Sterling Continues to be Pounded

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Marc Chandler
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Overview: Sterling’s pounding continued in Asia where it was driven to $1.0350, a new record low before stabilizing. UK rates also continued to rise sharply after the new government promised more tax cuts next year. The right-wing victory in Italy was not surprising but it kept pressure on Italian bonds. China took more action to slow the yuan’s descent The dollar is broadly higher. All the G10 currencies and most emerging market currencies are lower. Risk appetites are practically non-existent today. Many of the largest Asian equity markets, excluding China, were off 1.5%-3% Europe’s Stoxx 600 is off around 0.8% to bring it to new lows for the year. US futures off almost 1% UK’s 10-year Gilt yield is soaring by more than 30 bp, while European benchmark yields are 9-16 bp higher, with Italy’s gains the most following the right-wing election victory. The 10-year US Treasury yield is near 3.78%. Gold slipped through $1627 to record new lows for the year today but has rebounded in the European morning to test previous support, now resistance near $1650. Concerns about demand saw December WTI fall to $76.75, new lows since January. Separately, retail gasoline prices have begun stabilizing after falling for most of Q3. They rose on Saturday for the fifth consecutive daily gain US natgas is off 2.3%, after falling 12% last week (fifth weekly loss) Europe’s benchmark is off 6.3%. It fell nearly 3.5% last week (fourth consecutive weekly decline). Iron ore fell by about 2.25% today It was practically flat last week. December copper is heavy after falling 3.7% before the weekend. It is near three-month lows. December wheat is nearly 1.4% lighter today It fell 3.3% before the weekend to trim last week’s gain to 2.4%. 

Asia Pacific

The Bank of Japan acted on two fronts last week. First, it intervened and bought yen for the first time since 1998. With the yen still confined to the range seen on the intervention day, Japanese officials see the action as successful. Second, rising global yield pressured Japanese government bonds, and the BOJ stepped in for the first time since June to buy 10-year JGBs in an unannounced operation. The BOJ has come to dominate the market that there were two days last week when the 10-year cash bond did not trade. The BOJ stepped in today and bought JPY550 bln (~$3.8 bln) of 5–10-year notes today. It is the third operation for more than the plan of JPY500 bln and it follows an unscheduled purchase of JPY150 bln in the middle of last week. Separately, due to a holiday at the end of last week, Japan's preliminary PMI was reported earlier today. The manufacturing PMI softened to 51.0 from 51.5, but the services PMI rose to 51.9 from 49.5. The saw the composite recover to 50.9 from 49.4, which was its lowest reading since February

Beijing took another step to ease the selling pressure on the yuan. It imposed a 20% reserve requirement on short yuan forward positions Previously there were no requirements. The measure goes into effect Wednesday. The reserve requirement had been eliminated in October 2020 as the yuan strengthened Recall on September 5, Beijing cut the reserve requirement on foreign currency deposits by 2% to 6%. The dollar is allowed to trade in a 2% band around the fix. Most of the time, the greenback trades well within it. However, in recent days, it has approached the limit. Speculation that it may widen the band seems to be confused .A wider band now would accelerate the dollar's rise

Today, the PBOC set the dollar's reference rate at CNY7.0298. The upper band, 2% higher, would give CNY7.17. Today's high has been about CNY7.1685. The offshore yuan (CNH) often respects the onshore band, but today the dollar traded through it to around CNH7.1735. The dollar gapped higher Friday's high was slightly below CNY7.13 Today's lows were near CNY7.1360. The dollar remains in the intervention day range against the Japanese yen (~JPY140.35-JPY145.90. However, it did reach its best level since then and set a high near JPY144.25. Support now is seen in the JPY143.00-25 area. After the weak close before the weekend, the Australian dollar was sold further today, reaching $0.6485, a new two-and-a-half year low. The (61.8%) retracement objective of the rally since the March 2020 low (~$0.5510) comes in near $0.6465, which we have suggested as near-term target. Resistance now is seen around $0.6550. Lastly, we note that South Korean officials have stepped up their rhetoric, expressing displeasure with the won's weakness. There had been some idea that it was defending the KRW1400 level, around where it is stalling in the middle of the month. However, it closed above in the last two sessions last week, and gapped higher today, reaching KRW1435

Europe

Sterling slumped to $1.0350 in early Asian turnover as the market continued to react to the government's "mini-budget". The government seems undaunted by the criticism of economists and investors Chancellor of the Exchequer Kwarteng signaled more tax cuts were planned for next year. The main focus of the criticisms, leaving aside the regressive nature of many of the initiatives, has been on the risk to the twin deficits To attract funds, prices are being marked down, which is to say higher yields and weaker sterling. There is also the fear that the government's plans will be inflationary. The 10-year breakeven is around 4.30%, up from less than 4.10% a week ago. The market is rife with speculation of an emergency Bank of England meeting this week that would ostensibly hike rates. The swaps market is pricing in 110 bp increase in the policy rate by early November The BOE meets on November 3. This is up from around 75 bp after last week's BOE meeting. The 10-year yield was near 3.50% after the BOE meeting and surged to 3.85% before the weekend and traded to almost 4.20% today before steadying

