• A new calm has emerged after yesterday’s carnage and the dollar is seeing yesterday’s gains pared. The FOMC starts its two-day meeting, and this is likely to keep many participants sidelined ahead of the outcome.
• Chinese, South Korea and Taiwan markets remains closed for the holiday and re-open tomorrow. The property developers outside of Evergrande appeared to stabilize in HK today.
• The Reserve Bank of New Zealand Assistant Governor pushed against market expectations that the RBNZ’s first hike next week could by 50 bp.
• Canada’s Liberals appear to have gained a seat in the House of Commons but fell short of a majority. For the second consecutive election, it lost the popular vote. The combination of looser fiscal policy and tighter monetary policy is generally supportive of the exchange rate.
• US President speaks at the UN today and will deny Cold War intentions within a few days of announcing a new security pact and upgrading Australia’s military capability via nuclear-powered subs and within hours of the SEC warning about the risks of investing in Chinese companies that trade in the US.
Overview: Coming into yesterday’s session, the S&P 500 had fallen in eight of the past ten sessions. It closed on its lows before the weekend and gapped. Nearly the stories in the press blamed China and the likely failure of one of its largest property developers, Evergrande. Those that are prone to the sky-is-falling narratives refer to it as Lehman moment. The S&P ‘s 2.7% decline yesterday was the largest in half of a year, and the VIX jumped to four-month highs. China, Taiwan, and South Korean markets remain closed today, but the Hang Seng stabilized, and although Evergrande fell further in Hong Kong, others in the property sector stabilized. Japanese markets closed yesterday, played catch-up today, and the Topix fell 1.7%, and the Nikkei 225 was off almost 2.2%. Europe also is recovering today. After the Dow Jones Stoxx 600 fell 1.7% yesterday, the benchmark is up more than 1% through the European morning. US futures have also rebounded around 1%. The bid in the main bond markets has been sapped by equity stabilization. The 10-year Treasury yield is up a couple of basis points to almost 1.33%. European yields are firmer, though the periphery is lagging behind the core. The greenback (and yen) have also lost yesterday’s bid. The Norwegian krone and Canadian dollar lead the majors higher, while the freely accessible emerging market currencies, led by the Turkish lira and Mexican peso, are also advancing. The JP Morgan Emerging Market Currency Index is snapping a three-day slide. Gold is trading a little firmer after finding support near $1758. November WTI slipped below $70 a barrel yesterday but is back around $71 ahead of the US oil inventory estimate, which is expected to have fallen for the fifth consecutive week. Iron ore in Singapore fell for the tenth session in a row. Copper has steadied after dropping 3% yesterday. The CRB Index fell yesterday for the third successive session, the longest in a month.
Chinese markets were closed yesterday, but the NASDAQ Golden Dragon China Index of China-based companies whose stock trades in the US closed 5.8% lower after falling about 6.2% in the previous two weeks. It has been known for some time that Evergrande was facing financial difficulty. Until yesterday, it was largely confined to other Chinese property developers. Property developers themselves account for a little over 1/8 of China’s GDP, but a liberal inclusion of the ecosystem around them boosts the share to closer to 30%, according to some estimates. Foreign investors are thought to hold around $14 bln of Evergrande debt, but foreign banks have greater exposure to the property developers and their ecosystem. As we noted yesterday, Evergrande has two coupon payments due on Thursday, with a 30-day grace period. Unlike Western and Japanese capitalism, Beijing is unlikely to bail out the creditors directly, though the Chinese banks are mostly state-owned. Not intentionally, but opportunistically, another private sector will be brought to heel.
A few days after Washington surprised the world by announcing a new security pact that will give Australia nuclear-powered submarines to assist in efforts to contain the aggressiveness of China, and within hours of the SEC’s alert (yesterday) about the risks of investing in Chinese companies that trade in the US, President Biden will address the UN. He will reassure Beijing (and the world) that the US is not in nor seeks a Cold War with China. Is that really credible anymore? Are we being told not to believe our lying eyes? Until the US offers a different and compelling framing, the Cold War one will likely stick. Biden is expected to offer to cooperate on climate change, but Xi has already told Biden that it cannot cooperate with the US if it does not respect its red lines. The fact that Beijing rejected the US offer and that Biden goes to the UN with the same proposal is part of the “Cold War” that Biden is denying. The US has purposefully lobbied against Huawei, which has shrunk to a shell of its former self. It is gradually upgrading its relation with Taiwan. Reading the American press, one would never know that the US has cyber warfare capabilities or tries to influence foreign elections.
Minutes from the recent meeting of the Reserve Bank of Australia seemed to recognize that it would take longer for the country to reach its employment and inflation goals. While officials acknowledge that the economic hit was more severe than expected a month before, it still proceeded with its tapering. The RBA meets again on October 5. The fallout from the AUKUS deal may jeopardize or delay the free-trade talks with the EU. Separately, since New Zealand’s Q2 GDP surprised on the upside last week (2.8% quarter-over-quarter instead of the 1.1% anticipated by the median forecast in Bloomberg’s survey), there had been speculation that the central bank would launch the rate hiking cycle on October 5 with a 50 bp move. Given the broader uncertainty, this seemed a bit over-the-top, and the Assistant Governor of the RNBZ (Hawkesby) seemed to lean against the more aggressive scenario while confirming a move next week.
