Turn Around Tuesday Aside, is the Dollar Topping?

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Marc Chandler
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Overview:  Global equities moved higher in the wake of the strong gains in the US yesterday. US futures point to the possibility of a gap higher opening today. Most of the large Asia Pacific bourses rallied 1%-2%, with China’s CSI a notable exception, slipping fractionally. Europe’s Stoxx 600 is edging higher and is near two-week highs. If the gains are sustained, it will be the fourth consecutive advancing session, the longest in two months. Benchmark yields are higher—mostly 7-12 bp in Europe, while the US 10-year Treasury yield is up about three basis points to 4.04%. The dollar is mostly a little firmer with sterling, the Canadian dollar, and Norwegian krone about 0.25-0.30% lower. The greenback edged further above JPY149, but no intervention has been detected. Stronger than expected inflation lifted the New Zealand dollar, which leads the G10 currencies higher today. Among emerging market currencies Poland and Hungary are off slightly while the South Korean won, and Thai baht lead the advancers. The JP Morgan Emerging Market Currency Index is slightly lower after gaining 0.65% yesterday, the most in two weeks. Gold is trading in a narrow range (~$1648.7-$1660.9) inside yesterday’s range, which was inside last Friday’s range. Amid reports of new sales from the US Strategic Oil Reserve, December WTI is a little heavier and toying with the 20-day moving average (~$0.8385). Natgas is lower (-1.1% in the US) and (Europe’s benchmark is off 5.6%). EU officials meet today to try to regain control of the market. Iron ore rose 1.3% today after falling 2.3% yesterday. December copper is falling for the third session and is off about 0.8%. December wheat is down 1%. It posted a minor gain yesterday but is approaching its lowest level in about a month. 

Asia Pacific

China's Q3 GDP was to have been released today, but the National Bureau of Statistics indicated yesterday that it would be delayed. No reason was given which allows speculation to fill the void. Some suggested that it would be disappointing, and officials did not want to publish during the Party's Congress. The median forecast in Bloomberg's survey was for a 2.8% quarter-over-quarter expansion after a 2.6% contraction in Q2. If the median is accurate, it would be the strongest quarterly expansion since Q3 20202.

Is there really much to make from reports that Chinese banks (aren't they all state banks?) were swapping yuan for dollars in the forward market and then selling the dollars?  Could they be acting at the behest of Chinese officials?  Sure, but doing at their behest does not mean with their money. Isn't that the way open-mouth operation work?  Consider the BOJ. It threatens decisive actions. What happens?  Japanese banks reduce their long dollar position. Is that stealth intervention?  Intervention is best thought of as an escalation ladder and open-mouth operations have a place on that ladder. If verbal intervention is sufficient there is no need to climb the ladder further. The PBOC has continued to set the dollar's reference rate around CNY7.10-CNY7.11. Since the dollar is allowed to move in a 2% band from the fix, the PBOC is effectively capping the dollar around CNY7.25.

Unshaken by talk in Tokyo that the BOJ may have intervened after the US CPI last week, the market took the dollar above JPY149 in the North America yesterday. Comments by BOJ Kuroda earlier today did not add anything new. The dollar backed off to slightly below JPY148.70 in Japan. Three-month implied volatility is little changed, straddling 13%. Before the intervention last month, implied vol was near 13.6%. We look for the continuation of the recent pattern in which the dollar trades strong after the threat of intervention diminishes for the day and the greenback was bid to new highs (~JPY149.30) in the European morning. The Australian dollar initially extended yesterday's gains to reach about $0.6330. It has backed off, but we expect it to find support in the $0.6260-70 area. The New Zealand dollar was bolstered by stronger-than-expected Q3 CPI (7.2% vs. 6.5% median forecast after 7.3% in Q2). The odds of a 75 bp hike at the November 2 meeting rose to around 80% from about 35% yesterday. The dollar is trading in a narrow range against the Chinese yuan, holding slightly below CNY7.20. It is consolidating within yesterday's range and is little changed. The dollar's reference rate was set at CNY7.1086. The median projection in Bloomberg's survey was CNY7.1590.

Europe

The UK government's reversal of its fiscal thrust is fully appreciated by the market even as the Truss's tenure as Prime Minister may still not be secure. Truss did not win the part of the leadership challenge among the members of parliament, but she did win the vote among the rank-and-file. For the MPs to remove her now seems anti-democratic, yet her fiscal program has been gutted. Perhaps, one of the things that will come out of this is that the Tories change the way its leaders are chosen. Germany has its own remarkable reversal. Over-ruling the Vice Chancellor and Minister of Economic Affairs and Climate Action Habeck, Chancellor Scholz announced that Germany will extend the operation of the three remaining nuclear reactors until mid-April 2023. It seems to be a compromise between the Greens, who do not want an extension and the other coalition partner the Free Democrats, which wants Germany to use all available means to overcome the energy crisis.

