Yesterday's Dollar Recovery Questioned Today

Overview: The 11 bp jump in the 10-year US yield yesterday after dropping nearly 26 bp in the previous three sessions, helped the greenback recover and took a toll on stocks. Still, the S&P 500 is above the low set on November 30 (~3939) before Fed Chair Powell's talk that day. Global equities were dragged lower today. Most large bourses in the Asia Pacific region fell, including Hong Kong’s Hang Seng and the index of mainland companies that trade in Hong Kong. China’s CSI 300 and Japanese indices resisted the drag. Europe’s Stoxx 600 is off almost 0.5% and US futures are a little softer. European bond yields are mostly 2-3 bp lower, while the 10-year US Treasury yield is stead at 3.57%. Most G10 currencies are a little stronger today, while the sterling and the Canadian dollar are laggards, with small losses. Among emerging markets, Asian currencies are weaker, led by a 2% drop in the South Korean won. It is the biggest loss in two years. Some of the pressure may be linked to equity sales by foreign investors. The South African rand is the strongest in the EM space as it continues to recover (third day) from the recent sell-off due to domestic political issues. Gold has steadied after yesterday downside reversal that saw the yellow metal tumble to about $1766 after setting a new five-month high of almost $1810. Yesterday’s lows have held, and it is trading near $1773 late morning in Europe. January WTI is extending yesterday’s losses and is threatening the $75 a barrel level. US natgas is off 1.6% after falling 11.2% yesterday. It is extending its downdraft for the fifth consecutive session. It has lost nearly 25% over the run. Europe’s benchmark is about 0.25% lower after falling 2.3% yesterday. Iron ore fell for the first time in four sessions, but the loss was minor (~0.15%). March copper snapped a four-day advance yesterday with a 1.4% decline. It has steadied today and is up slightly. March wheat fell to a new low for the year yesterday ($7.34 a bushel) amid rising supplies, including talk of a record Australian harvest.

Asia Pacific

The Reserve Bank of Australia hiked its cash target rate by 25 bp to 3.10%. It was the eighth consecutive hike. Governor Lowe indicated that more hikes would be needed but is not a pre-set course. The futures market does not have another 25 bp fully discounted until April 2023. It has a peak rate of around 3.65%. Tomorrow, Australia reports Q3 GDP. Growth is expected to slow slightly to 0.7% quarter-over-quarter from 0.9% in Q2 and 0.7% in Q1. Growth is quarter may be the slowest of the year.

After unexpectedly contracting in Q3, the Japanese economy is off to a soft start in Q4. The composite PMI slipped below 50 to its lowest level since February. Today, it reported that household spending slowed to 1.2% year-over-year in October from 2.3% in September. Labor cash earnings rose 1.8% from a year ago, down from 2.2% in September. Tomorrow, Japan reports revisions to Q3 GDP and October current account figures. Japan's trade deficit nearly always improves in December before deteriorating in January.

The jump in US rates yesterday, which many accounts link to the ISM services, while ignoring the weakness in the services PMI, helped fuel a strong dollar rebound against the Japanese yen. We suspect yesterday's bonce in rates was a recognition that nearly 25 bp decline in the last three sessions of last week was exaggerated. The dollar rose to about JPY136.85 yesterday and extended it to almost JPY137.45 today. Resistance is seen in the JPY137.50-JPY138.00 band. The Australian dollar posted a key reversal yesterday by making new highs for the move and then settling below the previous session's low. The Aussie tested the 20-day moving average (~$0.6685) yesterday for the first time in more than three weeks. It has held yesterday's low today and recovered to nearly $0.6740. The $0.6750-70 area is the next hurdle. The dollar gapped lower against the Chinese yuan yesterday and traded below CNY7.0 the entire session. Today's bounce, anticipated by the dollar's gains against the euro and yen yesterday, stalled at CNY7.0. The pre-weekend low, the top of the gap, is at CNY7.0170. The greenback also stalled near CNH7.0 against the offshore yuan, but no gap is evident. The PBOC set the dollar's reference rate at CNY6.9746 compared with expectations (Bloomberg's survey) for CNY6.9785.

Europe

Germany's October factory orders were stronger than expected and the September series was revised to show a small decline. Factory orders rose 0.8% in October, well above the 0.1% median forecast in Bloomberg's survey. However, domestic orders fell by 1.9%, while foreign orders jumped 2.5% and were concentrated in capital goods orders. The Bundesbank noted that the large-scale orders were key. The 4.0% decline initially reported in September was revised to -2.9%. Germany reports industrial production figures tomorrow and are seen falling by 0.6% after a rise by a similar magnitude in September.

UK Prime Minister Sunak softened the plan that would set mandatory house building targets for local councils in the face of dissent among his own party. He could have still pushed forward as the Labour Party was more supportive. Sunak has agreed to make the targets advisory rather than compulsory. The next divisive issue is the government's effective ban on new onshore windfarms. Sunak's last two predecessors, Truss and Johnson are among the MPs that want to end the ban.

