What to Expect When you are Expecting
• The US dollar is mostly softer, but we remain concerned that it is vulnerable to a buy the rumor, sell the fact kind of activity, given the appreciation since the disappointing employment data. Much good news seems to be discounted, with a hike at the end of next year completely priced into the Fed funds futures strip.
• We expect the Fed’s economic assessment to be downgraded slightly in line with the Beige Book, a stronger indication of tapering before year-end, and with more officials seeing a hike next year, up from 7 in June.
• Evergrande says its yuan interest payment due tomorrow has been “resolved”. No details were forthcoming. BOJ Kuroda opined that the problem seems to be China’s and not a global story, so far.
• The BOJ kept policy steady as widely anticipated and will launch its new “green” initiative in December.
• UK PM Johnson recognizes little chance of a free-trade agreement with the US, but talk of interest in USMCA seems almost desperate.
Overview: The markets have stabilized since Monday’s panic attack but have not made much headway. China and Taiwan returned from the extended holiday weekend. Mainland shares were mixed. Shanghai rose by about 0.4%, while Shenzhen fell by around 0.25%. Taiwan got tagged for 2%, and Japan’s Topix was off 1%. Hong Kong and South Korean markets were closed. Europe’s Dow Jones Stoxx 600 is firmer for the second day but is still lower for the week. US indices barely entered the gap left from Monday’s sharply lower opening, if at all. The futures are higher today, but the gaps, which appear on the weekly bar charts, are technically important. The bond market is subdued, with the US 10-year yield near 1.33%. European rates are narrowly mixed. The dollar is mostly softer against the majors, with the dollar-bloc and Scandis pushing higher. Sterling and the yen are nursing small losses. The freely accessible emerging market currencies are firm, led by South Africa, Russia, and Mexico. Hungary is the weakest after the central bank delivered a smaller than expected rate hike yesterday. The JP Morgan EM FX index is paring yesterday’s 0.3% gain, the largest this month. Gold is consolidating in a narrow range below yesterday’s $1781 high. Oil has rebounded, helped by a large drop in US stocks (-6.1 mln barrels. according to API). November WTI fell to around $69.40 yesterday and is more than $2 higher. Iron ore was mixed. China’s contract fell. It has risen only once this month. Singapore’s contract jumped (~13.6%). Copper is about 2% higher to lead the base metals.
Evergrande reportedly indicated that the yuan interest payment due tomorrow has been “resolved.” The details are not clear, and there is a dollar payment due too. There are major concerns. The first is the direct knock-on effects on financial investors and the contagion. This has been what the markets have been focused on. The second is broader and structural. China’s property market and its ecosystem are estimated to be nearly a third of China’s GDP. Apartments have been used as savings and speculative vehicles. This helps explain the report of ghost buildings, where apartments are owned but unoccupied. It has driven prices higher and made them less accessible to the rising middle class, in a situation that has striking parallels to the surge in house prices in many Anglo-American and northern European countries.
The Bank of Japan held policy steady, as widely anticipated. It lowered its assessment of exports and production while keeping its overall economic view stable. There was one dissent (Kataoka) from maintaining the yield curve settings (-0.1% short-term and 10-year JGB around zero). The BOJ is at the forefront of central bank efforts to fight climate change. It provided more details of its new program that will start in December, giving zero-cost financing for “green” projects, including loans, bonds, sustainability-linked instruments, and climate-transition financing. The program will run until at least 2031. The loans are for one year and can be rolled over. BOJ Governor Kuroda played down the Evergrande contagion, saying that it looks like an individual company and issue for China’s real estate market. At this point, he does not see it turning into a global problem.
The dollar approached JPY109.10 before rebounding to about JPY109.60. The JPY109.10 area has been tested a handful of times since mid-August, and it has held. Some of the support may be option-related, with JPY109 being a popular strike. Today, a $625 mln option is struck there, but it seems too far away to be impactful. Yesterday’s high was near JPY109.70, and it tested JPY110 at the start of the week. This week, the Australian dollar has forged a shelf near $0.7220 and struggles in the $0.7265-$0.7285 area. An option for about A$565 at $0.7265, near the session’s high so far, expires today. In quite a feat, after not trading since last Friday, the onshore yuan is virtually flat today. The dollar settled at CNY6.4661 before the holiday weekend and is now near CNY6.4669. The PBOC injected liquidity at the end of last week and then on Saturday, and again today. The 10-year yield eased two basis points to 2.86%, a two-week low. It is not only the Evergrande strains that the PBOC may be addressing with its liquidity injections. Chinese markets are closed for most of next week, and the seasonal demand is strong. The PBOC set the dollar’s reference rate at CNY6.4693, slightly firmer than the CNY6.4685 median estimate in Bloomberg’s survey.
A free-trade agreement between the UK and the US was one of the plums of leaving the EU. When the Obama administration played down the salience for the US after weighing in against Brexit many scoffed. Prime Minister Johnson may celebrate the new security alliance with the US and Australia, but he has been forced to acknowledge not only that formal talks are unlikely any time soon. There is some noise about the UK possibly seeking membership in the USMCA (NAFTA2.0), but this seems a bit far-fetched, though the idea was floated many years ago. It captured attention for a little and then faded. Separately, Dutch Prime Minister Rutte contradicted claims from 10 Downing Street that he had offered to mediate the EU-UK dispute over Northern Ireland.
