Divergence Continues to Underpin the Greenback
The divergence reflected in the flash PMI readings seen yesterday underpinned the dollar, which is firmer in mostly quiet turnover. The initial Australian dollar gains scored in response to the slightly less decline in Q3 CPI have been unwound. The greenback also remains within striking distance of JPY150 where there are still some large options and some apprehension over possible BOJ intervention. Hungary’s larger than expected rate cut yesterday keeps the forint under pressure today, but most emerging market currencies are softer. The Canadian dollar is near the month’s low ahead of the Bank of Canada meeting. It is widely expected to leave the policy rate steady at 5.0%.
China’s stimulative measures helped lift mainland shares and those that trade in Hong Kong, but the early gains were not sustained. Among the other large markets in the region, Japan and Taiwan also rose. Europe’s Stoxx 600 snapped a five-day losing streak yesterday, but it is giving back those gains today. Mixed US earnings after the close yesterday has weighed on the index futures, pointing to a lower open. Benchmark 10-year yields are firmer, 2-4 bp in Europe and the US. The 10-year US Treasury yield is near 4.86%. Gold is consolidating in a narrow range (~$1968.50-$1977). The stronger dollar and firmer yields would be expected to be a drag, but geopolitics maybe lending support. December WTI is stabilizing after a three-day drop that took it down 5%. It is holding above $83, which it briefly traded below yesterday but is struggling to push back through $84.
Despite obvious differences and wariness of each other, Japan and China are dealing with similar macro challenges, including shrinking populations. Both are leaning against the weakness of their respective currencies, which largely reflect the broad strength of the US dollar and monetary policy divergence. China is still easing monetary policy. Japan has lifted the cap on the 10-year yield (in December to 0.50% and to 1.0% in July), and reports suggest further adjustment this year is possible. However, at the same time, the BOJ is continuing to buy bonds, both scheduled and unscheduled operations. It also continues to make long-dated loans to banks at attractive rates, with the logic being they will use the loans to buy government bonds. Its balance sheet is expanding.
The Kishida government is preparing a supplemental budget that will likely include one-year temporary income tax cuts, while extending subsidies for electricity, gasoline, and household gas to March or April 2024. Yesterday, China’s National People’s Congress standing committee authorized a larger budget deficit this year. It would reach 3.8% of GDP from 3% set in March. This includes additional bond issuance of CNY1 trillion (~$137 bln) this quarter to support construction and disaster relief. China rarely adjusts its budget in the middle of the year and does so typically in crises. The announcement indicated that half the new funds will be used this year. Beijing also recently announced a CNY1 trillion facility to allow regional government to swap high-interest rate off-balance borrowing for lower-interest rate bonds. At the same time, the standing committee endorsed the front-loading of next year’s local bond quota. China uses a range of formal and informal mechanisms to counter the pressure on the yuan. Japanese officials have expressed concern about the yen’s weakness, and used words that warned the market of the elevated threat of intervention. The BOJ’s unscheduled bond purchases appear to momentarily support the yen even though it caps yields.
Australia reported Q3 inflation did not slow as much as expected. It slowed to 5.4% from 6.0% in Q2. The 1.2% increase in the quarter means that Australia CPI is rising at about a 4.5% annualized rate this year through September. The underlying measures (weighted median and trimmed mean) rose by 1.2% and 1.3%, respectively in Q3, which brings the year-over-year pace to 5.2%. Housing and transportation, which seems like the impact of higher rates and energy prices, were the main culprits. Prices pressures are moderating, and the economy is slowing. Recall that Australian lost full-time jobs in September for the second time in three months. The flash composite October PMI crashed, falling by the most (4.2 index points) and to the lowest (47.3) since January 2022. The market’s response seems exaggerated. The futures market showed a sharp increase in expectations that the central bank will hike rates when it meets again on November 7. The odds roughly doubled to around 54%. Australia’s two-year yield jumped 12 bp to ~4.33%.
The dollar recovered from the session low set in Europe yesterday near JPY149.30 and returned to the session high in late North American activity, slightly above JPY149.90. For the eighth time this month, the dollar traded below the 20-day moving average but has not closed below it since the end of July. There still appears to be large optionality at JPY150 through the end of the month, including for $1 bln tomorrow and almost $3 bln Friday. It is in an exceptionally narrow range of about 15 pips above JPY149.80. The Australian dollar was driven almost half-of-a-cent higher to $0.6400 in response to the firmer than expected CPI but stalled. It has steadily retreated and recorded session lows in the Europe near $0.6330. A break, and especially, a close below yesterday’s low ($0.6330) would be a particularly bearish development. There are options at $0.6300 for around A$650 mln that expire today and a set ahead of it for A$420 mln at $0.6325. China’s CSI 300 gapped higher but spent the session trying to fill the gap and settled on its lows, with the gap unfilled. The dollar, which had traded down to CNY7.2980 yesterday, a nine-day low settled firmly yesterday, and follow-through buying today lifted it to CNY7.3170. If it closes here, it would be the highest settlement since September 8 when the high was recorded near CNY7.35. The PBOC set the dollar’s reference rate at CNY7.1785, slightly lower than yesterday. The median forecast in Bloomberg’s survey was CNY7.3167, the highest in four sessions.
