What Did Powell Say?

Overview:  Asia Pacific stocks rallied on the heels of the surge in US equities. China’s CSI 300 led the large bourses higher with a 1% advance. Europe’s Stoxx 600 is matching yesterday’s gain of a little more than 0.6%, while US futures are a touch softer. European yields are 9-13 bp lower, with the peripheral premiums shrinking. The US 10-year yield, which tumbled 14 bp yesterday is little changed now near 3.60%. The dollar is broadly lower. The strongest of the G10 currencies is the Japanese yen, where the drop in US rates is the driver. The weakest is the Canadian dollar, the only major not to be appreciating against the greenback today. Barring the Turkish lira, South African rand, and a couple of currencies from central Europe, the dollar is trading heavily against emerging market currencies. The strongest is the South Koran won (~1.1%) despite an unexpectedly large drop in exports and a deteriorating trade balance. Gold likes the combination of lower interest rates and a weaker dollar. It has moved within striking distance of the mid-November high near $1786.50. January WTI is consolidating mostly above $80 today, while US natgas edges higher after falling 4.2% yesterday. Europe’s natgas benchmark is continuing to surge. It is up 7.5% today after an 8.1% rally yesterday and 5.5% on Tuesday. Optimism in China helped lift iron ore by 2.2%, while March copper is edging higher for the third straight session of gains. Lastly, March wheat is giving back nearly half of yesterday’s 1.8% gain. 

Asia Pacific

Outgoing Vice Premier Sun gave the strongest signal to date of shifting Covid policy, saying that it has entered a new stage. The move to quieter and more targeted restrictions has been underway for a few weeks. The claim that Covid in China is less virulent still has to be seen. A new push to encourage vaccinations, especially among the elderly will help. As we have noted, Taiwan's experience since the opening up six months ago, if repeated in China would be catastrophic. Also, reports suggest Hong Kong's hospitals have had to turn away non-emergency procedures due to the Covid cases overwhelming capacity. In addition, we underscore the difference between declaratory policy (what is announced) and operational policy (what is done). Separately, the Caixin manufacturing PMI was improved slightly to 49.4 from 49.2. Still, it is the fourth month below 50. The "official" measure is at 48.0, which is the second month in contraction.

Japan's Q3 capex jumped to 9.8% from a year ago, twice the increase reported for Q2, and well above the 6.2% forecasts. This suggests Q3 GDP, which unexpectedly contracted by 1.2% may be revised higher. Corporate profits also surged un Q3, jumping 18.3% year-over-year, edging up the 17.6% pace seen in Q2, on the back of an 8.3% increase in sales (up from 7.2%). Still, the economy disappoints. The final November manufacturing PMI was revised to 49.0 from 49.4, and 50.7 in October. It matches the low from November 2020. 

Australia's manufacturing PMI was revised to 51.3 from the 51.5 preliminary estimate and 52.7 in October. When compared with most other major countries, it manufacturing PMI appears to be holding up well. Still, it is the lowest since June 2020. Separately, Australia reported that private capex unexpectedly fell in Q3 by 0.6%. Economists had projected a 1.5% gain (median forecast in Bloomberg's survey). Third quarter GDP figures are due next week, shortly after the central bank meeting.

The focus was not on South Korea's Q3 GDP, which expanded as expected by 0.3%, but on the poor trade figures, seen a broader indicator. Its exports fell 14% from a year ago. This was largest slump in two-and-a-half years. It was driven by two elements. First, exports to China were off by a little more than a quarter from a year ago. Second, exports of semiconductor chips fell by almost 30%. Imports, which are someone else's exports, slowed from 9.9% to 2.7%. The net result was a $7 bln trade deficit in November. In November 2021, the trade surplus was almost $3 bln. The deterioration of South Korea's trade balance might be thought to explain the won's weakness this year, but not its 8% rally last month, which halved the decline of the first 10 months of the year. 

Instead, like for the Japanese yen, the direction of US interest rates is key. After setting a five-day high yesterday a little shy of JPY140, the dollar reversed to about JPY137.65. Today, it was sold to about JPY135.85, its lowest level since August 23. The greenback has steadied in Europe and initial resistance is seen in the JPY137.00-50 area. The JPY135 area may offer some support ahead of the 200-day moving average near JPY134.40. After stalling near $0.6800 since mid-November, the Australian dollar powered up to $0.6840 earlier today. This is its best level since mid-September. It is trading a bit heavier in Europe. Support is seen around $0.6780, and as long as $0.6750 holds, the bull move looks intact. The next upside target is by $0.6870 then $0.6925. The greenback extended its slide against the Chinese yuan. Recall the dollar peaked on Monday near CNY7.24 amid claims from some quarter that officials were quietly devaluing it. Earlier today, the greenback dipped below CNY7.05, a two-week low. It gapped lower but has not recovered to nearly CNY7.09. Yesterday's low was close to CNY7.07. The PBOC set the dollar's reference rate at CNY7.1225, close to the median projection in Bloomberg's survey of CNY7.1234

Europe

The final manufacturing PMI reading followed a consistent pattern among the Big 4 in the eurozone. The improvement reported in the preliminary reports was pared but still showed slower contraction in activity than the previous month. Germany's stands at 46.2, down from the initial estimate of 46.7 and better than October's 45.1. The French reading is 48.3, down from 49.1 of the flash report but improved from 47.2 previously. Italy's manufacturing PMI improved from 46.5 to 48.4, which was a little better than expected. Spain's manufacturing PMI rose to 45.7 from 44.7 and was not quite as good as expected. The aggregate reading stands at 47.1, which is lower than the preliminary estimate of 47.3 but not as poor as October's 46.4. Still, it is the fifth month below the 50 boom/bust level.

