Overview: True to the market's penchant, it heard a
dovish Fed Chair Powell yesterday. He seemed to suggest that the bar to another
hike was high. This helped cap the 10-year yield just in front of 5.00% and
allowed foreign currencies to recover against the dollar. The US two-year yield
reversed lower after rising above 5.25%. It is now around 5.15%. Still, Powell
appeared to cover similar ground as several other officials, including Fed
governors in recent days. The dollar is trading with a firmer bias in Europe,
and it drew ever nearer JPY150. Most of the non-restricted emerging market
currencies, including the South African rand, central European currencies, and
Mexican peso are softer. Gold is extending it surge for the fourth consecutive
session and is above $1980 having settled last week a little below $1933. It is
up nearly $150 an ounce since the Hamas attack. December WTI is also rising for
the fourth consecutive session. It settled near $86.35 last week and approached
$90 today. It is up roughly 10% over the past two weeks.
Equities are lower, and given the geopolitical developments, risk-off moves ahead of the weekend are not surprising. Asia Pacific equities are a sea of red today and this week. South Korea and Australia indices lead today's move with more than 1% drawdowns, but on the week China's CSI 300's 4.2% drop is the region's largest loss. The Stoxx 600's nearly 1% drop today brings this week's decline to above 3%, the most since March. US indices are softer and have fallen for the past three sessions. European 10-year benchmark yields are narrowly mixed with most peripheral yields slightly softer and core rates a little firmer. Gilts remain under pressure with the 10-year yield up nearly three basis points to a new high for the week near 4.70%. The 10-year US Treasury yield is off 4.5 bp to about 4.95%. Itis up about 24 bp this week. The implied yield of the December 2024 Fed funds futures has risen by almost 12 bp this week.
Asia Pacific
It was a mixed week for
China. Growth in Q3
was a little better than expected even though the property sector remains
distressed, and Country Garden is on precipice of default, having missed the
final deadline of a coupon payment on a dollar bond. China surprised the
international community striking a debt agreement with Sri Lanka before the
Paris Club. It celebrated the 10th anniversary of the Belt Road Initiative,
Although the US has been critical, and Europe has become more disenchanted,
developing countries in Asia, Latam, and Africa are more may still be
attracted. The media jumped all over US Treasury data showing that China sold
$21.2 bln of US bonds, including Agency debt, in August. The $5.1 bln in
divestment of US equities appears to be a record. Still, before filing this
under de-dollarization, note that China's sales were largely offset by a
movement into bills and short-term securities, not out of the dollar. Note too
that in addition to the BRI, Xi's other global initiative, the Asian
Infrastructure Investment Bank also makes dollar loans. Meanwhile, the US
defense of Israel did not bolster Washington's standing among large parts of
the so-called Global South, which China's says it champions. Lastly, that
Chinese banks did not reduce the loan prime rates was not surprising after the
PBOC left the one-year Medium-Term Lending Facility rate unchanged earlier this
week at 2.50%.
Japan's September CPI
softened a little and was largely signaled by the Tokyo's report a couple of
weeks ago. Headline CPI
eased to 3.0% from 3.2%. This is the lowest reading so far this
year and matches the low since July 2022. The core rate, which excludes fresh
food, fell to 2.8% from 3.1%. This is the rate that the BOJ targets at 2%. It
peaked in January at 4.2%. The measure that excludes fresh food and energy
eased to 4.2% from 4.3%, which was the peak seen first in May and then July and
August. The low for the year as set in January at 3.2%. Both of these core
rates were slightly firmer than expected. Some press reports suggest that at
the BOJ meeting at the end of the month, the inflation forecast could be raised
to 3.0% this fiscal year from 2.5% and next year's projection raise to a little
above 2% from 1.9%. The forecast for FY25 may stay below 2% (set at 1.6% in
July). Note that here are two byelections on Sunday and Prime Minister Kishida
is set to deliver an important policy speech on Monday, which is expected to
address fiscal policy.
The dollar reached JPY149.96
in North America yesterday according to Bloomberg. In effect, it came within 2/10000 of a
cent shy of the equivalent of JPY150 (~0.006666). There are options for a
little more than $1 bln struck at JPY150 that expire today and Bloomberg has
today's high at JPY149.99. In the Powell-induced pullback, the dollar fell to
new session lows but found new bids slightly below JPY149.70, where it found
support today, as well. The Australian dollar recovered in North
America from the dip in Asia and Europe below $0.6300, and Powell's comments
goosed it up to almost $0.6360, where it ran out of steam. It stalled
near a retracement of the two-day decline and in front of the 20-day moving
average (~$0.6375). It returned to the $0.6300 area today and has mostly held
below $0.6330. The greenback rose against the Chinese yuan for the
fourth time this week and made a marginal new high today near CNY7.3185. It
is the strongest the US dollar has been since September 11. The PBOC injected a
record amount of liquidity (CNY828 bln, or ~$115 bln) through its reverse repo
operations today apparently to facilitate upcoming tax period and new government bond
issuance. The PBOC set the dollar's reference rate at CNY7.1793, a new low for
the week. The average projection in the Bloomberg survey was for CNY7.3074.
Europe
It was not a particularly
good week for the UK. It
announced that jobs were lost in September for the third consecutive month,
though wage pressures eased slightly more than anticipated in the three months
through August. Still, September CPI rose 0.5% and the year-over-year rate, and
especially service prices were firmer than expected. Earlier today, a 0.9%
decline in retail sales were announced, and a 1% drop when gasoline is excluded.
