Overview: News that Israel's ground assault
on Gaza is being delayed while hostage negotiations continue saw gold and oil ease,
but tensions continue to run high. Gold peaked near $1997 before the weekend
and pulled back to about $1964 today before steadying. December WTI peaked in
front of $90 a barrel at the end of last week, and fell to about $86.85 today,
but has also steadied. The dollar is firmer against the G10 currencies, with
the Scandis and Antipodeans the weakest (off ~0.25%-0.65%). Emerging market
currencies are also mostly softer. The Mexican peso is the heaviest, off about
0.7%.
Global equities are weaker. The
MSCI Asia Pacific Index fell 2.7% last week, the most in two months, and is off
to a poor start this week. China's CSI 300, Taiwan's Taiex, and India's main
benchmarks are off more than 1% today. Europe's Stoxx 600 fell 3.4% last week,
the most since March. It is extending its losses today and is posting the fifth
consecutive decline. The S&P 50 fell 2.4% last week and the NASDAQ was off
almost 3.2%. Both are poised to gap lower. These gaps have extra technical
significance if they remain open given that they will appear on the weekly bar
charts not just the dailies. Bonds are also selling off. The 10-year JGB yield
reached a new high above 0.86% amid talk that the BOJ may consider adjusting
the Yield Curve Control and raising its inflation forecasts at next week's
meeting. European benchmark yields are mostly 6-8 bp higher, though we note the
peripheral yields, including Italy, are up a little less. The 10-year US
Treasury yield is up nearly 10 bp to breech the 5.00% threshold.
Asia Pacific
Does the yen's price action
generate possible insight into the Chinese yuan. Of course, they have two different currency
regimes. Although Japan used to be more activist, it now intervenes rarely and
last year's September-October operations were the exception that proves the
rule. China uses formal and informal mechanisms to influence the exchange rate.
Apparently using the usual verbal intervention, the JPY150 level has been
respected, so far. The dollar did spend a few minutes above JPY150 on October 3
and it appears less likely that it was the centra bank, and more likely that it
was the market itself that generated the dramatic swings (the dollar fell to
~JPY147.45 and then rallied back above JPY149). In early trading today, the
dollar pushed brief above JPY150 and quickly pulled back. There are over $3 bn
of options at JPY150 that expire today and tomorrow.
Previously, the market buzz
was that PBOC was capping the dollar at CNY7.30. The dollar is averaging above it this
month and the average close last week was near CNY7.3135. Now the buzz is
CNY7.35 is threshold. How would we know? The dollar stopped just shy of CNY7.35
on September 8. It has not traded above CNY7.3355 and that was the following
session (September 11). Before the weekend, the dollar had risen to its highest
level since then. Just like we suspect that Bank of Japan is not really
defending JPY150, we suspect that the PBOC is not defending a specific level.
The price action is what one would expect if the PBOC was trying to manage the
depreciation of the yuan driven ultimately by the divergence of policy.
In Japan, there were two
byelections, and the LDP, which held both seats previously lost the upper
chamber seat but retained in a close call the lower house seat. Prime Minister Kishia spoke before the
Diet earlier today. He is still touting tax cuts in the face of slumping public
support for his cabinet. Subsidies for gasoline, electricity, and household
gas, which had previously been extended until the year, have been extended
again through Q1. The existing subsidies have shaved more than one percentage
point off overall CPI. The end of the subsidies could boost inflation just as
the BOJ appears to want to exit its extraordinary monetary policy.
The dollar continues push
against JPY150. Last
week's 30 bp jump in the US 10-year yield did not do trick. There was a brief
push in thin early Asia Pacific markets that took the dollar to about JPY150.10.
It has mostly stayed below JPY149.95 since, but the market is not done. It has
barely traded below JPY149.75 since the higher was recorded. Intervention to
curb excessive volatility is justifiable but in the past three sessions, the
dollar has been in a half a yen range below JPY150. Actual one-month volatility
has not been this low since Q1 22. The Australian dollar is pinned it its
trough. Last week's attempt on $0.6400 was rebuffed and it returned to
slightly below $0.6300. Last week's low was about $0.6290. There are A$410 mln
in options at $0.6300 that expire today. For the third session, the Aussie is
making lower highs. The pre-weekend high was about $0.6330 and today's high is
slightly below $0.6325. The US dollar is firm against the Chinese yuan, but
for the first session since Tuesday, October 10, it has not risen above the
previous session's high. The pre-weekend high was above CNY7.3185. News
of investigation into Foxconn, whose founder is running for president of Taiwan
as an independent candidate, and the arrest of three employees at WPP, which
follows other incidents of the arrest of foreign business officials. The PBOC's
set the dollar's reference rate at CNY7.1792, slightly lower than last week,
compared with the average projection in Bloomberg's survey of CNY7.3111, which
is slightly higher than last Friday's projection.
Europe
Greece's 10-year yield has
fallen about 15 bp this year coming into this week (to 4.35%). The 10-year Bund yield is up 33 bp (to
2.89%). Italy's 10-year yield has risen 24 bp (to 4.92%). Greece's discount to
Italy is a record. Ahead of the weekend, S&P became the first major rating
agency to recognize Greece as an investment grade credit (BBB-) and a stable
outlook. It will not impact the use of Greek bonds as collateral for ECB
operations, but it brings the country a little closer to be included again in
industry investment grade benchmarks used by used by asset managers. Last
month, Moody's upgraded Greece by two notches, but is still one step below
investment-grade. Fitch's review is due December 1. It currently rates Greece
at BB+, the equivalent of Moody's. A bigger problem is looming. S&P
maintained Italy's rating two steps above investment grade, but potential
threat comes from Moody's who has a negative outlook for its rating, one step
into investment grade. Its review is expected November 17. Italy's government
does not expect a budget deficit to meet the 3% target until 2026, a year later
than initially planned.