Separately, unemployment in the eurozone unexpectedly slipped to 6.5% in October from 6.6%. Perhaps underappreciated, it is the lowest since monetary union. On the other hand, German retail sales were exceptionally poor, falling 2.8% in October. The median forecast in Bloomberg's survey was for a 0.5% decline. The eurozone's aggregate figures will be published next week. Recall that yesterday France reported a 2.8% drop in consumer spending in October. Economists had forecast a 1% decline. 

The UK's manufacturing PMI initially was reported unchanged at 46.2, but the final reading today lifted it to 46.5. It is the fourth month below 50. It is difficult to get excited about it. By most accounts, the UK has already entered a recession. Meanwhile, Nationwide house price index fell 1.4%, more than expected. It is the third consecutive month of falling prices and the most in two-and-a-half years. 

The euro posted a key downside reversal on Monday after approaching $1.05. It reached a five-day low yesterday after $1.0290 before surging yesterday in North America to $1.0430 and closing above the previous day's high. The bullish price action saw follow-through buying today to almost $1.0465. New buying was seen in late Asia/early Europe on the brief dip below $1.04. Ahead of the US jobs data, the market may be hesitant about challenging $1.05 but a move above there would likely spur stop-loss buying and the next target is the $1.0600-20 area. Sterling has risen to a new three-month high near $1.2155 to kiss the 200-day moving average. It has not been below $1.2050 today. However, the intraday momentum indicator is overextended with the latest gains in the European morning. The $1.21 area may offer initial support and then $1.2070.

America

Leave the price action aside for the moment, Fed Chairman Powell broke no new ground yesterday. He reiterated what he has said before and what the market has known. First, if officials knew in September what they know now, the projected terminal rate would have been a little higher. The market is already there. The median dot in September was for the peak to be near 4.6%. The market has been within an eighth of a point of 5% since mid-October. Some observers have talked about Powell killing the so-called Fed put, but in a non-crisis situation, when systemic risk is not prominent, as is the case now, the Fed seems to still be following the market. Second, since at least early November, the market has accepted that the Fed would hike 50 bp at the last meeting of the year. This is not a new position for the Fed either. The median dot in September anticipated 125 bp increase in Q4 and in November, the Fed delivered a 75 bp down payment. Third, Powell's reference to the headline and core PCE deflators, which will be reported today, of 6% and 5% respectively matches precisely the median forecast in Bloomberg's survey. Fourth, if Powell's goal was to push back against market expectations of a cut in Q4 23, as some observers claim, he failed. In fact, the yield of the December 2023 Fed funds futures contract is 29.5 bp lower than the September 2023 contract, the most in nearly two weeks. The element that seemed somewhat new was Powell stating his own view that the decline in the labor force participation rate can be mostly explained by pandemic era retirement (2 mln of the 3.5 mln shortfall). That seems reasonable, except for the fact that the participation rate never fully recovered from the Great Financial Crisis. 

In addition to the PCE deflators, the personal income, and especially the consumption data will be used to adjust Q4 GDP estimate. While income is expected to have edged up by 0.4%, the same as in September, consumption is seen accelerating to 0.8% from 0.6%. That would be the most since June. The preliminary manufacturing PMI fell to 47.6 from 50.4, the first break of 50 since June 2020. It is subject to revision today. The November manufacturing is expected to confirm this break. New orders are expected to have remained below 50, which is consistent with other reports showing a drying up of the pipeline. Price paid are expected to have remained below 50 as well. October construction spending rose by 0.2% in September and likely gave it back in October. Weekly initial jobless claims are overshadowed by tomorrow's national employment report. November auto sales will trickle in today, and after jumping to 14.90 mln vehicles (SAAR) from 13.49 mln in September, economists are projecting a 14.60 mln pace. Last November, the US sold 12.86 mln vehicles (SAAR). 

Canada and Mexico see their November manufacturing PMI. They are not typically market-movers. Canada also reports employment data tomorrow. After a surge in October, slower job growth is expected. The Bank of Canada meets next week, and the market favors a 25 bp hike, though has about a 1-in-3 chance of a 50 bp move. Mexico reports IMEF activity surveys and October worker remittances. The remittances continue to more than cover the trade shortfall. They are expected to be around $5.1 bln in October. The average this year is around $4.8 bln. The average for the Jan-Sept period last year was about $4.15 bln.

After pushing above CAD1.36 on Tuesday, the US dollar fell to about CAD1.3410 yesterday. A little follow-selling pushed it a little below CAD1.3400 earlier today. Still the bout of Canadian dollar underperformance does not look over. It often underperforms in a weaker US dollar environment. Initial resistance is seen near CAD1.3450 and then CAD1.35. The greenback had fallen to almost MXN19.04 on Tuesday and bounced to nearly MXN19.46 yesterday before reversing lower. The MXN19.20 area offers initial support.

 

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