The dollar found support yesterday near JPY109.30. It recovered in the local session to about JPY109.70, where it is consolidating in the European morning. Initial support now is seen around JPY109.50, where a $760 mln option expires today. An option for $685 mln at JPY109.45 expires tomorrow. Recall that with few exceptions, the dollar has been confined to a JPY109-JPY111 trading range since the second half of May. The Australian dollar spent some time yesterday below $0.7250, which is roughly the (61.8%) retracement objective of the bounce off the August 20 low near $0.7100. It closed above it and has recovered to almost $0.7285 today. A close above $0.7300 helps lift the technical tone. With the mainland markets still closed, we look to the offshore yuan, recouping some of yesterday’s loss. Today’s small gain is sufficient to end the three-day slide. The dollar is trading near CNH6.4760. It settled last week slightly above CNH6.4710.
The fallout from the AUKUS pact is not over. Although as the EU has grown, there has been more reliance on qualified majority voting rather than unanimity, the EU-Australia free-trade agreement requires complete agreement. France is seeking to postpone the upcoming inaugural meeting of the EU-US Trade and Technology Council (September 29). The US proposal to lift the steel tariffs President Trump imposed on “national security grounds” in exchange for a quota/tariff regime was to be discussed. The EC is supporting France, and the dispute is happening on the heels of the Afghanistan tragedy, in which Europe was also caught off-guard. The US looks as it needs to re-launch the “America is Back” campaign. The EC and UK are still fighting about Brexit, and surely this episode will not help matters. Two broad interpretations are emerging. The first sees the French sub snub as a well-thought-out strategy, an Asian pivot, post-Afghanistan, and one in which the US cannot count on Europe. The second sees it as another example of the clumsy, tone-deaf American foreign policy, in which the French reaction was under-appreciated.
Sweden’s Riksbank left policy unchanged as widely expected. It still anticipates no change in rates through the forecasting period that extends to Q3 2024. This stands in stark contrast to Norway’s Norges Bank, poised to be the first high-income to hike rates Thursday. Hungary is expected to continue its rate hiking cycle with another 25 bp move today (to 1.75%). The Swiss National Bank meets on Thursday as well, but it will be a laggard in this cycle and will keep its key target at -.0.75 bp.
Europe is wrestling with the surge in energy prices. Reports suggest that while Russia’s Gazprom has boosted gas supplies to Turkey, its supplies to the EU remain capped. Russia has indicated that opening the new Nord Stream 2 pipelines would see supplies increase, but the existing pipeline has plenty of unused capacity. The EU Parliament may launch an investigation amid reports that Gazprom will not allow more gas to flow via Ukraine next month. Ostensibly, Russia claims to be rebuilding its own inventories. European storage sites are reported less than 72% filled, the lowest in more than a decade for this time of year. The rise in energy costs may pose an obstacle to European recovery.
The euro held support at $1.1700 yesterday and pushed marginally through yesterday’s high to reach $1.1740 in Asia and retest it in Europe. The euro is in less than a quarter of a cent range ahead of the North American opening. Trading looks likely to remain subdued. Even if the range is extended, many short-term operators may be reluctant to extend exposures ahead of the outcome of the FOMC meeting tomorrow. Similarly, sterling fell to almost $1.3640 yesterday and has managed to recover toward nearly $1.3700 today. Trading is subdued. If it pokes above $1.3700, it is unlikely to go far or fast. The $1.3715 may be a sufficient cap.
Trudeau’s Liberals failed to secure a parliament majority, but it did secure the most seats and will lead another minority government. It is the second consecutive election in which the Liberals lost the popular vote but carried more seats in the House of Commons. It is also the fifth minority government in the past seven. Still, Canada is doing it without the navel-gazing and soul-searching of its southern neighbor. Unlike most high-income countries, Canada is unlikely to embark on near-term fiscal consolidation. Both the Conservatives, who appear to have picked up a seat, and the Liberals promised new spending initiatives. A policy mix of tighter monetary policy and relatively looser fiscal policy tends to be supportive of the currency.
The US continues to wrestle with its self-imposed debt ceiling. This is different than spending authorization. The spending was authorized, the debt ceiling is about paying for what was spent, which is why Senate Leader Schumer has compared it to “dine and dash.” The Democrats could lift the debt ceiling through the reconciliation process but are reluctant to do so. The Republicans do not want to raise the debt ceiling without exacting a political price. Hence the apparent standoff. The House Democrats have included lifting the debt ceiling until December 2022, after the mid-term elections, in a stopgap spending bill that extends the authorization until December 3, 2021 (which means picking up the fight in a few months). Afghan aid is also in the package. The Democrats are trying to force the Republicans’ hand, leaving them to be responsible for a government shutdown, if it comes to that.
This political-economic drama steals the attention from today’s data that includes August housing starts and Q2 current account. Housing starts are expected to bounce back after the 7% drop in July. Activity in this sector remains strong, near its best levels since the housing bubble and the Great Financial Crisis. The US current account deficit is expanding. A rolling four-quarter measure stands at $700 bln. The record is a little over $830 bln. It appears to be on the way back to it.
The US dollar spiked to almost CAD1.29 in yesterday’s carnage. Today, it has returned to yesterday’s lows near CAD1.2740. Initial support may be a little lower, closer to CAD1.2725. However, the downside momentum stalled in Europe. On the upside, the CAD1.2800 offers chart resistance and holds an option for $1.54 bln that expires today. The greenback surged to MXN20.20 yesterday, and it’s back below MXN20.10 today. The MXN20.02 area may offer stronger support for the US dollar. Mexico’s economic calendar picks up in the second half of the week with its bi-weekly CPI on Thursday and July retail sales on Friday. The central bank meets on September 30. Ideas that Banixco would stand pat after hiking in July and August are fading, and the latest Bloomberg survey shows the median forecast now expects a hike.
Bannockburn Global Forex