For the past two weeks, the
euro has mostly traded in a $1.05-$1.0640 range. The brief exception was October 13,
slipped but held above $1.0495. This broad sideways movement needs to be placed
in the context of the 11 consecutive week of losses that ended in the first
week of October. The key issue is whether the price action is
"nesting" before another leg lower or whether a base is being forged.
The week's key events, (US Q3 GDP and the ECB meeting) are not until Thursday. The
euro has not closed above $1.0600 since October 11. So far today, the euro has
approached but not taken out last week’s high set on Thursday slightly above
$1.0615. Sterling closed near session highs before the weekend, but
after last Monday's high near $1.2220, sterling has been making lower highs. It
snapped that streak today, rising to about $1.2185. The pre-weekend high was
$1.2170. It had appeared to be forging a base around $1.2120, but this yielded,
and sterling found bids near $1.2090. It recovered but has been unable to
resurface above $1.2200. The Swiss franc is little changed after the weekend
election that is expected not to produce much of a change governing coalition
or in economic policy.
America
Four developments are
notable. First, the US
Treasury be selling almost $170 bln in coupons, including $26 bln of two-year
floating rate notes, and $218 bln of bills, without counting four-month bills
and the four- and eight-week bills. Last week's 20-year bond auction did not
tail as the previous week's refunding did. Partly this may be due to the
relatively smaller size and the concession that was given (the dramatic rise in
yields ahead of the auction).
Second, the implied yield of
the December 2024 Fed funds futures rose by 16 bp in the first three days of
last week. The 10-year
yield rose a little more than 30 bp at the same time. Hence, it seems
reasonable to conclude that half the rise in the long end was accounted for by
the adjustment in Fed expectations. However, in the last two sessions, the
implied yield of the December Fed funds futures contract fell by about 15 bp,
leaving the yield up a single basis point on the week at about 4.70%. The
10-year yield was flat in the last two sessions, settling the week, up 30 bp. As
Fed Chair noted, if it is sustained, it would imply a tightening of financial
conditions through the term premium that does some of the Fed's work. Related
to this is the dramatic shift in the US 2-10-year curve. It was inverted by
about 76 bp around the FOMC meeting last month and settled around -44 bp on
October 13 and -16 bp last week. That is the least since July 2022. Contrary to
conventional wisdom, it is not the inversion of the curve that has coincided
with recessions, but the re-steepening.
Third, surging long-end
yields sent bank shares reeling. Recall that early last week, the index of large bank shares and
regional bank shares were at the best levels for the month. They reversed
sharply. The index of large bank shares fell nearly 7.7% in past three sessions
and settled last week at its lowest level since May. The index of regional bank
shares fell by 8.2% from last week's high to the lowest since June 1. Financial
conditions have tightened dramatically over the past month and are back to less
since in last April. While the economy and the labor market seem resilient in
the face of higher rates, the Achille's Heel is the financial sector. Last
week, Fed Chair Powell seemed to play down the banking stress that led to a new
emergency facility--its use has been steady around $107-$108 bln in recent
months-- and risks arising from commercial real estate exposure. Still, the
dramatic tightening of financial conditions is worrisome even if the economy
boomed in Q3.
Fourth, the inability of the
dollar to rally in the context of the heightened geopolitical tensions, the
surge in long-term rates, the greater US two-year premium, and a series of
stronger than expected real sector data is notable. Moreover, as we noted in the weekly
commentary, the Dollar Index and euro, its largest component, saw the
five-day moving average cross the 20-day moving average for the first time
since July. The one-week/four-week moving average may be a helpful tool in
identifying trend and a proxy for a particular market segment. It is not
perfect. In the Dollar Index, there have been seven crosses this year before
last week, and only one whipsaw (July). Not responding to favorable news and
the moving average cross are sending cautionary signals. The price action has
yet to confirm. For that, the Dollar Index must push below the 105.50 area. The
comparable level for the euro is around $1.0640-50.
The US dollar settled last
week above CAD1.37. The
uptrend looks intact and there is little standing in the way of a rest of the
seven-month high set earlier this month near CAD1.3785. The proximity of
Wednesday's Bank of Canada meeting may deter much new position-taking. The
pre-weekend low was about CAD1.3670. Last week's high was about CAD1.3740 and
this looks likely to be challenged in North America today. The fact
that the greenback held below the month's high near MXN18.4860, and proceeded
to sell off more than 1.5%, have spurred talk of a possible double top, which
would project to back toward MXN17.00. However, to confirm a double top,
the dollar must be sold through the "neckline," which is near
MXN17.7550. Instead, it looks more likely that the US dollar will rechallenge
the recent highs and negate the talk of a double top. Above MXN18.50, the
initial risk may extend to MXN18.80. Lastly, in Argentina, Economy Minister
Massa did unexpectedly well in yesterday's election, garnering about 37% of the
vote. This set the stage for a run-off next month against Milei, a libertarian,
who received 30% of the vote. The results are expected to weigh on local asset
prices.
Reviewed by Marc Chandler
on
October 23, 2023
Rating:
