• The US dollar is heavier today, but the intraday momentum indicators warn that follow-through selling in North America today may be limited.
• China’s data disappointed. The covid breakout in Nanjing and the base effect may have exaggerated the weakness.
• Separately, China announced it will hold its first oil auction on September 24 for what seems like an inconsequential (for prices) 7.24 mln barrels.
• The UK reported higher than expected inflation and the market moved incrementally to now discount the likelihood of two hikes next year.
• The US reports the September Empire Fed manufacturing survey (it has been exceptionally volatile lately), August import/export prices (favorable terms of trade implications) and industrial production (slower growth is anticipated),while the utilization rate may rise to its best level since December 2019.
• Canada reports August CPI. A firm report will keep the central bank on course to taper further in Q4.
Overview: The sixth decline of the S&P 500 in the past seven sessions set a negative tone for equity trading in the Asia Pacific region, and the poor Chinese data did not help matters. News that China’s troubled Evergrande would miss next week’s interest payment weighed on sentiment too. Only South Korea and India of the large markets in the region managed to escape unscathed, even as North Korea tested ballistic missiles for the second time in a week. European bourses have also eased, falling for the second consecutive session and six of the last seven. Meanwhile, US futures are posting small gains. The US 10-year note has also stabilized around 1.27% yield. Yesterday’s rally in the US saw Asia Pacific yields ease, except in China. European yields are softer too. The dollar is trading with a heavier bias. The Scandis and the yen and Swiss frac are leading, while the dollar-bloc and sterling are lagging. Emerging market currencies are also mostly higher today, and the JP Morgan index is firmer. It would be the fourth gain in the past five sessions if sustained. Despite the disappointing data, the Chinese yuan remains firm, leaving the dollar weaker than the CNY6.45-CNY6.50 band that has confined the greenback since mid-June. Gold posted an outside up day yesterday, but no follow-through buying has seen some late longs exit, pushing the yellow metal back below $1800 in Europe. News that China’s steel production fell weighted on iron ore prices, which have now fallen in 11 of the past 12 sessions. Copper is rising for the first time in three sessions. Oil prices are firm, with the November WTI contract trying to establish a foothold above $71.00. API reported a 5.4 mln barrel drawdown and if confirmed, would leave US inventories at two-year lows.
China data disappointed. August retail sales rose by 2.5% year-over-year, down from 8.5% in July and sorely missing the 7.0% median forecast in Bloomberg’s survey. Industrial output slowed to a 5.3% year-over-year pace from 6.4%. Economists projected a 5.8% pace. Steel output fell to its lowest level since March 2020. However, Beijing has promised to cut output this year, and it is still up 5% year-over-year, warning of the risk of further cuts. Fixed asset investment slowed slightly more than expected, to an 8.9% year-to-date annual pace, down from 10.3% in July. Construction is off by about 3.2%. The lockdown in Nanjing and base effects may have contributed to the weaker economic readings. The economy is likely to stabilize in Q4 before recovering in Q1 22.
Beijing announced it would hold the first oil auction on September 24 as it taps its strategic reserves of an estimated 220 mln barrels to help ease price pressures. It will auction 7.38 mln barrels of various grades that were put into storage last year. Domestic end-users, in good standing, would be allowed to participate. However, it seems too small to make much of a difference to global prices and accounts for less than one day of China’s imports.
There are three other data points in the region to note, two of which are from Japan. First, core machine orders, a lead indicator of capex, rose by 0.9% in July, well below expectations, reflecting a smaller recovery from the 1.5% decline in June. Second, separately, after expanding in Q2, the world’s third-largest economy is off to a weak start in Q3 as the tertiary industry index (services) fell by 0.6%, defying expectations for a 0.3% gain. Finally, South Korea reported an unexpected drop in unemployment to 2.8% from 3.3%. It was a function of the sixth month of job gains and a drop (to 62.8%) in the participation rate to its lowest level since March.
Falling equities and the drop in US yields helped fuel the yen’s gains to its best level in about four weeks. The greenback has slipped from a little above JPY110 to almost JPY109.50 yesterday and recorded a low near JPY109.30 in Europe today. The intraday momentum indicator suggests that the low may be in place for the session. The JPY109.60-JPY109.65 area, where $1.2 bln in options will expire today, may offer a nearby cap. The Australian dollar initially extended yesterday’s 0.65% drop to test the $0.7300-level but rebounded through $0.7330. However, here too, the intraday momentum indicators warn that the upside may be nearly exhausted. The $0.7340-$0.7350 area may limit additional gains. The PBOC set the dollar’s reference rate at CNY6.4492, a bit stronger than the median projection in the Bloomberg survey for CNY6.4483. The PBOC rolled over maturing policy loans, and the overnight repo rate fell 15 bp (to 2.14%), and the seven-day repo rate fell seven basis points (to 2.22%). While the short-squeeze in the money market was alleviated, the dollar remains outside of the CNY6.45-CNY6.50 band. Indeed, near CNY6.4340, the dollar is at its weakest level since June 16. However, one-month implied vol is near the lower end of its recent range, around 3.50%.
UK August consumer inflation rose more than expected, and this is pushing the market in the direction it was already moving, and that is toward a more hawkish Bank of England next year. The market appears to have gone a long way toward pricing in not one but two hikes next year. The December 2022 short-sterling futures contract implies a 58 bp yield, which is up about 16 bp since early August. The implied yield has risen for six of the past seven sessions. The BOE’s preferred measure of consumer prices includes owner-occupied costs (CPIH), and it rose to 3.0% from 2.1%. The median forecast in Bloomberg’s survey was for a 2.7% rate. The core rate jumped to 3.1% from 1.8%. This probably overstates the case a bit. The base effect from last year’s cut in the sales tax for the hospitality sector dropped out, and apparel prices seem to reflect “normal” seasonal pressures. The BOE previously projected inflation would peak around 4% by year-end before falling back in 2022-2023. Separately, producer prices were also firmer than expected. The one area that saw less price pressure was house prices. The government house price index moderated to an 8% year-over-year pace, well below the 13.1% rate reported in June and below the median forecast for a 12.5% pace.
