Market Shrugs Off Chinese Signals and Keeps the Yuan Bid
Today’s Financial Markets Highlights
• The US dollar is mostly firmer to start the new week. The dollar-bloc is the main exception among the majors. Among emerging markets, the Turkish lira has steadied after last week’s 11.4% drubbing and the Chinese yuan edged higher despite signals of disapproval from the PBOC.
• Between the harassment of Filipino boats meant to resupply an atoll within the Philippine’s island group and the mysteries surrounding Peng Shuai, China continues to appear clumsy and heavy-handed. It can only boost the risk of at least a diplomatic boycott by some countries ahead of the Winter Olympics.
• Over the weekend, Japan acknowledged it was considering releasing oil from its strategic reserves.
• BOE Governor Bailey toned down his rhetoric though he blames the market for last month’s misunderstanding. The implied yield of the December short-sterling interest rate futures is easing for the fourth consecutive session today.
• Three Fed officials open the door to an acceleration of Fed tapering at next month’s FOMC meeting. No Fed officials are scheduled to speak this holiday-shortened week. Still, a jump in the PCE deflator may see others move in this direction.
The US dollar has come back bid from the weekend against most currencies following the talk by a couple of Fed governors about the possibility of accelerating the tapering at next month’s FOMC meeting. The weekend also saw protests against the social restrictions being imposed by several European countries in the face of a surge in Covid cases. The Swedish krona, yen, and sterling are the weakest, while the dollar-bloc currencies are resisting the greenback’s tug. Most of the freely accessible and liquid currencies among emerging market currencies, including Russia, Hungary, South Africa, and Mexico, are heavy. At the same time, the Turkish lira recoups a little of the ground lost last week, and the Chinese yuan shrugged off apparently warnings from the PBOC to post its first gain in three sessions. Equity markets in the Asia Pacific area mostly fell, though China and South Korea were notable exceptions. Europe’s Stoxx 600 snapped a six-week advance last week but has begun the news week with a small gain through the European morning. US futures are trading higher. The bond market is heavy, with the 10-year US Treasury up about three basis points to around 1.58%. European benchmark yields are 2-3 bp higher. Gold finished last week on a softer note and edged lower today to trade below $1840 for the first time since November 10. Resistance is around $1850. News that Japan may join the US to release oil from reserves saw January WTI slip below $75 but recover back above $76. It met the (38.2%) retracement of the rally from the late August low near $60.75. European natural gas (Netherlands) is lower for the fourth consecutive session, during which time it has fallen around 11%. Iron ore extended the 5.6% gains before the weekend with another 4% gain today. On the other hand, copper rose 3.3% in the past two sessions and has come back offered today. Lastly, the CRB Index eased less than 1% last week and is off two of the past three weeks. Its seven-month rally is at risk.
Despite China’s economic success, it remains clumsy and heavy-handed. As the US and some other countries were considering a symbolic diplomatic boycott of the winter Olympics in Beijing, the tennis star Peng Shuai is being censored or worse for allegations against a former Politburo member. Meanwhile, at the end of last week, three Chinese coast guard vessels launched water cannons against two Filipino boats sent to resupply a garrison on the Second Thomas Shoal (Ayungin Shoal), which is within the Philippines’ Kalayanan Island Group. The aggressive harassment brought a rebuke by the US, which reminded Beijing of its mutual defense agreement with Manila. The Philippines will attempt to bring provision again this week. Separately, note that after being notified by the US of the military nature of the Chinese construction project in the UAE, the project has been halted.
With the yuan at six-year highs against a trade-weighted basket, Chinese officials have begun expressing more concern about the one-way market. The FX Committee, composed of industry participants, wants members to do a better job monitoring prop trading, and it follows the PBOC works of caution about risk management at the end of last week. In its quarterly monetary review, the PBOC made a few tweaks that suggest it could ease policy.
Japan’s Prime Minister Kishida acknowledged that releasing oil from its strategic reserve was under discussion. China indicated it would tap its reserves last week for the second time since September, while it is still under review in the US. Currently, Japan keeps reserves that are intended to last 90 days, while the private sector must hold reserves to last 70 days, according to reports. Japan is considering selling oil and using the funds to subsidize the rising gasoline prices. It may also reduce the duration of the reserves.
The dollar is straddling the JPY114.00 level as its hugs the pre-weekend range (~JPY113.60-JPY114.55). The JPY114.30 area offers initial resistance, while the focus in early North America may be on the downside. Still, it appears to be going nowhere quickly. The Australian dollar finished last week at its lowest level since early October. That low, just below $0.7230, held, and momentum traders covered shorts, helping lift the Aussie back to session highs near $0.7260. A move above here allows gains into the $0.7270-$0.7290 area. The PBOC set the dollar’s reference rate at CNY6.3952 today. The market (Bloomberg survey median) had projected a CNY6.3931 fix. Although the dollar is softer today, it held above last week’s lows as consolidation is evident. It remains within the range set last Tuesday (~CNY6.3670-CNY6.3965).
With the Swiss franc appreciating to six-year highs against the euro, it would not be surprising to see the SNB intervene. The first place to look for it is in the weekly domestic sight deposits. They rose by CHF2.58 bln, the second-most in the past three months. Recall the mechanics. The SNB buys euros but just sitting on them distorts the allocation strategy. So it needs to either sell some euros for dollars or Swiss francs for dollars. If it does later, its overall level of reserve growth accelerates. Many suspect it will do the former, i.e., sell some euros for dollars.
