Currency and Bond Markets Challenge the Bank of Japan

by
Marc Chandler
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Overview: Asia Pacific equities were mixed as the China, Hong Kong, Taiwan, and South Korean markets, among the large markets were unable to gain in the wake of a solid performance in the US. Europe is also struggling to maintain the upside momentum that has lifted the Stoxx 600 for the past four sessions. It is nearly flat as this note is penned. US futures are firm. Benchmark bond yields are higher, and the 10-year US Treasury yield is edging above 4.05%. European yields are mostly 3-4 bp firmer. The greenback has a modest upside bias, though the dollar-bloc currencies are holding their own. Emerging market currencies are modestly lower. Gold has slipped to a new low for the month, a little below $1640. December WTI has steadied around $83 after yesterday’s nearly 3% drop. US natgas is slightly softer after falling more than 11% over the past three sessions, while Europe’s benchmark is snapping a four-day slide of around 30%. It is up about 5.4% today. Iron ore gave back half of yesterday’s 1.1% gain. December copper is off 1.2% today, extending its decline into a fourth session. It was off about 2.75% over the past three sessions. Lastly, December wheat has come back bid (~0.8%) after falling around 1.3% yesterday. 

Asia Pacific

Japan's policy challenge is intensifying ahead of next week's BOJ meeting. The yen's inexorable decline continues, and it, coupled with the rise in global bond yields, has pressured the 10-year JGB yield through the 0.25% cap. BOJ Governor Kuroda argues that the one-sided move is not good for the Japanese economy, but that seems to imply the need of more, not less support for the economy. There were rumors again of "stealth intervention" yesterday and a newswire quoted one person suggesting that it was "warming up" for a substantial move. But does that make sense?  At the end of last month, the BOJ intervened by a record amount. Does it really need to warm-up?  Yesterday, Finance Minister Suzuki announced that officials were intensifying the monitoring of the markets and increasing the frequency of the detailed checks. He said officials "remains ready to take action if needed."  Since it is ready to take action, it would seem to imply it hasn't. The market took the dollar to new 32-year highs near JPY149.50. The market is on edge, thinking the BOJ may intervene, and can act skittish. Some market participants may try to play on such fears.

Two reports out tomorrow are worth highlighting. First, although accounts of yen weakness nearly exclusively cite the divergence of monetary policy, there is another important development that will be underscored tomorrow with Japan's September trade data. Even if there was not the yawning interest rate differential, the deterioration of its trade balance would be seen a negative for the yen. Consider that through August, Japan reported an average monthly deficit of JPY1.53 trillion (almost $11 bln). In the first eight months of 2021, the average was a trade surplus of JPY73.5 bln (~$565 mln). Second, Australia reports September employment figures. Australia has created 41k full-time jobs a month this year compared with almost 27k average in the same year ago period. Unemployment was at a generation low of 3.4% in July and was at 3.5% in August. The Reserve Bank of Australia meets on November 1, and the futures market favors another 25 bp hike.

The market knows it is tempting BOJ intervention. The dollar is edging higher, and the three-month implied volatility has pushed above 13.3%. When the BOJ intervened last month, volatility was only slightly higher. Given that the BOJ would be acting unilaterally and without signaling a policy shift, the intervention, and that the intervention would hardly be considered a surprise, the impact would likely be less than before. This would suggest that dollar buyers may seize the intervention as a "dip" to buy. Also, failed intervention could embolden the market. The Australian dollar is trading quietly inside yesterday's range (~$0.6265-$0.6340). A break of yesterday's low could force out some weak longs as the momentum fades. It could be worth another quarter of a cent or so. The dollar is poised for its highest close against the Chinese yuan since 2008. In late September, when it recorded the intra-session high a little above CNY7.25, it closed a touch above CNY7.20. It is trading north of CNY7.22 in late mainland dealings. Meanwhile, the recent pattern (since October 11) remains intact: The PBOC has consistently set the dollar's reference rate between CNY7.1075 and CNY7.1105. Today's was set at the CNY7.1105. That means that the top of the 2% band is CNY7.2527. Against the offshore yuan, the greenback reached CNH7.2675 in late September and is trading at its highest since then around CNH7.2475.

