.5% surge on Monday. Europe’s benchmark is 3.6% stronger and is up a little more than 15% this week. Iron ore rebounded 2% today after falling nearly as much yesterday. March copper is little changed. It rose 1.1% yesterday to snap a six-day drop. December wheat is trading heavily. It has not closed higher since November 15. 

Asia Pacific

The Reserve Bank of New Zealand delivered a hawkish 75 bp rate hike, lifting the cash rate to 4.25%. While forecasting a recession in the middle of next year, the RBNZ also raised its likely terminal rate to 5.5% from 4.1%. Labor shortages and wages pressure were cited as evidence of the overheating economy. It warned that house prices will fall by 20% from last year's high, more than it previously projected. New Zealand's two-year yield rose 19 bp (to 4.56%), while the 10-year yield rose a little more than four basis points (~4.18%). The New Zealand dollar wobbled a little and is holding below last week's high, slightly above $0.6200.

The Australian dollar, where the market is not fully convinced  that the central bank will hike when it meets on December 6 is little changed on the day after soft preliminary PMI. The manufacturing PMI slowed to 51.5 from 52.7, and the service PMI fell to 47.2 from 49.3. The composite spent the second month below 50 at 47.7 (vs. 49.8). It is the lowest since January. The new orders component fell to 48.4 from 49.3, the weakest since September 2021.

Japan's markets were closed today for the Labor Thanksgiving holiday. Its flash PMI will be reported tomorrow. Note that the OCED's newest forecasts have the Japanese economy the fastest next year at 1.8%. The dollar is consolidating in a narrow range of about a third of a yen on either side of yesterday's close (~JPY141.25). It looks comfortable on a JPY141 handle. The Australian dollar extended yesterday's recovery from the dip below $0.6600 seen on Monday. Yesterday's high was slightly above $0.6650 and today's high was near $0.6670. The next target is closer to $0.6690, but that may be a bridge too far today. The greenback is trading within yesterday's range against the Chinese yuan (~CNY7.1325-CNY7.1655). The continuing surge in Covid cases has spurred local governments to reintroduce mass testing and travel restrictions in Beijing, Guangdong, and Chongqing. Starting tomorrow, entry into offices, supermarkets, hotels, public transportation, and airport will require a negative PCR test within 48 hours. The PBOC set the dollar's reference rate at CNY7.1281 tightly to expectations but a little firmer than the median in Bloomberg's survey of CNY7.1274.

Europe

The eurozone preliminary November PMI was a little stronger than expected, but we are reluctant to read much into it about the implications of the depth or duration of the downturn. The manufacturing PMI rose to 47.3 from 46.4. The service PMI was unchanged at 48.6. The composite PMI edged up to 47.8 from 47.3. This was the first increase since April, but it is the fifth month the composite output measure is below 50.

The uptick is a result of small gains in Germany, where all three measures remained below the 50, the boom/bust level. The manufacturing PMI rose to 46.7 from 45.1, and the service PMI slipped to 46.4 from 46.5. The composite stands at 46.4, up from 45.1. France saw a tick up in the manufacturing PMI to 49.1 from 47.2. But the services PMI slid to 49.4 from 51.7. The composite PMI fell to 48.8 from 50.2, its first sub-50 reading since February 2021. The OECD's news forecasts see the German economy contracting 0.3% next year, while the French economy may grow 0.6%.

The UK preliminary PMI was little changed and does little to change the stark outlook. The manufacturing PMI was unchanged at 46.2, as was the service PMI at 48.8. The composite ticked up to 48.3 from 48.2. The OECD sees the UK economy contracting by 0.4% next year before growing 0.2% in 2024. Prime Minister Sunak's honeymoon was brief as he struggles with a rebellion among Tory MPs over a major housebuilding bill. It was due for a vote next week, but Sunak has delayed the vote in the face of the opposition within his own party. This comes after a pushback from the MPs on plans to seek closer ties with the EU, which Chancellor Hunt intimated. Moreover, while many MPs did not like Truss's unfunded deficit course, they are not happy with the coming tax hikes.

The G7 are expected to announce the price cap on Russian oil later today. There has been some dilution from the initial ambitions. The EU added a 45-day transition period for oil loaded before its December 5 ban takes place and unloaded by January 19, to match the exemption secured by the US and UK, for example. The price cap may be $65-$70 rather than the $60 that had been previously discussed. A report also suggests that Japan's oil from Russia's Sakhalin-2 facility may be exempt from the price cap. The goal of the price cap is to keep Russian oil on the market but minimize its revenue. Separately, The EC proposed a cap on natural gas prices, but the bar to impose it seems too high to be effective. The cap would be triggered if two conditions were met. First, that the front-month Dutch Title Transfer Facility (TFF, which we track in the overview) is above 275 euros per megawatt hour for more than two weeks. Second, that the gap between the TFF and regional LNG prices is greater than 58 euros for more than 10 trading days. Even during the peak a few months ago, these conditions were not met.

