Dollar Recovers from Yesterday’s Stunning Reversal, but has Sentiment Turned in North America?

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Marc Chandler
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Overview: There has been little follow-through dollar selling so far today after yesterday’s dramatic downside reversal after the initial flurry of buying in response to the stronger than expected US CPI. Still, the upticks look corrective in nature and the intraday momentum indicators are stretched, raising the prospect of new sales by North American operators today. The sharp recovery in US equities did carry over into Asia and Europe where most bourses are ending the week on a firm tone. Europe’s Stoxx 600 has edged above last week’s closing level. However, US futures are trading a bit heavier. European bonds are rallying, with 10-year yields off mostly 4-9 bp. Gilts are continuing to recover. The 10-year yield is off about 18 bp to bring the week’s decline to more than 45 bp. The 30-year yield is off 17 bp to around 4.36%, which is a 30 bp decline this week. Sterling is the weakest of the major currencies, off around 0.85% (~$1.1265). Gold remains on the defensive below $1655. It is off about 2.4% this week. December WTI rose every day last week but is falling today for the fourth session this week. Around $87 barrel, it is down around 4.7% this week after surging 16% last week. US natgas surged 4.75% yesterday but is down 1.6% today. It was practically flat on the week coming into today. If the losses are sustained, it will be the eighth consecutive weekly drop. Europe’s benchmark fell 4.3% yesterday and is off 3.6% today. It is off about 5.5% this week, which is seventh weekly fall. It has fallen by more than 50% over this run. Iron ore rose 2.2% today to finish the week unchanged. December copper is slightly firmer and is up about 1.9% this week. December wheat is giving back most of yesterday’s 1.1% gain. On the week, it is up about 0.6% after falling 4.55 last week.

Asia Pacific

More than a whiff of deflation is evident in China's latest data. September producer price inflation slowed to 0.9% year-over-year in September. It was driven by falling prices in raw materials, mining, and manufacturing. It is the weakest growth since January 2021 and is the result of 11 consecutive monthly slowing. Do not be misled by the rise of headline CPI to 2.8% from 2.5%, which was still below expectations. It was bolstered by higher food prices. Pork price accelerated to 36% year-over-year from 22.4% in August. The government has begun taping into the strategic pork reserves to ease pressure on prices. Adverse weather may have helped lift vegetable and fruit prices. Core CPI, excluding food and energy slowed to 0.6% from 0.8% in August. It is the slowest pace of core inflation since March 2021.

China's Communist Party's 20th Congress begins over the weekend, and Xi is expected to deliver a speech on Sunday, which will likely set the general tone. It comes at a difficult time for China. China's property market was a key catalyst of its growth and development over the past decade. It is broken and is unlikely to return to its former prominence. In fact, there still seems to be more pain coming from it as the special purpose vehicles of local governments are generally in poor shape and the connection to the federal government is, as is typical, opaque. In addition to the suffering people of Ukraine, and the seeming objection of Russian people, the war has been politically costly for Beijing. Europe is being drawn closer to the US for energy and defense (including weapon procurement). Japan, Australia, and others in the region are stepping up defense spending and have been encouraged by the bravery and success of Ukrainian forces. The "wolf diplomacy" appears to have backfired. Biden has not just continued Trump's tariffs and sanctions on China and Chinese companies, but he is expanding them.

Japanese investors continued to sell foreign bonds last week. They sold JPY1.7 trillion of foreign bonds. Over the past five weeks they have sold JPY5.04 trillion (~$35.5 bln). Japanese investors have looked more kindly toward foreign stocks. Over the past five weeks, they have bought JPY1.76 trillion (~$12.4 bln). For their part, foreign investors sold Japanese JPY110 bln of Japanese bonds, and over the past five weeks they have divested JPY6.55 trillion. Perhaps, encouraged by the weaker yen, last week, foreign investors bought nearly JPY1.4 trillion of Japanese equities, the most in nearly six months. It was the first week of net purchases since mid-August.

Japanese officials are stepping up their warnings as the yen slumps to new lows in thirty years. There were some rumors that Japan stepped into the market yesterday after the US CPI, but they are not credible. It is not Japan's way, and as we have noted intervention outside of Tokyo hours would be highly unusual and protocol requires notifying the US. The dollar's dramatic move after the CPI appeared a case of "buy the rumor sell the fact" after a short delay. Given the slim chance of intervention outside of Tokyo, it is not surprising that dollar highs are recorded in the US or Europe. The next target is near JPY148, while support is seen around JPY147. The Australian dollar posted a potential key upside reversal yesterday and follow-though buying lifted it to almost $0.6350 today before encountering selling pressure in early European turnover. The intraday momentum indicators are getting stretched. Initial support may be around $0.6270, but a break of $0.6250 may begin negating yesterday's favorable price action. The greenback is firmer against the Chinese yuan and could be poised for its highest close of the week above CNY7.19. The dollar's reference rate was set at CNY7.1088, little changed in recent days, while the median projection in Bloomberg's survey was for CNY7.1583. Given the 2%-dollar band, the fixings seem to suggest a cap around CNY7.25. Finally, note that Singapore Monetary Authority tightened monetary policy by raising the midpoint of the policy band to the prevailing level, allowing the currency to strengthened.