The eurozone reported money supply figures today ahead of the ECB meeting tomorrow. M3 growth peaked in 2007 at 12.6% and peaked in January 2021 there as well. However, M3 slowed in 2008-2009 and went negative in late 2009-2010 (-0.4% February 2010). Money supply growth is imploding more now. It shrank by 0.4% in July, -1.3% in August, and -1.2% in September. There was a small increase in loans. The swaps market sees practically no chance that the ECB changes policy tomorrow. It sees the next move as cut and now has around 95% of it discounted for June 2024. Separately, Germany’s IFO survey stabilized. The current assessment ticked up to 89.2 from 88.7 and expectations edged up to 84.7 from 83.1. The overall business climate measure rose to 86.9 from 85.8. It is the first increase since April. Yesterday’s flash PMI less optimistic.
In a true Turn-Around Tuesday, the euro gave up Monday’s gains. The euro stalled in front of $1.07, its best level this month. Its gains were pared after the disappointing European PMI and then again after the US stronger than expected PMI. The single currency did not find much support until around $1.0580. We had suggested a break of the $1.0600-20 would be disappointing. The euro fell to almost $1.0565 in the European morning and now a break of the $1.0530-50 warns that three-legged correction since the year’s low was set on October 3 (~$1.0450) is over. Sterling’s upside correction since the seven-month low on October 4 (~$1.2035) has been flatter than the euro, the price action was just as poor. It returned to almost Monday’s low (~$1.2155 vs. $1.2145) yesterday and has been sold further today. The break of $1.2135 signals a retest of last week’s low near $1.2090. There are two chunky set of sterling options that expire today of particular interest. There are about GBP550 mln at $1.2125 and around GBP845 mln at $1.2100. The low set in the European morning is slightly below $1.2115.
In contrast to Japan and the eurozone, which saw the preliminary October PMI soften, the US improved. The manufacturing PMI edged up to 50.0 from 49.8. The median forecast in Bloomberg’s survey was for a small decline. Similarly, the service PMI rose to 50.9 from 50.1. The composite rose to 51.0 (from 50.2). It has not been below the 50 boom/bust level since January after spending H2 22 below it. The US report new homes today, and a small rise in expected after the sharp 8.7% drop in August. However, the focus is on tomorrow’s Q3 GDP. The Atlanta Fed’s GDP tracker will be updated later today, and it stood at 5.4% as of October 18. The median forecast in Bloomberg’s survey is for 4.5% Q3 GDP, driven by a 4% rise in consumption from 0.8% in Q2. The GDP figure is unlikely to shift the conviction that the Fed is on hold next week. Meanwhile, looking further down field, a week from Friday is the October employment report. Before the 336k surge in jobs in September, the three-month average was slightly below 190k. The early call is for about 185k increase this month.
The Bank of Canada meets today. It has been on hold since a 25 bp hike was delivered in July that brought the overnight target rate to 5.0%. With September inflation lower than expected, including the underling core measures, there is little pressure on the Bank of Canada to move. The 0.2% contraction in Q2 GDP likely overstates the weakness of the economy. It is expected to grow slowly in Q3 and the following two quarters. The swaps market shows a little more than a 5% chance of hike today and a little less than an 80% chance it stands pat at the last meeting of the year on December 6.
The US dollar traded on both sides of Monday’s trading range yesterday and closed just below its high. Still, it was the strongest close for the greenback since October 4. While the Canadian dollar did not fall as much as the euro or sterling yesterday, it was the weakest among the dollar-bloc. The US dollar reached its highest level since March earlier this month near CAD1.3785 and is approaching it today ahead of the Bank of Canada meeting. It reached almost CAD1.3780 in the European morning. There are roughly $300 mln in options that expire at CAD1.3755 today. There are also options for about $685 mln at CAD1.3800 that expire tomorrow. While the Canadian dollar weakness may not help efforts to restrain price pressures, the Bank of Canada is unlikely to make much of it. Year-to-date, it is off 1.6%, which means it is holding up better than most currencies. The US dollar was confined to Monday’s range yesterday against the Mexican peso (~MXN18.0775-MXN18.3750). It is trading quietly so far today between MXN18.2370 and MXN18.3365. The greenback must overcome the recent highs and push above MXN18.50 to signal the next leg up. Barring that look for consolidation above MXN18.00.
Bannockburn Global Forex