There seemed to be little progress yesterday in the US-EU trade and technology talks. There is tension over the $370 bln in subsidies for green energy in the Inflation Reduction Act, and tax breaks for US-made electric vehicles and batteries. Some observers are that Europe is subsidizing energy bills for business and households, but it is not that the WTO prohibits all subsidies but certain types. Europe can take the case to the WTO. Separately, reports suggest the US and EU have begun discussing the possibility to impose a carbon tariff on China's steel and aluminum exports as partly a green measure but also to address the overcapacity. Much thinking and discussion is needed and is likely to be a 2023 issue.

The euro peaked yesterday slightly shy of the $1.06 level, but reversed lower and settled near $1.0490, its lowest close in three sessions. The euro slipped through yesterday's low near $1.0480 briefly in late Asia Pacific turnover. Support was found near $1.0475. The session high was recorded earlier in session around $1.0520. The expiring options for about 785 mln euros at $1.0550 look safe. Sterling also made new highs since June yesterday near $1.2345 before succumbing to profit-taking pressures. It fell to nearly $1.2160 and held 5/100 of a cent above it today. However, the underlying tone sees soft and a push back below the 200-day moving average (~$1.2140) looks likely. A break of the $1.2120 area could signal another half-cent decline.

America

There are two distinct ways companies can service foreign demand, exports and build locally. The traditional way is exports, of course, but this is not America's way. In fact, for more than half-of-a-century, the sales by the foreign affiliate of US multinationals exceed US exports by a huge factor. Consider that for 2020, the latest year data is fully available, the sales by majority owned affiliate of US multinationals were $4.58 trillion. US exports that year were a more modest $1.43 trillion. The reasons for the US companies to adopt a foreign direct investment strategy (build and sell locally) rather than an export thrust appear to be historical reasons (over-valued dollar after WWII and protectionism). Those are the forces that drove Japanese auto and parts makers to build and sell vehicles in the US. No matter how high the yen went it did not satisfy some US officials and corporate leaders. And the type of US protectionism, like "orderly market arrangements" and "voluntary export restrictions" where acceptable under GATT, which led to its reform (WTO). Kenichi Ohmae, a nuclear scientist by training, and later the of McKinsey's Tokyo office, suggested a "total market penetration" measure that added local sales to exports. Moreover, because of the fragmentation of production, made possible by improvement in command, control, and communication functions, as well as reduced shipping costs and tariff barriers to trade, the cross-border movement of semi-finished good within the same company (think autos, US, Canada, and Mexico), simply adhering to a state-centric model (does the good or service cross the a border?) fails to appreciate the evolution of trade and the organizational contribution of multinational companies.

The US reports its October trade balance deficit today. We already know that the goods shortfall widened to $99 bln in October, a little more than a 7.5% deterioration, which is a little less than half of the deterioration over the past year. Due to distortions and disruptions of the supply chains and challenges managing inventories in a phase characterized by uneven re-opening from the pandemic appears to be the main factor behind the trade deficit recovering from a monthly record in March of almost $107 bln. It fell to about $65.7 bln in August, which was the smallest since February 2021. The improvement is likely behind it, and a new deterioration has likely begun. The median forecast in Bloomberg's survey is for an $80 bln shortfall. If true, that would be the largest since June. There was a period in the mid-1980s that the US trade report was the key report of the month and a source of volatility. Those days are long over but may come back in the form of a narrative to explain why the dollar is weaker even while maintaining an interest rate differential over Europe and Japan.

Canada reports is October merchandise trade balance. So far, this year, Canada has not reported a monthly trade deficit. If this is sustained in Q4, it would be the first such year since 2007. The C$2.4 average monthly surplus through September contrasts with a C$0.23 surplus in the same period last year and a C$1.80 bln deficit in 2019. The Canadian dollar does not seem particularly sensitive to the merchandise trade flows. The Bank of Canada meets tomorrow. The swaps market had leaned toward a 50 bp hike at the start of last week (~78%) but has downgraded it to slightly less than a third.

The US dollar posted an outside up day against the Canadian dollar. It rallied from a five-day low near CAD1.3385 to a four-day around CAD1.3605 amid the sharp sell-off in US equities. The greenback is extending yesterday's gain and it near CAD1.3625 in the European morning. Last week's high by CAD1.3645 is the next immediate target. The CAD1.36 area represents the (50%) retracement of the US dollar's losses since peaking on October 13 slightly above CAD1.3975. The (61.8%) retracement is around CAD1.3690. The Mexican peso was shellacked yesterday. The US dollar soared to MXN19.8640 from a little below MXN19.35. As we have suggested, last week's push to MXN19.04 seemed to have sapped the peso bulls and adjustment on the crosses seemed to have had an exaggerated effect. The US dollar settled near MXN19.7550 and has spent little time above there today. The low so far is slightly below MXN19.68. The dramatic price action has been enough to lift the five-day moving average above the 20-day for the first time in two months. We look for near-term consolidation.

 

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