Taper, No Tantrum
• The dollar’s gains spurred by Fed Chair Powell’s admission that tapering would be completed around the middle of next year, have been pared in Asia and Europe.
• The mid-year completion of tapering keeps open the possibility of two hikes next year and was the key to the market’s reaction.
• Europe’s preliminary September PMI disappointed.
• Norway became the first high-income country to hike rates and signaled another hike likely in December.
• The BOE outcome is due shortly. Governor Bailey may push against the two hikes for next year that the market appears to have discounted.
• Brazil hiked 100 bp yesterday and signaled another hike of the same magnitude next month. Turkey and South Africa’s decisions are awaited.
Overview: The market’s reaction to the FOMC statement was going according to our script, with the dollar backing off on a buy rumor sell the fact type of activity until Powell provided an end date for the tapering (mid-2022) before providing a start date (maybe next month). This spurred a dollar rally. Equities pulled back but recovered. The dollar is paring its gains today. It is lower against the other major currencies, but the yen, and the euro, which had fallen to $1.1685, is back above $1.1700 despite disappointing eurozone flash PMI. Emerging market currencies are also higher as the outcome of the South African central bank, and Turkey central bank meetings are awaited. The Bank of England’s announcement is expected shortly. The Swiss National Bank stood pat as widely expected, and Norway delivered the anticipated 25 bp rate hike and signals another one is likely at the end of the year. The US 10-year yield is up a few basis points near 1.34%, while European yields are 1-2 bp higher. Equities closed strong in the US, and the futures are pointing to a higher opening. Europe’s Dow Jones Stoxx 600 (~+1%)is advancing for a third session and is poised to snap a three-week downdraft. Japan’s markets are closed for a holiday, but most other markets in the region advanced, including notable Hong Kong’s Hang Seng, led by a 4.6% rally in the real estate sector. Gold initially extended its rally on the FOMC statement, but the hawkishness saw it reverse from $1787 to about $1765 and today found support near $1760. It is straddling little changed levels in Europe. Oil, driven by the seventh weekly drawdown of US oil inventories, which now stand at their lowest level in three years, pushed against $72 yesterday and is firm near $$72.50. Iron ore prices in China and Singapore rallied. China’s contract snapped an eight-session slide. Copper prices rallied 3% yesterday and are giving back a little more than a third of it today.
The Evergrande saga continues to play out, and the anxiety seen Monday and claims of a “Lehman moment” have died down. A dollar payment is due today, and recall that there is a grace period. The direct contagion outside of China seems limited, and many observers may underestimate the “non-market” mechanisms that can be deployed. Moreover, with next week’s holiday, PBOC officials have plenty of cover for additional injections of liquidity into the banking system. Today’s provision of CNY110 bln (~$17 bln) was the most since early this year. This is not a call that all is clear or that it is business as usual. There are likely to be medium and long-term implications, and the humbling of the property sector in China does not appear inconsistent with the broadening of the state’s control and further subjugation of the private sector. Separately, we note that China and Taiwan have both applied for membership in the CPTPP. Taiwan is a member of the WTO and APEC. Neither is poised for ascension any time soon. It does not appear to be a market factor yet.
Australia’s preliminary PMI composite stabilized below the 50 boom/bust level. The September composite stands at 46.0, up from 43.3 in August, which could be the low point. It is the first gain since April and is the third month below 50. The manufacturing sector looks fine at 57.3, up from 52.0, and is at its best level since June. The lockdown has, as one would expect, crushed services. The PMI edged up to 44.9 from 42.9. There is no big implication. The Reserve Bank of Australia will lag behind the Reserve Bank of New Zealand in the rate hiking cycle. The Australian dollar is in the upper end of this week’s range.
The dollar is in a quarter of a yen range above JPY109.75 today after posting an outside up day yesterday (trading on both sides of Tuesday’s range and closed above Tuesday’s high). The week’s high is a little above JPY110.00, but it has not closed above it since September 8. This week, the Australian dollar has formed a base around $0.7220 and is trading near $0.7290 in Europe. Some demand may be related to today’s expiration of a A$1 bln option at $0.7440 today. The next technical target is near $0.7315 and then $07345. The Chinese yuan is strengthening for a second session. It had begun softer and recovered in full. The greenback tested pushed above CNY6.47 initially but is back near CNY6.4540. The PBOC set the dollar’s reference rate at CNY6.4749, tight against expectations for CNY6.4745.
Although many jumped to the defense of the AUKUS announcement and justified it on all sorts of grounds, President Biden seemingly offered what is as close to a public apology for this sort of thing as imaginable. A statement issued after a conversation between the US and French presidents: The two leaders agreed that the situation would have benefitted from open consultations among allies on matters of strategic interest to France and our European partners. President Biden conveyed his ongoing commitment in that regard.” This makes things copasetic on the one hand. The French ambassador will be sent back to Washington. Next week’s US-EU Trade and Technology Council in Pittsburgh will likely go forward. Yet, it puts the US foreign policy on the other horn of the dilemma. It was not a purposeful slight of France or Europe. It was clumsy and ill-thought-out, which could be misconstrued as incompetence. It appears that the slight to Europe was meant to overcome a slight to Australia. After being engaged in the war in Afghanistan for the past two decades, Canberra apparently did not hear about the US withdrawal until it was on television and during the siege of Kabul. To make it up to him, nuclear-powered submarines were offered. As of August 31, it appeared the French sub deal was still on. India is part of the Quad, and it has been seeking nuclear-powered submarines. It leasing Russian models because the US has refused, according to reports.