Europe

Falling fuel prices were not sufficient to offset higher food prices last month in the UK. As a result, headline inflation rose by 0.5% for a 10.1% year-over-year rate. Food prices rose 1.1% for a nearly 15% increase over the past 12 months. Services, which are almost half the CPI, are up 6.1% year-over-year. Core CPI edged up to 6.5% from 6.3%, which is a new cyclical high. Producer price inflation slowed but not as much as expected, leaving input prices 15.9% above year ago levels and output prices 20% higher. The Bank of England meets on November 3. In the turmoil in late September, the swaps market had discounted a 150 bp hike. The government's fiscal policy was reversed and the BOE stepped and bought Gilts. The net result is that the market has downgraded its rate hike expectations. It is now pricing in about an 80% chance of a 100 bp move. Note that the unwinding of the BOE's balance sheet will also resume in early November.

Next week, the ECB may debate unwinding its own balance sheet starting next year. Meanwhile, sovereign bond auctions may become more strained if Germany's experience is any guide. Yesterday's seven-year bond auction saw a record-low bid for this maturity since it was first offered two years ago. Recent sales of 10- and 30-year bonds also saw weak take-up when offered via syndication earlier this month. The ECB meets on October 26, and the swaps market has 75 bp nearly fully discounted. Separately, tomorrow, the eurozone's September current account will be reported. Like Japan, the eurozone has seen a significant deterioration of its external balance this year, reflecting to a large degree the energy shock. It has recorded an average monthly shortfall of almost 3.9 bln euros. In the first eight months of last year, it reported a surplus of a little more than 29 bln euros. As we have noted, while the euro has declined by about 13% against the dollar this year, on a trade-weighted basis it is off almost 2.5%.

The euro is trading a bit heavier today, but yesterday's low, slightly below $0.9815 is holding. A break of $0.9800 could spur some option-related sales with large expirations that tomorrow and Friday. On the upside, resistance is seen in the $0.9860-80 area. For its part, sterling remains within the range set Monday (~$1.1150-$1.1440). It recorded the session low, so far, in the early European turnover near $1.1250. The intraday momentum indicators are turning up in late morning activity. A move above $1.1300 could help lift the tone, but the consolidation looks likely to continue.

America

The US reports September housing starts today, and it will likely break the string of favorable economic news that began with the jobs report and retail sales and ran through yesterday's industrial production figures. The third quarter appears to have ended on a firm note, and later today, the Atlanta Fed will update its GDP tracker, which stood at 2.8% as of October 14. Housing starts have been volatile this year and in the first eight months saw three monthly swings in excess of 10%. After a 12.2% surge in August a 7.2% decline is the median forecast in Bloomberg's survey. The Fed's Beige Book will be released this afternoon. The headlines can cause a little stir in the market, but there is little doubt that the Fed will deliver another 75 bp hike on November 2. The Fed's Kashkari speaks again today but his views are clear. He is an activist and tends to be among the most dovish members in an easing cycle and among the most hawkish members in a tightening cycle. Bullard and Evans speak late today, after the markets close.

A formal announcement of the US Strategic Petroleum Reserves is expected today. There are 15 mln barrels left in the current operation. As of the end of last week, the SPR held 405 mln barrels with a 714 mln barrel capacity. The release of the oil is part of an attempt to drive down gasoline prices, but the price of crude is about 50% of the cost. The other is from refining and that is where the shortage seems more acute. At the same time, where the government plans to buy back the crude is also subject to some debate. Biden had said $80 a barrel, but this was walked back. New reports suggest $67-$72 a barrel. 

Canada reports September CPI figure today. The headline rate peaked in June at 8.1%. It is expected to slow to 6.7% from 7.0% in August. If accurate, it would be the match the lowest since February. However, the problem is with the core rates, and they remain firm. The three averaged 5.2% in August. They are expected to be little changed on average in September. Despite evidence that the economy has lost the momentum seen in earlier this year, the Bank of Canada is focused on inflation. Still, the market is having second thoughts about a 75 bp hike next week. At the end of last week, the market had discounted a little more than a 75% chance of a three-quarters-point move. By the close yesterday, it had been downgraded to about a 40% chance.

The US dollar peaked on October 13 slightly above CAD1.3975. At the low point yesterday, it slipped marginally through CAD1.3660 and traded below its 20-day moving average (~CAD1.3780) for the first time in a month. The momentum faded, and the greenback is firm, holding below CAD1.3785. Support is seen ahead of CAD1.3700 today. The Mexican peso remains remarkably stable. The dollar continues to trade within the range set last Thursday (~MXN19.95-MXN20.1585). So far today, it is in about a MXN20.01-06 range. The narrow trading range discourages short-term traders who typically need to see more volatility. At the same time, the stable exchange rate is conducive for carry trades, and long peso short yen has been popular for some commodity-trading advisers.