Semblance of Calm Returns

by
Marc Chandler
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(Business travel will prevent me from updating the blog for the next couple of days.  Thank you for your patience.  Good luck.)

Overview: After extending last week’s moves yesterday, the capital markets are mostly calmer today. Sterling is firmer, as are UK Gilts. The dollar is mostly consolidating inside yesterday’s range. Equities are stable to higher. Most of the large markets in the Asia Pacific region, but India edged higher, led by a 1.45% gain in China’s CSI 300. The Stoxx 600 is up about 0.25%, the first gain in four sessions. US futures are 0.75%-1.0% higher as they try to snap a five-day slide that has brought them to almost the lows from earlier this year. The US 10-year yield is near 3.84% after rising to almost 3.93% yesterday. Peripheral yields in Europe are firmer, while core yields are little changed. The 10-year Gilt is off 14 bp to slightly below 4.10%. Sterling has recovered around 1% from its shellacking. All the G10 currencies are firmer. Emerging market currencies are mixed. The South African rand and South Korean won lead the advancer, but the Philippines, China, and Russia are among those nursing modest losses. Gold is recovering after reaching almost $1621 yesterday and today. It needs to resurface above $1650 to or not. December WTI has also steadied today after slipping below $76 yesterday. It reached $77.80 today before sellers halted the recovery. US natgas is 2.9% higher after advancing 1.1% yesterday. Europe’s benchmark is up 10.4% today after yesterday’s 4.1% drop. Damage to the idled Russian pipelines weighed on sentiment. Iron ore is up 1.9%, its first gain in three sessions. The same if true of December copper, and ironically, December wheat.

Asia Pacific

The market will have a better idea how much the BOJ intervened with last week. Estimates based on the BOJ’s current account balances seem to be around JPY3.0-JPY3.6 trillion (~$21-$25 bln). This would be a record amount. Without the benefit of a full surprise (threatening it can “checking prices”, it was not multilateral, and did not signal a change in monetary policy, the impact was widely recognized as having a short-term impact.

The Ministry of Finance, whose decision it is to intervene, bought little more than one session of stability. The dollar rose by more than 0.8% and reached JPY144.80, its highest level since the intervention on September 22. If it intervenes again now, which would seem to make tactical sense, it may find itself perceived to be defending a certain level (JPY145? JPY146?) that complicates its strategic interests. Meanwhile, the BOJ’s cap on the 10-year yield has deflected pressure to the 20-year bond. Yields rose above 1% today for the first time since 2015. The yield edged higher even after the central bank announced an unscheduled bond purchase. It bought JPY150 bln ($1.04 bln) of note due in 5-10-years, and JPY100 bln of 10-25-year bonds.

The US dollar held yesterday’s high and found support ahead of JPY144.00. Helping the yen today was the pullback in US yields. The nine-basis point drop in the US 10-year yield is the most in two months. The seven-basis point decline in the US two-year yield if sustained would be the first decline in nearly three weeks. The Australian dollar found support ahead of yesterday’s low slightly below $0.6440. It overshot the $0.6465, (61.8%) retracement objective of the big rally from the March 2020 lows. It was bid back into the Bollinger Band (~$0.6490) but is struggling to stay inside. Resistance is seen in the $0.6520-35 band. The US dollar remains firm against the Chinese yuan inside yesterday’s range. The PBOC set the dollar’s reference rate at CNY7.0722. The puts the upper end of the band (2%) near CNY7.2135 and the greenback did not approach it against either the onshore or offshore yuan. The dollar is trading a little softer against the offshore yuan, which if sustained, will be the first decline in seven sessions.

Europe

The market reaction to the UK’s mini budget was dramatic, to put it mildly. It will standout like the 1985 low and then when the UK left the ERM. The Bank of England compounded injury with insult. Speculation circulated that the BOE would/should call an emergency meeting and hike rates. This speculation helped steady sterling. After hitting $1.0350 in Asia yesterday, sterling recorded a session high in early US activity, reaching $1.0930. It was still trading near $1.08 when the BOE promised it would raise rates “as much as needed” to bring inflation back to its target. However, Governor Bailey needlessly added that the MPC would discuss the government’s fiscal program and sterling at the November 3 meeting. This seemed signal less urgency and rule out an emergency meeting. Sterling fell back to around $1.0650. Bailey did not need to rule out an emergency meeting. This is not to argue that there should be one, and transparency is importance, but so is strategic ambiguity. The swaps market is now pricing in nearlym150 bp of tightening at the November MPC meeting. The terminal rate is now seen near 6% around the middle of next year. It currently stands at 2.50%.