What to do? Rising natural gas prices, droughts, other disruptions have sharply raised the price of electricity in many countries. The price of carbon emissions contracts has also risen sharply. Madrid announced an unexpected 2.6 bln euro tax on power companies who may not use natural gas but benefited from it. Prime Minister Sanchez got 650 mln euros from power companies earlier this year that benefitted from the rise in carbon prices. To ease the pressure on households, the Italian government has eased taxes on energy, and Spain will also take steps to make energy more affordable. Italy spent 1.2 bln euros in Q2 to mitigate the spike in energy prices and is looking to repeat its exercise. Spanish households have seen their electric bill rise by a little more than a third over the past year.
Yet, the climate summit in Glasgow is only a month away, and the UN report was less than two months ago. It seems like an awkward time to lower the Special Electricity Tax and the VAT on electricity. Other countries are wrestling with similar issues. French President Macron is reportedly considering extending the direct subsidy for fuel payments. Athens launched a 150 mln budget to help blunt the recent rise in electricity prices. Part of the challenge is that Russia appears to be sending lass gas to Europe. There seem to be two schools of thought as to why. The first suspects Russia is rebuilding its domestic supplies. The second sees a more nefarious motivation: pressing Europe to start the controversial Nord Stream 2 pipeline.
The euro broke below $1.18 on Monday and but closed above it. It continues to find bids near there, and there is an option for about 675 mln euros struck there that expires today. On the other hand, it has not traded above $1.1850 for a week. Sterling rose to its best level in over a month yesterday near $1.3915, but it reversed lower and settled on its lows just above $1.38. It briefly slipped below $1.38 today but rebounded to almost $1.3845 after the inflation data. It is struggling to maintain the upside momentum. Initial support is seen near $1.3820 now. The euro had been turned back from the GBP0.8600 area last week and fell about GBP0.8510 on Monday and Tuesday to begin forming a base. The cross is near GBP0.8550 now after recovering yesterday.
The US 10-year yield fell to match a seven-day low after news that August CPI did not rise as much as economists expected. The headline pace eased to 5.3% from 5.4%, matching expectations, while the core fell to 4.0% from 4.3%. Expectations had been for around 4.2%. Sometimes the story drives the price action, but this time it appeared that the price action drove the story. Most economists quoted seemed to say that the data did not affect their views on tapering, but the “other person’s” views changed as if the tapering expectations were the only driver. It also seems to pretend the there is some automaticity involved; turn this dial on tapering timing, and it equates to a certain change yields. This simply, ain’t so, Joe. A critical reason tapering is important is that it needs to be completed before the Fed can hike. So a delay in tapering should see a push back in expectations for the first Fed hike. Yet, the December 2022 Fed funds futures contract slipped a single basis point, but at 23 bp is still fully discounting a hike.
The details of the CPI are in line with what the Fed broadly expected and therefore is unlikely to alter its course or the timing for that matter. In a speech over the summer, Chair Powell used two examples, lumber and used cars, to illustrate what the Fed expected. Lumber had rallied strongly on supply disruptions (a four-fold increase from last October to May) and had fallen and continued to fall and have now nearly returned to pre-pandemic levels. Used car prices were stickier, but Powell suggested that used car prices would also begin falling if his view was right. The wholesale market has softened, which fed through the retail market, and the prices of used vehicles fell by 1.5%. Some price increases were unwinding last year’s cuts (base effect), and when this washed out, price pressures would subside. Airfare fell by slightly more than 9% (Covid?), and vehicle insurance fell by nearly 3%. Hotels and car rental prices eased. Medical goods prices eased by 0.2% (Covid?). Rents rose by 0.3%, and owner-occupied rent rose by 0.3% as well for a 2.6% year-over-year pace.
The US reports the September Empire manufacturing survey. It fell sharply in August but has been especially volatile lately (18.3 vs. 43.0 in July and 17.4 in June). Another decline, albeit small, is expected. The US also reports August import and export price indices. The takeaway is that while both are elevated, export prices are rising faster than import prices, and this speaks to favorable terms of trade developments. The data highlight is the industrial and manufacturing output. Slow gains are expected after 0.9%, and 1.4% increases were reported, respectively. Although it does not draw the interest as it did in the past, note that the capacity utilization rate is expected to rise to 76.4%, which would be the highest since December 2019.
Canada reports August CPI figures. A small 0.1% rise would lift the year-over-year rate to 3.9% from 3.7%. The core measures may also tick up slightly. The Bank of Canada met last week, and despite unexpected weakness in Q2 GDP and possibly July as well, it stuck to its projections that the output gap will close around the middle of next year. Updated forecasts will be made provided next month, and further tapering to C$1 bln a week in Q4 looks likely.
Falling equities yesterday helped the greenback find support near CAD1.2600 and recover to close near session highs slightly below CAD1.2700. It briefly pushed through yesterday’s highs in Asia before turning better offered in Europe, where it has been sold to about CAD1.2665. The intraday momentum indicators warn that the US dollar may find support in the CAD1.2640-CAD1.2650 area. Meanwhile, the dollar remains within its well-defined two-week range (~MXN19.85-MXN19.98). It looks likely to stay in that range today, though the key may lie with the broader appetite for risk rather than domestic developments. Reports suggest the Mexican government did buy about $7 bln of reserves from the central bank, which AMLO intends to use to ease the debt burden of Pemex (estimated at around $115 bln).
Bannockburn Global Forex