As widely expected, a right-wing coalition won handily in Italy. It will take a little time to sort things out President Mattarella is expected to recognize the election results and allow the Brothers of Italy to put together the new government. Ministerial appointments are focus Still, it does not look as if the right secured a sufficient majority to enact constitutional reforms. The 10-year Italian bond yield has jumped about 15 bp to 4.47% and the premium over Germany has risen around six basis points on top of the 11 before the weekend to approach 240 bp, the upper end of this year's range. The two-year premium near 116 bp. That is roughly a 20 bp increase over the past two sessions

The German IFO survey worsened in September. The current assessment fell to 94.5 from 97.5. The expectations component stumbled to 75.2 from 80.5. The in the early days of the pandemic was a little below 72.0. This left the overall assessment of the business climate at 84.3, down from 88.6, where it had been in July and August. The pandemic low was 86.8. Germany is on the verge of a contraction that will likely carry into at least the first part of next year. 

The euro fell to about $0.9550 in Asia and quickly bounced back to $0.9650. It is little changed on the day in late morning turnover in Europe as it hovers a little below $0.9700. The upside may be limited in North America as the intraday momentum indicator is getting stretched. The session high was recorded in early Asian turnover near $0.9710. It may take a move above $0.9750 to stabilize the tone. The lower Bollinger Band (two standard deviation below the 20-day moving average) is around $0.9730. Sterling was pounded to $1.0350 in early Asian turnover and has gradually climbed back to approach $1.08. That effort has also stretched the intraday momentum indicators, even though sterling remains well below its lower Bollinger Band (~$1.0965). The three-standard deviation (from the 20-day moving average) is near $1.0740

America

Since the FOMC meeting, the market shifted toward a later (Q2 23) and higher (4.50%-5.0%) peak in the Fed funds rate. This shift is not smooth (non-linear) and has injected volatility as the adjustment is made. Meanwhile, a fiscal drama playing out could lead to a shutdown of the Federal government. To ensure passage of the Inflation Protection Act, Senate leader Schumer cut a deal with Manchin to include his bill that changes the approval process for government energy projects in a "must-pass bill."  Schumer chose the continuing resolution bill that needs to be approved this week to keep the government funded. Most Republicans and at least a few Democrats are opposed to Manchin's bill and have threatened to vote against the continuing resolution bill

As the Fed pursues its most aggressive tightening since Volcker and the dollar soars, the fancies of many otherwise grounded observers turn to the possibility of a Plaza-like accord. A similar, or at least parallel argument is that the tightening of the US monetary policy in response to the highest inflation in a generation is a "reverse currency war". While exchange rates, of course, can impact domestic price pressures, the rise in energy and food prices is playing a more significant role. Making the dollar the key driver in the narrative does not do justice to other drivers, including terms-of-trade shock, which helps explain the general outperformance of Latam currencies. 

The major industrialized countries, and yes, despite the trash talk of the UK being an emerging (or submerging, as the FT saw fit to quote Summers' schadenfreude on the front page over the weekend) it is still in this group, did not intervene during the Great Financial Crisis and the Pandemic. The thinking has evolved from defining the problem in terms of price to one of access (hence the swap lines). While Treasury Secretary Yellen does not repeat what had once been the strong dollar mantra, the policy is alive and well and the Fed. There can be no Plaza-like agreement to drive the dollar lower because it is a channel through which financial conditions are tightening. Contrary to allusions to the US "responsibility" for countries that borrow dollars, the Federal Reserve is not the world's central bank. Pursuing a purposeful weaker dollar would contradict the Fed's monetary policy.

There are US economic data every day this week, and with the FOMC meeting behind us, the Federal Reserve officials also are speaking every day. Today's data, the Chicago Fed's national activity index and the Dallas Fed's manufacturing survey are not typically market movers. Tomorrow features durable goods orders, house prices and the Conference Board's measure of consumer confidence. Among Fed officials, Collings, Bostic, Logan, and Mester speak. Tomorrow, Powell (on a panel on digital currencies) speaks, as will Evans, Bullard, Kashkari, and Daly The data highlight in Canada is the July GDP on Thursday. A small contraction is expected Mexico reports its economic surveys today, employment and trade figures will be released before Thursday's central bank meeting, where a 75 bp hike (to 9.25%) is widely expected. Brazil reports its July current account today and inflation readings, but the focus is on the first round of the presidential election October 2. A run-off is expected, and it will be held on October 30

The Canadian dollar remains under pressure. It fell 2.4% last week, its largest weekly loss in three months. The US dollar so far today has reached slightly below CAD1.3640 The (61.8%) retracement of the greenback's decline from the 2020 high (~CAD1.4670) is found near CAD1.3650. A move above there were initially target the CAD1.3700-20 area, but the risk extends toward CAD1.40. The continued losses in US equities are a considerable drag. The Mexican peso succumbed to the dollar's strength in the last two sessions. The dollar has rallied from around MXN19.9060 to MXN20.2620 before the weekend and today has stretched of almost MXN20.37. The greenback has not been this high since August 8 Near-term potential extended toward MXN20.42-MXN20.45