The mini budget was not a surprise. Truss had been critical of Sunak’s tax increases. She had campaigned in part on reversing them. Most of the tax cuts including in the last week’s budget announcement were that. It is as Oscar Wilde quipped about the two tragedies in life, not getting what you want and getting it. The policy mix of fiscal stimulus and monetary tightening is the same policy mix under Reagan-Volcker when Germany had when the Berlin Wall came down and unification was pursued. The US also experienced that mix with Trump’s tax cuts and tighter Fed policy. That policy mix is associated with an appreciating currency, even if not immediately. While some have been very critical of the UK efforts, and it is a gamble, but like a losing trade is an orphan and a winning trade has many parents, so too in politics. In a favorable turn of event, including lower energy prices and stronger growth, the gamble would pay off.

Meloni, who looks most likely to become Italy’s next prime minister says, “Italy chose us.” She talked about family and the nation and did not seem to say much that the center-right would find objectionable. The right victory was just as much as function of the disarray of the center-left in a system whose rules favor pre-election pacts. The anti-immigration rhetoric is seen in other European countries, and even the Social Democrats in Sweden, who recently lost in the national elections adopted more anti-immigration rhetoric. ECB President Lagarde has the Transmission Protection Instrument to contain “unwarranted” increases in interest rate differentials, but she was clear that she would not use the instrument to offset “policy errors”.

While UK markets are given some reprieve today, not so in Italy. Italy’s 10-year premium over Germany rose to its highest level since mid-2019 to 255 bp. It was closer to 210 bp before the Draghi government collapsed and 220 bp last Thursday. The two year-premium has risen from around 100 bp to 137 bp. It took out the summer high near 130 bp and is at its highest level today since May 2020.

The euro fell to about $0.9555 yesterday and has held above $0.9580 today. It recorded the session high in late Asian turnover near $0.9670. The euro has come back off in the European morning to almost $0.9615. The intraday momentum indicators are getting stretched. The market may turn cautious ahead of Thursday’s preliminary CPI. The headline is expected to accelerate to 9.7% from 9.1% in August, according to the median projection in Bloomberg’s survey, and the core rate is expected to rise to 4.7% from 4.3%. Sterling held above $1.0650 and worked its way to $1.0835 in late Asian turnover. It has been stuck in a narrow range in the European morning around a quarter of a cent on either side of $1.08. Gilt yields are also lower. Sentiment remains fragile. A move above $1.0930 is needed to help the technical tone. Lastly, market sees the central bank of Hungary lifting its base rate 100 bp to 12.75% today.

America

Despite, or maybe because, of the dramatic jump in the US two-year yield, indirect bidders (often foreign accounts) were not so interested in yesterday’s sale of $43 bln of the note. The yield of 4.29% represents a nearly 100 bp increase from last month’s auction. Some thought the strong direct bidders (often US asset managers) were reinvesting proceeds that fled the equity market drop. Today, the Treasury sell $44 bln five-year notes. It is currently yielding about 4.10%, down from 4.19% at the close yesterday. The yield has risen every session this month but two coming into today. The run actually began near the middle of August with the yield slightly below 2.90%.

Today’s economic calendar features August durable goods orders (transportation orders are seen weighing on the headline) and house prices (expected to moderate a little). New homes sales (August) are expected to have declined again. They have only risen once this year (May). The seasonally adjust annual pace is seen falling to about 500k. Last August, they were at 686k. Raising mortgage rate and limited supply are seen as the main drivers. The Conference Board’s consumer confidence and the Richmond Fed manufacturing survey are also due. Meanwhile, several Fed officials speak in during the North American session, including Chair Powell, and two of the leading hawks-Kashkari (yes!) and Bullard. Note that the Senate may hold a procedural vote today on the continuing resolution to fund the federal government past the end of this week. It includes Manchin-inspired effort to change the way the government permits energy projects, which has proven to be controversial. Canada economic calendar is light while Mexico reports August employment and trade. Banxico is expected to lift the overnight rate target by 75 bp on Thursday.

The US dollar recorded a wide range against the Canadian dollar yesterday (~CAD1.3560-CAD1.3810). A narrower range and calmer tone have emerged today. The greenback has been confined to a range roughly between CAD1.3640 and CAD1.3745. The low was recorded in late Asian turnover and US dollar resurfaced above CAD1.3700 in Europe. The intraday momentum indicator is getting stretched and look for the CAD1.3720 to hold now, provided US equities can stabilize after falling for the past five sessions. The Mexican peso fell to its lowest level in nearly six weeks yesterday and it too has steadied today. The US dollar reached about MXN20.4515 yesterday and pulled back to almost MXN20.2625 today, slightly below the 200-day moving average (~MXN20.27). But it is little changed from yesterday’s settlement now (MXN20.36). It may need to break MXN20.20 signal a top is in place.