Earlier this month, Russia disappointed expectations by raising its key rate by 25 bp instead of 50. Its first hike in March was 25 bp, but then the central bank three times by 50 bp, and then the last hike in July was for 100 bp. At 6.75%., it now matches headline inflation (6.7% August CPI). It does not meet until October 22. The small move suggests the central bank thinks it is at the end or nearly the end of the cycle. The derivatives market is pricing in another 50 bp over the next three months, but in Q3 22, they are back where there are now, if not a little lower. Yesterday, Hungary delivered a 15 bp hike instead of 25 bp. It had hiked rates three times by 30 bp, a move to 1.50%. Its headline inflation is slightly less than 5.0% and will likely rise further in August, at least in part due to the base effect (August 2020, CPI fell by 0.4%). In fairness, the pace does appear to be moderating. The cumulative monthly gain in Q1 was 2.3%, and in Q2, 1.9% and 0.7% in the first two months of Q3. The Czech central bank meets next week. With inflation running a little above 4%, and the key rate at 75 bp. Although some may think that Russia and Hungary are a tell for the Czech Republic, we are skeptical. Some board members apparently favored a 50 bp hike, but Governor Rusnok prefers a steady and moderate pace.
The euro has been confined to a half a cent range so far this week (~$1.1700-$1.1750) and today has not ventured out of a 20-tick range. It has remained below the $1.1745 level, where an option for about 505 mln euros expires today. Interest appears to have evaporated ahead of the FOMC meeting. With a bride exception in August, the euro has been in a $1.17-$1.19 range since the end of June. Sterling continues to underperform. It is recording new lows for the month in Europe today, near $1.3630. It held $1.36 last month and briefly dipped below it on an intraday basis in July. There has not been a close below it since mid-January. Part of the pressure on cable is coming from the cross, where the euro has bounced off last week’s test on GBP0.8500 and is now trying to secure a foothold above GBP0.8600. It has not closed above it for two months. The Bank of England meets tomorrow but is not expected to take fresh initiatives. It may lean against the aggressiveness of the market that appears to have discounted two hikes next year Note too that the flash composite PMI for September, also due tomorrow, is expected to have declined for the fourth consecutive month, which would be a longer streak than seen last year.
The long-awaited conclusion of the FOMC meeting is at hand. Since early this year, the market has generally anticipated tapering to begin before the end of the year. Given the importance of avoiding a repeat of the “taper tantrum,” Chair Powell has promised to give the market ample notice. Given that there are two meetings left after today’s so to taper in Q4 requires another step in the gradual evolution of the Fed’s guidance. To maximize its flexibility, the Fed is unlikely to offer a start date. That is expected in November. Tapering to wind down, as opposed to the ECB’s “recalibration,” will likely begin in December, barring a new significant downside shock. Look for three things: First, the Beige Book already downgraded the growth assessment to moderate. The statement is likely to echo it but emphasize that the recovery is intact. Second, look for confirmation that the conditions for tapering are near. Third, look for a few more Fed officials to recognize that a rate hike in 2022 may be appropriate. In June, only seven did. At the same time, Powell will likely emphasize that there is no Fed view, that the dots are simply individual forecasts of limited predictive value. Also, Powell will repeat that the conditions for a hike are not the same as tapering and that the requirements for a hike do not exist. If asked about the debt ceiling and spending authorization, he will demur and express confidence in the legislative branch. There will also be questions about Fed officials’ personal investments and the need for a higher bar for conduct.
US August housing starts were stronger than expected, rising by 3.9%, nearly four times the gain the median in Bloomberg’s survey anticipated. Permits jumped by 6%. It was the largest rise since January. Economists had looked for a decline. The market may be too pessimistic on existing home sales due today, where the median call is for a 1.7% decline. Separately, note that there has been the expected surge with the expiration of the Federal moratorium foreclosures.
A few hours after the Fed’s announcement, the central bank of Brazil is widely expected to deliver its second 100 bp hike in a row. Recall that the Selic rate began the year at 2.0% and was hiked by 75 bp in March, May, and June. It held steady in July at 4.25% before the 100 bp hike in August. Tomorrow the IPCA September inflation report is expected to show another jump in Brazilian CPI to around 9.9% from 9.3%. Price pressures have more than doubled this year (January CPI stood at 4.3%). Without fail, CPI has accelerated every month since July 2020. The real policy rate (adjusted for inflation) remains negative. The Brazilian real is off about 1.4% for the year coming into today.
The US dollar has trended higher since the disappointing jobs data at the beginning of the month. The market seems ripe for “buy the rumor, sell the fact” on the FOMC today. The market has discounted much of the good news for the dollar. The greenback is consolidating in Monday’s range against the Canadian dollar (~CAD1.2740-CAD1.2895). Lower highs and higher lows have been recorded. There are a couple of chunky options set to expire today. There is a roughly $1.75 bln option at CAD1.2750 and one for about $640 mln at CAD1.2775. The greenback is also stuck in Monday’s range against the Mexican peso (~MXN20.00-MXN20.2040). A band of support is seen in the MXN19.9850-MXN20.0275 area. Mexico reports its biweekly CPI reading tomorrow and July retail sales on Friday. Banxico’s rate decision is on September 30.
Bannockburn Global Forex