Europe’s flash PMI disappointed. In the eurozone, the German and French preliminary readings were all below expectations. The slowdown in September is more pronounced than expected. The aggregate readings remain firm, and the expansion continues but at a less robust pace. EMU’s manufacturing PMI fell to 58.7 from 61.4. The median forecast expected it to stay above 60. The service PMI fell to 56.3 from 59.0. It had been expected to slip to 58.5. This left the composite at 56.1, down from 59.0. The UK’s flash reading was also less strong than expected, and the manufacturing sector appeared harder hit. It fell to 56.3 from 60.3, while services slowed to 54.6 from 55.0. The composite stands at 54.1, down from 54.8.
The UK’s PMI comes as the BOE deliberates. It is not expected to change its stance, though there may be a repeat of last month’s dissent, which wanted to make a marginal reduction in Gilt purchases. The BOE hawkish rhetoric contributed to the market apparently pricing in two hikes next year, but Governor Bailey may push back against it. The Swiss National Bank meeting has concluded, and as expected, it stood pat. On the other hand, as widely anticipated, Norway’s Norges Bank delivered the first-rate hike among the high-income countries and signal another hike is likely at the end of the year. Among emerging markets, the South African central bank and Turkey’s are expected shortly. The former is expected to stand pat, while there later may deliver a cut after the central bank shifted its focus from headline inflation to the core.
The euro recovered from about $1.1685 to test the $1.1735 area in the European morning. There are options for 3.9 bln euros struck at $1.17 that expire today. The intra-day technicals are stretched, and the $1.1750 area offers nearby resistance. Yesterday’s outside down day did not bring follow-through selling today. However, a strong close today may give a sense that a base is being formed. Sterling tested support near $1.36, where a GBP575 mln option will expire today. It needs to re-establish a foothold above $1.37 to lift the tone. The intraday momentum indicators are also stretched. Initial support may be seen near $1.3640. The euro punched through GBP0.8600 yesterday but again failed to close above it. Indeed, it has not settled above GBP0.8600 since July 20.
There are four important takeaways from the FOMC meeting. First, barring an unexpected shock, the Fed is likely to announce a moderation in the pace of bond purchases at the next FOMC meeting in early November. Second, the tapering, once begun, will finish around the middle of next year. This was the biggest surprise. The biggest surprise and the turn in the market’s response came as Powell said that the tapering would finish mid-2022. In effect, he provided an end date before fixing the start date (maybe next month). Three, more officials now see a hike in 2022 (nine compared with seven in June). In June, two officials thought two rate hikes would be needed next year, and now three do. Four, by our calculation, assuming that the effective Fed funds rate remains at 8 bp, then fair value, given a hike next December, is 23 bp, and that was where it settled on Tuesday. In response to the FOMC, it rose three basis points and is up another basis point today (to imply 27 bp). The implied yield above 23 bp is the market pricing in the risk of a second hike next year, which the completion of the tapering around mid-year would allow for if needed (Q3 22 and Q4 22). That will be the next battlefield. For the record, making similar conservative assumptions, the effective average rate is unchanged. Fed hikes by 25 bp, fair value for the September 2022 Fed funds futures is 15.5 bp, and the contracted settle at 14 bp yesterday. It is now quoted at 14.5 bp.
The FOMC meeting seems to cast a shadow over today’s data, including the weekly initial jobless claims, the preliminary PMI, leading economic indicator, and the KC Fed manufacturing survey. Canada reports July retail sales. A pullback after a 4.2% surge in June is expected. With rising equities and firm oil prices, the Canadian dollar can shrug off weak retail sales data. Mexico reports its bi-weekly reading of CPI. It is expected to creep up. While we lean against a Banxico rate hike next week, this is seemingly a minority view. Separately, Brazil’s central bank delivered a 100 bp rate hike yesterday, as widely anticipated, and signaled another 100 bp hike next month. Tomorrow it reports September IPCA inflation, which is expected to approach 10%.
The panic attack on Monday drove the US dollar to almost CAD1.29. As the panic subsided, the US dollar surrendered its gains. It set the week’s low in Europe near CAD1.2650. A break of CAD1.2600 would boost the chances that a durable high is in place and possibly setting up a test on the CAD1.2525 area next week. Take directional cues from the US stock market. The greenback peaked on Monday near MXN20.20 and fell to MXN19.9370 yesterday before rebounding back above MXN20.00. It is trading inside yesterday’s range but with a downside bias. However, as we have observed with other pairs, the greenback’s fall today seems stretched ahead of the US open. Therefore, caution is in order for short-term participants.
Bannockburn Global Forex