Previously, Habeck had relented and accepted that two of the three plants. Germany's gas inventories are 95% full but there is concern that is may not suffice in a cold winter. Recall that the FDP failed to garner the 5% of the popular vote to be represented in the state government in Lower Saxony earlier this month. Ironically, this defeat seems to have emboldened the FDP (led by Finance Minister Linder) to press its case. We anticipated that the state election results would strain the coalition but did not envision it would be over nuclear power. Still Scholz did not let the issue stew for long. Still, the Greens cannot be pleased as it has voted against the extension of nuclear power at a party convention this past weekend. Meanwhile, Dutch natgas benchmark gapped lower yesterday after gapping lower before the weekend. Indeed, it gapped below the 200-day moving average. This long-term moving average have not been violated in four months. It is still double the pre-war price even though it is off more than 60% from its late August peak.

We anticipated that the US two-year premium over Germany would peak before the exchange rate bottomed. The peak was two-and-a-half months ago, around 277 bp. It fell to 220 bp early last month and recovered to almost 260 bp this month. A break of 240 bp sets up a test on 220 bp again. To get there it needs to take out the 200-day moving average (~227 bp). It has not been below the 200-day moving average since June 2021. In the October ZEW survey, the assessment of the current situation deteriorated (-72.2 vs. -60.5), while expectations unexpectedly improved albeit marginally (-59.2 vs. -61.9).

The euro extended yesterday's gains to nearly $0.9875, a nine-day high before pulling back in late Asia/early European turnover. The $0.9800 area may offer critical support. There are large options struck there this week, including one billion euros today that expire and about 3.5 bln euros the roll off Thursday and Friday. Ahead of it, support may be seen around $0.9820. On the upside, regaining $0.9860 could spur near-term gains toward $0.9915. Sterling reached almost $1.1440 yesterday as some 2/3 of the Truss/Kwarteng's tax breaks were unwound. There are options for GBP370 mln at $1.1450 that expire today. It has not been able to sustain the momentum. It has not been above $1.1410 and is more than a cent below its intrasession highs. Still, the intraday momentum indicators are getting stretched, favoring new buying in early North America today. Support will likely be encountered in the $1.1250area.    

America

The market has nearly priced in a 5.0% terminal Fed funds rate by the end of Q1 23. We think for the market to get beyond that it needs stronger guidance by the Federal Reserve. One of the most hawkish members voting members of the FOMC, Bullard declined to push the point in recent days. It is true that the market is fickle, and this is not the first time the market has reached some conclusion about the peak. Moreover, the market continues to price in a cut in late Q4 23. The yield on the December 2023 Fed funds futures contract is a little more than 20 bp below the yield of the September contract. Perceptions of peak Fed funds is understood as a necessary precondition of a turn in the dollar. In this context, we note that yesterday was the first session in 12 that the implied yield of the December 2022 Fed funds futures decline (albeit slightly).

As the near-term focus shifts away from the key US economic data (inflation and employment), the dollar looks ripe for at least a correction. We have suggested that sterling looks like it bottomed against the dollar last month when amid panic and talk of the UK being an emerging market economy to fell to $1.0350 in Asia. Then often it seems that when the dollar does make an extreme, it comes in the form of a double top/bottom. The Dollar Index peaked in late September slightly shy of 114.80. It fell to about 110.00 before rebounding and reaching almost 113.95 after last week's September CPI. A break of the 110 area could lend credence the view that a top of some import is in place. A break of the trendline connect the mid-August and mid-September lows comes in today near 110.90.

The Bank of Canada's quarterly survey picked up a sharp fall in the business outlook while consumer inflation expectations reached 7.1% in one year and 5.2% in two years. Forty percent of employees expected 4%+ wage gains. Consumers and businesses see a 50% chance of a recession, while a Bloomberg survey put it at 45%. The Bank of Canada meets next week, and the swaps market is pricing in a little more than an 80% chance of a 75 bp hike. September housing starts and August portfolio flows will be reported today. Tomorrow sees September CPI. The headline pace is expected to slow for the third month, but the core rates are expected to be little changed.

For its part, the US reports September industrial output and the August TIC report is due late in the session. Industrial production has risen by an average of 0.33% through August (0.35% in the January-August period last year. It is expected to have stabilized (0.1%) after falling by 0.2% in August. Manufacturing output is expected to match this year's average of 0.2%. It rose 0.1% in August and rose by an average of 0.3% in the first eight months of 2021. Note that the Fed's Bostic and Kashkari speak late today.

Follow through selling pushed the US dollar below the 20-day moving average against the Canadian dollar (~CAD1.3695) for the first time in a month. However, it caught a bid near the middle of the Asian session that carried through the European morning, lifting the greenback to around CAD1.3770. With equities firm and the intraday momentum indicator stretched, we look for the Canadian dollar to be better bid in North America. Initial support may be around CAD1.3700. The Mexican peso is going nowhere fast. The US dollar is straddling the MXN20.00 level in quiet dealings. The lower end of this month's range is around MXN19.9350 and the upper end is about MXN20.1550.