Although there are options for nearly 1.4 bln euros that expire today at $1.03, we suspect the options have been neutralized. The euro has held above $1.03 until late morning turnover in Europe, after rising above it yesterday. It reached nearly $1.0350 earlier today, recouping about half of its losses since the November 15 high (~$1.0480). While we continue to believe the dollar's large rally is turning, we see the market in need a technical correction and the move to $1.0225 earlier this week was the first leg. We do not think corrective phase is over. A break of $1.0280 would signal a return to this week's lows. We suspect the $1.02 area will give way and that the euro may fall back to the $1.00-$1.01 area. Sterling is holding in better as it remains within the range set last Tuesday (~$1.1740-$1.2030). While a retest on the $1.20 area is possible, we do not expect it to escape the dollar's upside correction. A break of the $1.1770 area could signal that the correction has begun in earnest and there may be scope to return toward $1.1600-$1.1650.

America

Thin trading in the US Treasury market has made for some sloppy auction results. Yesterday's $35 bln seven-year note sale generates a nearly three basis point tail (the difference between high yield and average yield). Direct and indirect bidders were a bit light, and this left dealers with the most since July 2021 (21.4%). Monday's five-year note sale ($43 bln) also tailed. Monday's two-year note sale ($42 bln) was the best received of this week's auctions and dealers were left with 20.6%, the least in a couple of months. One possible implication is that the investors are reluctant to take on longer duration. There are no coupon auctions next week and almost $95 bln in a maturing seven-year note.

There is a slew of US economic reports today. Durable goods orders tend to be a a volatile series, but capex seems weak, poised to contract for the third consecutive quarter. Weekly jobless claims are averaging about 221k here in Q4, which is a little lower than the Q3 weekly average of about 231k. The monthly employment report will be released next Friday, and the early estimates are for around a 200k increase in non-farm payrolls. The Flash PMI draws attention. The composite is expected to have remained below 50 for the fifth consecutive month. It was consistently above 50 in the first half of the of the year, even though GDP contracted. It spent five months in 2020 below 50. The University of Michigan's final consumer sentiment and inflation expectations survey will be reported. The one-year inflation expectations edged up to 5.1% in the preliminary report from 5.0% in October. It is the highest since July's 5.2% reading. The 5–10-year expectation was for inflation to average 3.0%, up from 2.9% and the highest since June. New home sales are expected to have fallen by 5.5% in October after a 10.9% decline in September. High prices and mortgage rates, coupled with limited supply are weighing on activity. A little after that data are reported, the Atlanta Fed will update its GDPNow tracker which as of last week stood at 4.2%.

We do not put much weight on today’s FOMC minutes. The November 2 meeting resulted in a 75 bp hike and the Fed noted it would take into account the cumulative effect of past hikes and that impact is with a lagged effect. The market initially thought this was a dovish pivot and the press conference saw the market reverse. Still since the day after the meeting, US financial conditions have eased. The S&P 500 is about 8% above the low it made the day after the FOMC meeting. A trade-weighted measure of the dollar is about 4.75% lower than November 3. The two-year yield is off about 10 basis points, and the 10-year yield is down closer to 30 bp. Bloomberg's measure of financial conditions has eased from -1.034 on November 3 to -.693 yesterday. Fed Chair Powell said at the press conference that if the "dot plot" were redone then, this year's projection would be higher. This is likely to be confirmed in the minutes. The mitigating factor, we think, is that the market is ahead of the Fed and the Fed funds futures show the terminal rate a little above 5% compared to the median dot at 4.6%.

The US dollar has found support near CAD1.3360 this week against the Canadian dollar. The nearby cap may be CAD1.3420-40, with CAD1.35, a more formidable obstacle. The Bank of Canada recognizes that its aggressive tightening is slowing economic activity. The swaps market is nearly evenly split between a 25 bp and 50 bp rate hike on December 7. The greenback has run into offers ahead of MXN19.60 for the past two days. Initial support is around MXN19.38-MXN19.40. News that Brazil's Bolsonaro is challenging the recent vote weighed on the real and Brazilian assets yesterday, and this may have helped the peso recover.

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