Stocks and Bonds Sell Off, while the Dollar Rallies

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Marc Chandler
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Overview: The reverberations from last week continue to roil the capital markets today. Equities and bonds have been sold and the greenback bought. Most of the large markets in Asia Pacific fell by more 2%, including Japan’s Nikkei, Taiwan’s Taiex, and South Korea’s Kospi. Ironically, the Shanghai and Shenzhen Composites eked out minor gains, but the CSI 300 still eased. Europe’s Stoxx 600 is off 1% after falling nearly 1.7% before the weekend. US futures warn of another lower opening. Recall that the major indices gapped lower last Monday as well. The US 10-year yield is up 7 bp to 3.11%, probing last week’s highs, while the two-year yield reached new highs near 3.48% before steadying. European benchmark yields are 12-13 bp higher. The dollar is firmer against all the major currencies. Most of the European currencies but the Norwegian krone and British pound are off modestly, while the yen, the Australian dollar and sterling are off more than 0.5%. Emerging market currencies are under pressure, though the Hungarian forint and Czech koruna are steady to firm. Rising rates and a stronger dollar are no match for gold, which has been sold to a new low for the month (~$1720.45). There appears little support in front of $1700. October WTI is firm near $93.75. Talks with Iran will carry over into next month. US natgas slipped fractionally last week and is up nearly 2.5% today to about $9.55 after testing $10 last week. News that Germany is near its 85% tank capacity objective for next month has seen Europe’s benchmark soften a little (off ~1.8%). Iron ore is giving back most of last week’s 4.7% gain. December copper is off 3.4% after posting a minor gain last week (~0.7%). December wheat rallied 4.4% last week and is off almost 1% today. 

Asia Pacific

As China's Xi awaits the coronation for a third term, the challenges seem to be intensifying. Shijiazhuang, the provincial capital of the Hebei province that borders Beijing is in a partial lockdown for three days, which started yesterday, and includes the suspension of subways and non-essential business operations. It is a city of more than 11 mln people and follows lockdowns in other parts of Hebei last week. Power shortages are leading to rolling blackouts in different regions and compounding the challenge arising from the end of property boom. The economic toll spurred the government into action recently with rate cut and new lending/spending initiatives mostly concentrated on infrastructure. Over the weekend, China reported that industrial profits fell 1.1% in the Jan-July period. They had risen by 0.8% in the first half. The decline in profits dovetails with the deepening of the economic slump seen in a batch of data reported recently.

While several central bankers used the Jackson Hole gathering to brandish their anti-inflation credentials, BOJ's Kuroda stuck fast to his commitment to easy monetary policy. He argued that nearly all of Japan's inflation is a function of higher commodity prices. He said that inflation would decelerate next year toward 1.5%. It was 2.6% in July, but 1.2% excluding fresh food and energy. Kuroda's inflation outlook is not much different than the market’s. A recent Bloomberg survey found a median forecast for Japan's 2023 CPI of 1.3% at the headline rate than 1.4% core.

July retail sales in Australia surged 1.3%, the most in four months, and four-times more than the median forecast in Bloomberg's survey. It did nothing for the Australian dollar, which extended the pre-weekend sell-off. Still, the resilience of the Australian consumer was impressive despite the cost-of-living squeezes. Gains were recorded in five of the six retail categories., with only demand for household goods softening. The Reserve Bank of Australia meets on August 6 and the swaps market has a little more than a 70% chance of 50 bp hike discounted and about 150 bp priced between now and the end of the year.

The jump in US rates helped lift the dollar to JPY139.00 in late Asia turnover. It is the highest since July 15, the day after the 24-year high was set near JPY139.40. Japan's Cabinet Secretary Matsuno noted that the government is closely was closely watching market movements. However, the price action can hardly be surprising given the divergent messages at Jackson Hole. The greenback's momentum stalled a bit. Initial support is seen near JPY138.50. Although there was not take-up at the BOJ's offer to buy bonds today, the 0.25% cap on the 10-year is being approached again. The Australian dollar recorded a bearish outside down session ahead of the weekend by trading on both sides of Thursday's range and settling below Thursday's lows. Follow-through selling today has seen it approach $0.6840, new lows for the month. Importantly from a technical perspective, it appears to have broken the neckline of a possible head and shoulders top that projects through the two-year lows set in mid-July near $0.6680. Nearby resistance is now seen around $0.6870. The dollar gapped sharply higher against the Chinese yuan. It reached a new two-year high of CNY6.9225 and did not trade below CNY6.90 today. The pre-weekend high was about CNY6.8730. Since August 10, the greenback has risen by roughly 2.50%. The CNY7.0 is an important psychological level, but it peaked in September 2019 near CNY7.1850 and revisited it in May 2020 (~CNY7.1780). For the fourth session, the PBOC set the dollar's reference rate weaker than the median in Bloomberg's forecast as it moderates the pace of the dollar's rise. Today's fix was at CNY6.8698 vs. expectations for CNY6.8794.

