After Strong Demand for US Three-Year Notes, Treasury will Sell $38 bln 10-year Notes

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Marc Chandler
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Overview: The first leg of the US refunding was well received, with the three-year note being scooped up by investors, driving the yield below it was trading in the when-issued market. Today, the Treasury sells $38 bln 10-year notes, whose auctions have been less than stellar recently. The US 10-year yield reached 4.20% last week and is now straddling 4%. Italian bonds are also firm as the Italian government clarifies the new tax on banks' windfall profits. Other European bond yield are mostly little changed, though UK Gilt yields are softer. Despite China's CPI slipping below zero (as expected), the 10-year Chinese government bond yield edged slightly higher. Equities are stabilizing, though Japanese and Chinese markets trading off. Most of the other large markets in the region rose, including Hong Kong and the mainland shares that trade there. Europe's Stoxx 600 is about 0.9% better, which is sustained would be the largest rise in nearly two weeks. US index futures are also firmer.

The dollar has come back softer, with the Scandis leading the move. The Swiss franc and sterling are the laggards and nursing minor losses. Among emerging market currencies, only the Turkish lira, South African rand, and Russian ruble are lower. The Chinese yuan is snapping a three-day fall. Gold is finding support ahead of yesterday's low near $1922. It has not been above $1950 in a week and retaking it would lift the tone. API estimated US crude oil inventories rose by 4 mln barrels last week, which if confirmed by the EIA today, would be the first increase in four weeks and follows last week's massive 17 mln barrel draw. Nevertheless, after a strong recovery from $80 a barrel yesterday, September WTI rose to a new high since last August near $83.80.

Asia Pacific

On the heels of yesterday's trade report, showing a deepening of the contraction in China's import and exports, the world's second-largest economy announced the first negative year-over-year CPI print in two years. It is the first time since November 2020 that Chinese producer and consumer prices are both falling outright. Consumer prices fell to -0.3% year-over-year last month from a flat reading in June. Producer prices turned negative last October, and the decline has accelerated every month in the first half to -5.4% in June. In July, producer prices were off 4.4% year-over-year. Three considerations suggest that deflation pressures are likely to begin easing. First, although details still seem somewhat vague, the government will take actions to support economic activity. The measures should bolster demand. Second, the base effect--favorable year-over-year comparisons--may also help put a floor under prices. The base effect for oil and metal prices appeared to be behind the marginal slowing of deflation in producer prices. Third, the core rate, which excludes food and energy accelerated to 0.8% year-over-year (from 0.4%) and is the highest since January. Prices for services, such as recreation and education rose. Recall that last week, PBOC officials projected that CPI may finish the year near 1%. 

The consensus among US opinion-makers is that the possible new set of talks with China are wholly a good thing. Yet, we have argued that talks that do not lead to a change of behavior will strengthen the hawks on both sides. And the US appears be doing two things since the establishment of talks were broached that seem to contradict the effort to de-escalate the relationship. For the first time the Biden administration is drawing on standing congressional authority to transfer weapons from the Pentagon directly to Taiwan. A $300 mln weapon's package was recently announced, a down payment of the $1 bln deal. Also, the Biden administration reportedly considering new curbs on Americans' ability to invest in China. Still, amid the bleakness there is reason to be a little hopeful. Yesterday's US trade figures showed, US imports from China are falling. They are off about a quarter in the first half of this year from H1 22. If this continues, and there is good reason to think it will, it will ease one source of tension. Of course, as China replaced Japan as the source of US trade angst, as the US imports from China fall, they rise from other countries, and Vietnam could be the next in America's trade crosshairs. Also, a change in Taiwan's domestic politics could also reduce the tension between the Washington and Beijing. Taiwan's presidential elections are six months away (January 13). Although the Kuomintang candidate, and mayor of New Taipei City, has proposed a military draft, he wants to maintain the status quo and is opposed to independence. The current vice president of Taiwan is the other main candidate. The Democratic Progressive Party is more strident and seeks independence. His statements on cross-strait relations have often been controversial.

The dollar is meeting offers near yesterday's high around JPY143.50, which stands in the way of last week's high near JPY144.00. Above it there is little to resist a challenge of the year's high set on June 30 by JPY145.00. There are about $755 mln in options struck there that expire Friday. Support is seen in the JPY142.80-JPY143.00 area. The Australian briefly and barely traded below $0.6500 yesterday for the first time in two-months. It trended higher for most of yesterday's North American session but stalled near $0.6545. It reached $0.6570 today, slightly below yesterday's high (~$0.6575). Technically, it needs to reestablish a foothold above $0.6600 to improve the tone. The greenback had held below the downtrend line against the Chinese yuan from the June 30 high (~CNY7.2690), the July 19 high (~CNY7.2270), and the August 3 high (~CNY7.1955) but gapped above it yesterday and remained above it today (~CNY7.1910) despite the pullback. The dollar is snapping a three-day advance against the yuan. After some questions of the PBOC's intent were raised with yesterday's less aggressive fixing, today the officials answered with a weaker dollar reference rate (CNY7.1588 vs. median projection of CNY7.2136

Europe

The ECB conducts a monthly survey of consumer inflation expectations. Yesterday's report showed a drop in 12-month expectations to 3.4% from 3.9% three months ago. The three-year outlook eased to 2.3% from 2.5%. The ECB's staff said last week that underlying inflation has probably peaked. The 10-year German breakeven is near 2.40% and averaged slightly more than 2.30% last month. The seven-year breakeven pushed briefly above 2.40% this week, for the first time in three months but appears to have been turned back. Germany does not appear to have short-term securities linked to inflation. Italy's one-year breakeven is near 2.47%, testing a two-month high. The three-year breakeven is near 2.15%. It also is being turned back from a two-month high.