The US continues to warn that Russia’s troop and equipment movement is consistent with a rapid large-scale push into Ukraine from multiple spots simultaneously. The suggestion, according to reports, is that the operation could take place early next year. Both Ukraine and Georgia are seeking more US assistance. Recall Russia invaded Crimea in February 2014.
Bank of England Governor Bailey has toned down his rhetoric, though he blames the market for misconstruing his remarks last month. He warns now that next month’s decision is finely balanced and that the price pressures are emanating primarily from supply-side disruptions for which monetary policy is less directly effective. The implied yield of the December 2021 short-sterling interest rate futures contract is slipping for the fourth consecutive session. Today’s yield of about 21 bp is the lowest since early October. The yield peaked in mid-October near 62 bp. Lastly, while progress on the UK-EU talks has been reported, the two sides are still far apart. Talks between Frost and Sefcovic will resume at the end of this week.
The prospect that a new German government could be announced this week has not helped the euro very much. The single currency, which was sold through $1.14 and $1.13 last week, is struggling to find a base. It has held above the pre-weekend low near $1.12560 but only barely (~$1.1260), and the attempt to resurface above $1.1300 was rebuffed. A move above $1.1320 may suggest some near-term consolidation, perhaps ahead of Wednesday’s US PCE deflator report. That said, tomorrow’s flash PMI composite reading for the eurozone is expected to have weakened for the fourth consecutive month. Sterling could not rise 15 ticks from its pre-weekend close (~$1.3450). The downside was also limited (~$1.3420). It caught a bid in the European morning that could extend into the US morning. Still, the $1.3460-$1.3480 band may be a sufficient cap. The market does not appear inclined to see trigger the $1.3395 option that expires today for about GBP425 mln.
President Biden’s announcement on the Fed’s leadership could come as early as tomorrow, as he is set to deliver a speech on the economy tomorrow. But it probably would be a separate announcement. Given the expiration of the terms of the two vice-chairs, changes among a few of the regional presidents, and the challenging situation, President Biden is likely to follow Treasury Secretary Yellen’s recommendation to re-appoint Powell. Moreover, a tradition goes back to Volcker of one party making the initial nomination and the other party approving of another term. This helped “depoliticize” monetary policy. Trump broke with that tradition, and as Biden has done in a number of other areas, is restoring some traditions. Lastly, we suspect that if Bernanke or Yellen, or Brainard were at the helm of the Fed, there would not be substantive monetary policy differences.
Vice-Chair Clarida and Governor Waller joined regional Fed President Bullard to suggest that Fed may consider accelerating the pace of tapering at next month’s FOMC meeting. We suspect others will be sympathetic after this week’s October PCE and deflator news. The economy is rebounding in Q4 from the disappointing 2% annualized pace in Q3 (which is likely to be revised higher on Wednesday), and a critical part is consumption. Personal consumption expenditures are expected to rise by 1% after a 0.6% increase in September. The headline PCE deflator, which the Fed targets 2% on average, which Governor Brainard reportedly helped devise, is expected to jump above 5% from 4.4% in September. The core rate is expected to exceed 4%. No Fed officials are slated to speak this week, but the minutes from the November 3 FOMC meeting will be released on November 24.
El Salvador caught the crypto world’s attention again. It is the first country to make Bitcoin legal tender. It announced plans to issue a $1 bln bond, and half the proceeds will be used to buy Bitcoin (~2000 coins). The other half will be used to fund infrastructure projects to build the infrastructure of more Bitcoins. It will offer a 6.5% coupon, which is lower than current dollar issues. It looks like one pays a lot for BTC exposures. El Salvador is rated BB+ of the equivalent by the top three rating agencies. This makes El Salvador bonds risky, to begin with, and adding Bitcoin on top of that would seem to preclude most retail and institutional investors. It seems like a desperate act that only an impoverished country can try. The idea that other countries will quickly follow seems to be a stretch. There is a good reason why Tesla had few corporate followers to buy Bitcoins with reserve funds. The same principle would seem to apply to countries.
The economic calendar for North America begins off slowly this week. Today’s main feature is the US existing home sales report. A pullback after September’s heady 7% gain is expected, the strongest in a year. After a weak start to the year, existing home sales have recovered. They averaged 5.66 mln (seasonally adjusted annual rate) last year and have averaged more than 6.0 mln for the past three months. The Canadian dollar has weakened for the past four weeks. It briefly poked above CAD1.2660 ahead of the weekend to reach its best level since early October. The greenback is in about a 15-tick range on either side of CAD1.2645 today. Support is seen in the CAD1.2600-CAD1.2620 area, but it may take a break of CAD1.2585 to boost confidence that a high is in place. The US dollar rose 1.5% against the Mexican peso last week. It was the third weekly gain in the past four weeks. The greenback is trading above last week’s high (~MXN20.89) and looks set to test the high set earlier this month near MXN20.98. Lastly, the Chilean presidential election will go to a run-off next month, as widely expected between the far-right and far-left candidates. The dollar snapped a five-week pullback against the Chilean peso last week, rising 3.6%, the most in three months. Year-to-date, the peso is off nearly 14.25%.
Bannockburn Global Forex