The drop was more than twice the median forecasts in Bloomberg's survey. Many
economists think the UK economy stagnated in Q3 and look for the same in Q4.
The 10-year Gilt yield jumped 30 bp this week, the most in nearly four months and
rose every day this week. Separately, the Labour took both previously held
Conservative seats in yesterday's byelection.
Germany lifted its
objections to (France) using state subsidies to fund its nuclear power plants,
which provide 70% of its electricity. However, in the grand horse-trading exercise, it may mean
that Berlin will not compromise on its backing of re-imposing the Stability and
Growth Pact, which will force many countries to tighten fiscal policy. Germany
has an "escape clause” if it is in a recession. Meanwhile, US and European
officials meet in Washington today. The US wants Europe to impose a 25% tariff
on steel and 10% on aluminum from non-market economies (i.e., China). In
exchange, Europe wants the so-called Trump-era tariffs to be permanently
lifted. The US is trying to preserve the right to reimpose the duties on Europe
in the future. Lastly, there is still hope that a US-EU agreement can be struck
on critical minerals.
With Powell's help, the euro
rose to a five-day high near $1.0615 yesterday. Some of the buying may have been
related to the nearly 900 mln euro options at $1.0550 and nearly 2 bln euros in
options struck at $1.06 that expire today. There are almost nearly $2.5 bln in
options at $1.0625 expiring today. Still, the euro failed to settle above
$1.0600, which tarnished the otherwise firm performance. Last week's high was
near $1.0640. A move above there would lift the technical tone, but so far
today, the euro has held below $1.06. Support is seen in the $1.0555-60
area. Sterling's recovery from $1.2090 was impressive but new sellers
emerged as it approached $1.2200. Yesterday was the first session
since the US employment data on October 6 that sterling was unable to trade
above $1.22. It retested yesterday's lows today after the disappointing retail
sales report. It recovered by looks capped around $1.2140. Separately, note
that S&P reviews Greece's debt later today and its BB+ rating. An upgrade
to investment grade is possible. DBRS already did so last month. S&P is
also due to review Italy's BBB rating today. We suspect the risk is of an
outlook downgrade to negative from stable.
America
It was a mixed week for the
US. The key economic
data were stronger than expected. This included retail sales, industrial
production, and business inventories. The Atlanta Fed's GDP tracker for Q3 GDP
was lifted to 5.4% (from 5.1% in the previous week) and several money center
banks revised up their forecasts as well. The median forecast in Bloomberg's
survey sees 4% growth, when it is reported next week. The 10-year bond yield
reached 4.99% yesterday. It settled at 4.61% last week. Almost half the
increase seems to come from the change in expectations for overnight rates next
year. The implied yield of the December 2024 Fed funds contract rose 16 bp this
week before pulling back in response to Fed Chair Powell's comments. The other
half of the increase in the 10-year note yield appears to reflect the term
premium, which is "compensation" for risk that the yield rises over
the life of the bond. It is the part that can be argued is tightening financial
conditions beyond what the Fed has done. Yet, the rising rates did not prevent
bank shares from advancing, even b Coming into today the index of large bank
shares, perhaps helped by the earnings reports is up about 0.20% this week,
which if sustained would be the first back-to-back weekly gains since July. An
index of regional bank shares is up about 2.4% this week, the largest advance
in seven weeks. On the other hand, the House of Representatives still has been
unable to pick a speaker and the Beige Book picked up growing concerns about
the economic outlook.
Canada and Mexico report
August retail sales today. The median forecast in Bloomberg's survey calls for a 0.1%
decline, which would be the first since March. If true, it probably overstates
the weakness of the Canadian economy. Still, the economy is nearly stagnant.
The Q2 contraction of 0.2% at an annualized rate is expected to be followed by
a 0.3%-0.4% expansion in Q3. The Bank of Canada meets next week, and the odds
of a hike have been downgraded in the swaps market to less than 13% from more
than 38% at the end of last week. Retail sales are expected to edge up by 0.1%
in Mexico. They had risen by 0.2% in July. Mexico's retail sales rose at an
annualized rate about 14% in Q2 after falling at a 4.0% annualized rate in Q1
23. On a quarterly basis, the Mexican economy expanded by 0.8% in Q1 and Q2 23.
It is expected to slow to around 0.5% in Q3 and further in Q4.
The US dollar was
consolidating its gains that took it to CAD1.3740 in Europe yesterday before
Powell spoke. The
greenback slumped to CAD1.3680 but quickly bounced before stalling near
CAD1.3710. It is consolidating quietly inside yesterday's range. A close below
CAD1.3680 would be constructive for the Canadian dollar. Still, the US dollar
needs to fall back below CAD1.3600 to be anything of technical importance and,
ideally, below last week's lows in the CAD1.3570-80 area. The US dollar
reached almost MXN18.40 yesterday in Europe and fell to a session low near
MXN18.16 after Powell's comments before stabilizing. The dollar is
consolidating firmly near yesterday's highs. A break of the MXN18.4860 high
seen earlier this month, could signal a move toward MXN18.80. Recall that in
Q2, the peso fell in four weeks. Assuming it does not recover much today, the
peso would have weakened for the sixth week in the past eight. At the risk of
oversimplifying, it appears the risk-off has met the overweight positioning.
Moreover, as the volatility is rising, and this also impacts the attractiveness
of carry strategies. Three-month implied volatility has risen from below 9% in
July to above 16% this month and is now around 15.25%. Lastly, Argentina holds
presidential elections on Sunday, but a second round will likely be necessary
(November 19).
Reviewed by Marc Chandler
on
October 20, 2023
Rating:
