The Dollar Comes Back Better Bid

by
Marc Chandler
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Overview: Animal spirits are retreating today. Asia Pacific and European equities are lower, and US futures are narrowly mixed. US 2- and 10-year yields are edging higher, while European benchmark 10-year yields are mostly softer.  Italy and the UK are notable exceptions. Gilt yields are firming ahead of the budget statement. The dollar is trading higher against the G10 currencies. It still appears to be in a consolidative mode, but we continue to see risk of a more genuine correction after its recent downside momentum stalled. Emerging market currencies are also trading with a downside bias today. Like the foreign currencies, gold’s upside momentum has faded, and near $1763 in Europe, the yellow metal is at a three-day low. Support is seen near $1750. December WTI is little changed near the trough carved in recent sessions near $84 a barrel. US natgas is higher for the fourth consecutive session, its longest advance in two months. It is up about 8.4% this week, recouping last week’s 8.1% drop. Europe’s natgas benchmark is up 3% today and is up a little more than 13% this week. Iron ore’s four-day rally stalled, and it slipped marginally today. December copper is extending its slump into the fourth consecutive session. It is off about 4.8% this week after rallying almost 14% over the past two weeks. December wheat is extending yesterday’s pullback. It fell 1.3% yesterday and is down 2.3% today.

Asia Pacific

Practically everyone agrees that the Chinese yuan is closely managed. The PBOC sets the reference rate every day. The dollar can move away from it, while other currencies, such as the euro have a 5% band. More often than not, it deviates from market projections. Yet, it also makes sense that over time, the tactics change. Considerations change.  Policy goals change. There are many moving parts but often observers seek one grand unified explanation that does not do justice to the intelligence and savviness of PBOC officials. In most explanations the role of other currencies movements in explaining the dollar-yuan changes are played down. Yet the rolling 60-day correlation between the changes the dollar-yen and dollar-yuan is at the highest since early 2017. Similarly, the 60-rolling correlation with the changes in the euro and dollar-yuan is its highest since mid-2018. Of course, this is not the final word, but this is to say that with Chinese officials as a known unknown and the range of levers it uses to manage the currency, include what we might call a modified halo effort (like slowing down when you see a police car on the highway) opaque as ever,  knowing what the dollar is doing against the euro and yen, sheds some light on what the yuan doing, now.

Japan reported a larger than expected October trade deficit.  The JPY2.16 trillion (~$15.5 bln) shortfall was about a third larger than expected. Exports slowed to 25.3% from 28.9%. Imports accelerated to 53.5% from 45.7%. The J-curve effect through which the trade deficit worsen after sharp depreciation of a currency continues. Separately, weakening global demand is also evident. South Korea and Taiwan have recently reported declines in exports. Today, Singapore reported a 5.6% decline in its exports, the most in three years.

Australia’s grew 47.1k full-time jobs in October, more than four-times September’s figures. Overall job growth was more than twice the median forecast in Bloomberg’s survey. The participation rate was unchanged at 65.5% after the September series was revised lower from 65.6%. The unemployment rate ticked down to 3.4%, matching July’s cyclical low. The increase in hours works bodes well for GDP. Still, the swaps market does not have a 25 bp hike fully discounted for the December 7 meeting (now about 65%). Nor has the robust report prevented the Australian dollar from being among the weakest of the G10 currencies today

The dollar continues to trade in a narrow range against the Japanese yen, and today is the first day since the end of August that the dollar has not been above JPY140. The consolidative tone persists, and the greenback remains in the lower end of Tuesday’s broad range (~JPY137.70-JPY140.60). The Australian dollar’s rally stalled in front of $0.6800 for the past two sessions and now has backed off to below $0.6700. A band of support is found $0.6640-60. The US dollar is extending its recovery against the Chinese yuan after finding support near CNY7.0250 in the past two sessions. It is moving above CNY7.14 now. Ahead of the weekend, the greenback could see CNY7.1760 and possibly CNY7.20-21. After a couple of days of setting the reference rate for the dollar close to market expectation, in the face of more buying interest, the PBOC fixed the greenback at CNY7.0655 vs. expectations for CNY7.0803. Separately, the PBOC did two notable things. First, it warned that inflation was likely to rise as the economy recovered. Second, in the face of a slump in government bonds, it queried banks on liquidity.

Europe

The long-awaited UK budget statement will be made today.  Part of the latest delay is to the allow the Office for Budget Responsibility to use lower interest rates than the ones that resulted from investors panic strike in response to Truss/Kwarteng proposals. Truss had won the rank-and-file vote over Sunak at least partly because of her pro-growth program in comparison with Sunak’s tax hikes as Chancellor. After the chaos polls suggest that Tory voters would have changed their minds. So what? Polls suggest that if people knew then what they know now, the Brexit referendum would have gone the other way. The UK is still out of the EU and Chancellor Hunt will deliver an austere budget. There are many moving parts and nuances.

Perhaps, among the most important aspect for the market is the net new borrowing. Ironically, it may turn out that it is not significantly different than Kwarteng projected. Debt is rising and the cost to service the debt is rising. For most market participants outside the UK, the precise details, like the bracket creep, or lowering the threshold for the highest tax bracket, or the reduction of the surtax on banks, may be less important than the appreciation that on top of the interest rate hikes, and the balance sheet unwind, which includes outright Gilt sales, fiscal policy is tightening. Broadly speaking, reports suggest a 60/40 mix of spending cuts and tax increases. And this comes despite the BOE anticipating a prolonged economic downturn that has already begun. Also, at the risk of being cynical, political considerations and an eye to the next general election (by January 2025) may also shape how the pain is distributed and for how long.

The 30-year Gilt yield, where much of the turmoil was focused has made a round trip. Consider in mid-August the yield was around 2.50%. By the time Truss took office on September 6, the yield has risen slightly above 3.40% amid the rise in global yields. During her brief stint, the 30-year yield peaked on September 28 around 5.15%. The yield backed off as Truss began backtracking and the BOE launched an emergency Gilt buying operation, focusing on the long-end and inflation-linked bonds, which pension funds were large owners. A miscommunication of misunderstanding saw the 30-year Gilt yield jump back to nearly 5.10% on October 12. Subsequently the 30-year yield has fallen and yesterday, briefly slipped through 3.30% to its lowest rate since, yes, September 6. It is not just a decline of the yield in absolute terms, but also relative to German and the US. The UK 30-year premium over Germany rose to what appears to be a record high in late September of almost 290 bp, twice what it was on August 31. Yesterday, it was below 140 bp. The US typically pays a premium over the UK to borrow 30-years. That premium was around 80 bp at the start of the year. It was hovering around 50 bp in mid-August, and by late September swing to a record 116 bp discount. It did not switch to back until early in the second half of October. The US was paying a 56 bp premium yesterday.

For the past two sessions, the euro poked through the 200-day moving average on an intraday basis but closed below it (~$1.0420 today). It is holding above yesterday’s low near $1.0330, but it looks vulnerable in the North American session as the consolidative phase continues.  A break of this week’s lows (~$1.0270-80) may be the first signal of a correction rather than just consolidation, and would target $1.02 initially, and maybe $1.0140-50. Sterling is faring better, but also looks vulnerable. A break of yesterday’s low around $1.1830 would be the first sign, and the initial risk may be around a cent. Some late longs likely were washed out with the news from Poland earlier this week that saw sterling fall to $1.1740. The week’s low, set Monday, was closer to $1.1710.

America

The US reports October housing starts. After the 8.1% drop in September, the median forecast in Bloomberg’s survey calls for a 2% decline last month. It would be the first back-to-back decline since Jan-Feb 2021 and breaks the sawtooth pattern of alternative increases and declines that characterize this year’s data. Permits are holding up better then starts this year. Starts were off about 7.7% year-over-year in September. Permits were down half as much. After the retail sales, industrial production, and business inventory data out yesterday, the Atlanta Fed’s GDPNow tracker was revised to 4.4% this quarter from 4.0%. Weaker than expected starts could see it shaved.

The Philadelphia and Kansas City Fed surveys are out. The former rather than latter can move the markets if it significantly different than expectations. Recall that earlier this week, the Empire State survey was considerably stronger than expected and moved above zero for the first time in four months. Weekly jobless claims are not the focus they were earlier this year. The four-week moving average is almost 219k, which is around the middle of the range seen in H2. Continuing claims have risen for the past four weeks but at 1.493 mln they are still associated with a tight labor market. They bottomed at 1.306 mln in late May.

Canada’s October CPI was largely in line with expectations; unchanged at 6.9% year-over-year. The underlying core rates remained firm. The swaps market was unmoved by the data and have about a 33% chance that the Bank of Canada hikes again by half-a-point rather than slow another notch to 25 bp. It meets on December 7. The target rate is now at 3.75% and the market looks for a peak in Q2 23 between 4.25% and 4.50%. We continue to note the strong correlation between the changes in the Canadian dollar and the S&P 500. The 60-day rolling correlation reached beyond 0.78 yesterday, the highest since late 2011. The relationship has been fairly stable, and the 120-day rolling correlation is around 0.72, the most 10 years.

The US dollar has carved a shelf around CAD1.3225-35 for the past four sessions. Short-term momentum traders may be covering short positions, which has lifted the greenback to a new high for the week slightly above CAD1.3360. The immediate risk extends to around CAD1.34. The US dollar is in its trough against the Mexican peso. The downside momentum that saw it trade near MXN19.25 earlier this week has faded, but the carry gives the long peso positions some cushioning. The dollar has held so far today below yesterday’s high (~MXN19.4030). If this is paid, the greenback can move toward MXN19.47-MXN19.50.