Germany may still be in a recession. It contracted in Q4 22 and Q1 23 before stagnating in Q2 23. Early this week, it reported a 1.5% drop in June industrial output, three times more than the median forecast in Bloomberg's survey anticipated and that follows a 0.8% drop in June retail sales (the median forecast was for a 0.3% decline). The economy has entered Q3 with little forward momentum. However, in the global effort to secure chip fabrication capacity, German has scored twice. Intel is building a new plant in Magdeburg (costing the German government 10 bln euro in aid) and Taiwan Semiconductor Manufacturing Company has agreed to build a fabrication plant in Dresden. It will be in partnership with Infineon, NXP, and Bosch. Reports suggest that the German government will provide as much as 5 bln euros or about half of the projected cost. There looks to be some EU funds too.

The euro has traded in a 1.5-cent range (~$1.0900-$1.1050) for the better part of the past two weeks. Today, it is trading inside yesterday's roughly $1.0950-$1.1010 range. The technical tone is soft, but some of the momentum indicators lend credence to ideas that a base may be in the process of being forged. The euro's uptrend line drawn off the May, June and July lows comes in near $1.10 today. So far this month, sterling has been confined to a $1.26-$1.28 trading range. So far today, it is also trading within yesterday's range (~$1.2685-$1.2785). We suspect that until it can overcome the $1.2850 area, the bears may have an upper hand. Next week, the UK has several high-frequency data reports that may inject more volatility: labor market, CPI, and retail sales, and that is after this Friday's GDP data. 

America

The US and Canada's trade balances are moving in opposite directions. Helped by falling imports (lowest since 2021), the US trade balance narrowed to a three-month low of $65.5 bln in June. Imports fell by 1% and exports slipped by 0.1% in value terms. Part this reflects the shift in US consumption toward services rather than goods. Adjusted for prices, the real goods deficit narrowed to $86.2 bln from $88.93 bln in May. However, in Q2 the real goods deficit widened to $271.5 bln from $256.7 bln in Q1, explaining the modest drag on Q2 GDP. Canada's June goods trade deficit widened more than expected to C$3.73 bln, the largest shortfall since October 2020. It brings the deficit in Q2 to C$5.34 bln. It recorded a surplus of almost C$850 mln in Q1. In value terms, exports fell 2.2% and imports slipped by 0.5%. In volume terms, exports were off 1.1% while imports rose by 0.9%. Statscan warns that the recent port strike in British Columbia (handles around 9% of Canada's exports and ~5% of imports) and flooding in Nova Scotia (~0.8% of exports and 1.4% of imported goods) will disrupt trade with the July data (due September 6).

In part the bank stress seen in March was a challenge posed by the rise in long-term US yields. To be sure, there were other considerations, including the reluctance to compensate savers (depositors) and idiosyncratic (bank specific) issues. The long end of the US curve saw interest rates recently rise above the level seen in March. In announcing the downgrade of 10 small and medium-sized lenders, and warning of the possibility of additional action on some larger banks, Moody's warned about 1) high funding costs, 2) potential regulatory capital weakness, and 3) risks related to commercial real estate exposure. The KBW index of money center banks and leading regional banks fell 1.3%, around a third of the loss seen at the worst yesterday. Rather than be the largest loss in three months, it was the largest in two weeks. The index had rallied by about 28.5% from the early May lows to the July highs. That rally stopped short of retracing half of the losses from the early February high. The regional bank index settled almost 1.5% weaker. It was down around 4.5% at its worst and stopped a three-day rally in its tracks. It was also the biggest drop in three months. The regional bank index rally almost 37.2% from its early May lows, almost meeting the (61.8%) retracement objective of this year's losses. and stalled near the 200-day moving average. Both bank indices closed on their highs yesterday.

The US dollar may have exhausted itself on the push to CAD1.35, its best level in two months. On an intraday basis, it overshot the (38.2%) retracement of the US dollar's fall from the March 10 high near CAD1.3860 to the mid-July low slightly below CAD1.3100. It settled below the retracement (~CAD1.3487) and below the 200-day moving average (CAD1.3450) and below the upper Bollinger Band (~CAD1.3435). It is in a narrow range so far today (CAD1.3400-CAD1.3430). A break of the CAD1.3360-80 area would lend credence to the idea of a top being in place. Mexico reports July CPI today, and the data from the second half of the month will show that inflation is continuing to fall. With some conservative assumptions, the headline rate, which is likely to have fallen below 5% last month could fall by another 1.5 percentage points by the end of Q3. The core rate is also falling, albeit at a slower pace. The dollar lost about 1.5% against the peso in the previous two sessions before rising around a quarter-of-a-percent yesterday. The greenback has trended higher since the multiyear low was set on July 28 near MXN16.6360. The momentum indicators are stretched and are beginning to look toppish. A convincing break of MXN17.00 may signal a heavier dollar.