Europe

In addition, the reversal in risk appetites after the knee-jerk reaction to the stronger than expected US inflation, the UK's outperformance was aided by another consideration. It was not so much about the BOE. Indeed, Chancellor Kwarteng, whose mini budget sparked the turmoil (different than just elevated volatility) seemed petulant in  claiming that any more turmoil will be due to ending of the BOE's emergency bond buying. Instead, with Kwarteng still in Washington at the IMF/World Bank meetings, government officials have been signaling the likelihood of another tactical retreat. It may abandon its plan to overturn Johnson/Sunak's corporate tax hike for next year (from 19% to 25%). Rejecting the tax hike cost around GBP13 bln a year, Kwarteng previously estimate, or GBP67.5 bln over five years. Confirmation is expected over the next few days. Yesterday's price action suggests at least some of it is already in the market.

The eurozone reported a larger than expected August trade deficit of 50.9 bln euros. The combined deficit in June and July was almost 55 bln euros. This brings the year-to-date deficit to 228.2 bln euros. In the first eight months of 2021, the eurozone recorded a trade surplus of 120.3 bln euros. All else being equal, which it rarely is, the deterioration of the trade balance would be associated with a weaker currency. The terms-of-trade shock is weight on the euro separate from monetary policy considerations. Reports of a new staff paper suggest a terminal rate near 2.25% for ECB policy. The swaps market sees it closer to 3%. There are also some reports suggesting that the ECB could begin unwinding its balance sheet early next year.

The euro recorded a potential upside reversal yesterday. It fell to new three-week lows (~$0.9635) initially after the US CPI and rallied through and closed above Wednesday's high. It reached $0.9805 and follow-through buying today was limited to a few tenths of a cent. It has slipped to $0.9720, stretching the intraday momentum indicators. Provided the $0.9700-20 area holds, we suspect a recovery ahead of the weekend is possible. UK Gilts continue to recover in dramatic fashion, but after two strong days of gains (~4.5 cents), sterling is struggling today. The big outside up day saw sterling recover slightly below $1.1060 to $1.1380 yesterday. There has been no follow-through buying and sterling has been sold to around $1.1230. A break of $1.12 would weaken the technical tone, and a push below $1.1150 could signal another cent decline, at least. That said, the intraday momentum indicators are stretched, perhaps encouraging buying from early North American operators. 

America

In the last week, the US reported strong jobs growth and drop back to the generation-low unemployment rate (3.5%) and stronger than expected inflation. Calls from some quarters that the Federal Reserve should ease its efforts to return to price stability for the sake of the world economy (for which the worlds' second- and third-largest economies are monetary and fiscal policy, while central bank of the fourth largest economy warns that a recession is inevitable) will fall on deaf ears. Indeed, the market, trying to decipher the Fed's reaction function, is moving in the opposite direction. The Fed funds futures market is discounting almost a 20% chance of a 100 bp hike when the FOMC meets on November 2. This seems exaggerated, but the heightened chance of a 75 bp hike in December, may be more reasonable. While the terminal rate is seen closer to 5.0% (at the end of August it was seen near 4%, the market continues to look for a cut in Q4 23. The December 2023 Fed funds futures' implied yield is 20 bp below the implied yield of the September 2023 contract. 

Today's retail sales, import/export prices, and business inventories are unlikely to outweigh the jobs and inflation data. The data will help economists firm up Q3 GDP estimates and the Atlanta Fed's GDPNow will be updated from its 2.9% estimate made after last week's employment data. The University of Michigan's preliminary October survey results and its inflation expectations will draw some attention, primarily because Fed chief Powell has cited them earlier as part of the reason it stepped-up the pace of hikes. Several Fed officials have indicated that actual inflation is more important forecasts, while at the same time expressing fear that the persistence of higher inflation will become embedded into workers, households, and business expectations. Today's Fed officials George, Cook, and Waller speak. Note that Bullard's speech tomorrow on the sidelines of the IMF meeting is on inflation (origins and remedies).

Lastly, the US budget balance may be reported. It is not a market mover. At the risk of being repetitive, few observers seem to recognize the dramatic tightening of fiscal policy that is taking place. Monetary policy has been sucking up all the oxygen it seems. Yet, the budget deficit is projected to fall to 4.2% of GDP this year from 10.8% last year. After the Great Financial Crisis, it took more than three years to achieve that kind of fiscal consolidation. Thinking in calendar year terms rather than the fiscal year, consider that the average monthly shortfall this year through August was $71 bln. In the same period last year, the average monthly deficit was $267 bln. What about before the Covid-related spending, you ask. In the first eight months of 2019, the deficit averaged $128 bln a month.

The S&P 500 and NASDAQ posted large key reversals yesterday, initially selling off sharply in response to the implication of the stronger CPI but recovered in dramatic fashion and settled a new high for the week. There are gaps from last Friday's sharply lower opening in response to the employment report. Those gaps are technically important. In the S&P 500, the gap is roughly 3706-3739 and, in the NASDAQ, the gap is about 10892-11051. The earnings season gets under way today with a few large bank earnings.

The US dollar initially approached the CAD1.40 area (~CAD1.3975) before reversing and falling to almost CAD1.3700. Like we have seen with the other pairs, there has been no follow-through selling of the greenback today and the CAD1.38 area is being probed in Europe. Resistance is pegged around CAD1.3840, and a push through CAD1.3875 would warn of a return to the CAD1.40 area. Still, we expect that North America is not going to be quite as bullish as the US dollar with intraday momentum indicators is being stretched. The Mexican peso remains well within this week's ranges. Around MXN20.04-05, the greenback is nearly unchanged on the week. Yesterday, the JP Morgan Emerging Market Currency Index was snapped a six-day drop and rose by about 0.35%. Today, it has edged a little higher. It too is virtually unchanged for the week.