Europe

Europe is on the verge of a recession. Indeed, it may have already begun. It is not going to deter the European Central Bank or the Bank of England from continuing to aggressively tightening monetary policy. A few ECB members from creditor countries, like Austria and the Netherlands, want the central bank to consider raising rates by 75 bp at next month's meeting. They do not yet seem to represent a majority, but it is not like the members from the periphery are advocating a quarter point move. 

The surge in natural gas and electricity prices promise to drive inflation higher and intensify the squeeze on the cost-of-living. Before the weekend, the UK regulator (Ofgem) confirmed what was suspected. The cap on gas and electricity will be lifted by 80% on October 1. This likely means that UK inflation will rise above the BOE's latest forecast of 13.2%, and the new UK government face strong pressure to help households and businesses. It had previously committed GBP30 bln to households but that was three months ago. To cover the same proportion now of the increase would require another GBP14 bln, according to some estimates. We had thought that increased military spending would replace some of the Covid-related spending, and while that may be true, it now seems that energy subsidies and the like will also generate wider deficits. It may also lead to increased nationalization of the parts of the energy sectors.

Sweden holds legislative elections on September 11 and the law-and-order and anti-immigration party that has been shunned by the mainstream parties appears to be surging in the polls. The Swedish Democrats could be the second largest party after the ruling Social Democrats. Three different polls published last week give it 1/5-1/4 of the vote compared with 30% for the government. The Moderates have been pushed into third place with 16-18% support. The center-right bloc of the Moderates, Christian Democrats, and Liberals could ally with the Swedish Democrats. The polls show it is virtually tied with the center-left bloc of Social Democrats, Left, Centre, and Green parities. Separately, Sweden reported the economy expanded by 0.9% in Q2, missing 1.4% expectations, though Q1 was revised from a 0.8% contraction to a 0.2% expansion. Sweden's CPI was at 8.5% in July and the underlying measure, which uses fixed interest rates, and is the target measure was at 8.0%. The policy rate stands at 0.75%, following the 50 bp hike in June. The Riksbank meets on September 20 and the swaps market is pricing in a large hike (~100 bp).

The euro retested last week's 20-year low near $0.9900, and when it held a small, short-covering bounce in early European activity lifted it to almost $0.9960. A combination of bearish sentiment and options for nearly 1.6 bln euro at $1.000 may deter a move above parity. The session high is a little shy of $0.9990. For its part, sterling slumped to a new two-year low near $1.1650. It posted a bearish outside down day ahead of the weekend. Sterling has met the double top objective near $1.17, we had monitored that had a $1.20 neckline. The spike low in March 2020 saw it trade to almost $1.1410. Sterling is finding some support in the European morning, and the $1.17 area now should offer resistance.

America

Fed Chair Powell terse speech at Jackson Hole before the weekend did not appear to change expectations for the trajectory of monetary policy. The implied yield of the March 2023 Fed funds futures contract continued to trade about 20 bp above the December 2022 contract as it had for a couple of weeks. This points to a strong expectation of a rate hike n Q1 23. The implied yield of the December 2023 Fed funds futures was about seven basis points below December 2022 contract. This implies a small chance of a cut late next year. These spreads were virtually unchanged in response to the Fed Chair's speech. Powell did succeed in doing was to drive down the two-year breakeven, which speaks to the much-maligned anti-inflation credibility of the Federal Reserve. The two-year breakeven dropped almost 16 bp before the weekend to 2.74%. Consider that it was near 4.5% as recently as mid-June. This speaks to the increase in the real rates, which in turn punished equities and risk assets more broadly.

One common refrain against the Federal Reserve is that is does not have tools to address the supply shocks that have lifted prices. Another tact, illustrated by a paper presented at Jackson Hole, is that fiscal policy is responsible for around half of the recent increase in inflation and that when inflation is of a fiscal nature, monetary alone does is not effective. There are at least two answers to these criticisms. First, it underscores our claim that the extent of fiscal tightening has not been appreciated. The budget deficit is expected to fall to below 4.5% of GDP this year from 10.8% last year. Consider that after the Global Financial Crisis, the US deficit peaked around 10% of GDP (2009) and did not fall below 5% of GDP until 2013. Second, Powell address this in his Jackson Hole Speech in the first lesson of the 1970s inflation. Price stability, regardless of what threatens it, is the Fed's responsibility. He argued that the Fed needs to constrain demand to bring it in line with supply. 

What will be a data-packed week, culminating with August nonfarm payrolls, will begin slowly, with only the Dallas Fed manufacturing survey and the sale of $96 bln in 3- and 6-month bills on tap for today. The risk-off mood has sent the greenback through last week's highs (~CAD1.3060-5) against the Canadian dollar. The next chart area is seen around CAD1.3100-35, and the two-year high set in mid-July (~CAD1.3225). The intraday momentum indicators are flagging and warning of the risk of some backing and filling before those highs are attacked. Initial support is seen in the CAD1.3030-50 band. Meanwhile, the greenback appears to have built a base around MXN19.82 and looks poised to challenge recent highs near MXN20.26. It reached MXN20.15 in Asia before pulling back to below MXN20.10. Further easing toward MXN20.05 may provide a lower risk entry.