Sharp Fall in US Yields ahead of Large Supply

by
Marc Chandler
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Overview: The market continues to monitor developments in Israel and the Middle East. The economic calendar is light today and the market is showing a strong appetite for risk. Except for China and South Korea, large bourses in the Asia Pacific rallied. Japan's indices jumped more than 2% and Australia by 1% to lead the region. Europe's Stoxx 600 is up 1.5% near midday, which, if sustained would be the largest in nearly a month. US index futures are firmer. After yesterday's partial US holiday, US Treasury yields have fallen sharply. The 10-year yield is off 13 bp (to about 4.67%) in the European morning and the two-year is off almost nine basis points to straddle the 5% level. Note that the heavy supply of bills and coupons begins today. Europe's 10-year benchmark yields are mostly 1-2 bp higher. The 10-year JGB yield eased a few basis points to about 0.77%.

The dollar is mixed. The euro and sterling are trading firmer and above their 20-day moving averages, building on a move that began last week and survived the stronger optics of the US jobs report.  The dollar rebounded from slipping below its 20-day moving average against the yen to return to the JPY149 area. That said, the moves seem to be stalling ahead of the US open. Emerging market currencies are mostly firmer. Gold gapped higher yesterday and is trading quietly in about a $5 range on either side of $1860. November WTI also gapped higher yesterday and it too is consolidating. It has been confined to about a $0.70 range on either side of $86.00. Last week's low was near $81.50.

Asia Pacific

Japan's current account surplus narrowed to JPY2.28 trillion in August from JPY2.77 trillion in July. Arguably, under-appreciated, Japan's current account surplus is not driven by the trade balance. June and July stand out as exceptions, when Japan did run a trade surplus on the balance of payments basis, but it reverted to deficit in August. In fact, before June, the last time Japan ran a monthly trade surplus was in October 2021. The trade deficit on a balance of payment basis through August was JPY5.95 trillion compared with a JPY9.3 trillion in the first eight months of 2022. In the January-August 2019 period before Covid, Japan reported a JPY64 bln deficit. This speaks to the continued though easing terms of trade shock Japan has experienced.

The dollar traded heavily against the yen yesterday, within the pre-weekend range (~JPY148.35-JPY149.55). No help from the Treasury market, which was closed on Monday. Still, the futures showed softer yields. The 20-day moving average is about JPY148.20 and the dollar briefly dipped below it but snapped back and returned to the JPY149 area. The dollar has not closed below this moving average for more than two months. At the same time, the greenback remains within the range set last week, when it rose briefly above JPY150 and reversed lower spurring talk of intervention. The range day (Oct 3) was roughly JPY147.45 to JPY150.15. The Australian dollar traded lower yesterday, but as the session progressed, it gradually recovered and pushed above the pre-weekend high near $0.6400 in late North American turnover. It settled above the 20-day moving average (~$0.6405). It rose to a high so far today slightly below $0.6435. Re-establishing a foothold above $0.6420 would improve the technical tone and re-target $0.6500, which it penetrated on an intraday basis but has not closed above in nearly two months. The greenback traded below CNY7.27, its lowest level since mid-September. Country Garden woes seem to be coming to a head amid reports of a pending default and creditor group being formed for restructuring. The dollar bounced back to approach CNY7.2970. The PBOC set the dollar's reference rate at CNY7.1781. The average projection in Bloomberg's survey was CNY7.2776. The spread between the two narrowed while the reference rate continues to slip.

Europe

Italy is the last of the large eurozone members to report August industrial production. It unexpectedly rose by 0.2% instead of fall by 0.3% as the median forecast in Bloomberg’s survey had it. Still, the July drop was revised to -0.9% from -0.7%. The Italian economy expanded by 0.6% in Q1 (quarter-over-quarter) before contracting by 0.4% in Q2. The median forecast in Bloomberg's monthly survey has the economy expanding by 0.1% in Q3 (and Q4). Meanwhile, the Italy's interest rate premium over Germany continues to widen. The 10-year premium began the year slightly over 210 bp. As the Meloni government was not an extreme as many expected the spread spent most of H1 between 170-190 bp. It fell to almost 155 bp in mid-June, but since early last month, it has traded back and is near the year's high set in January a little over 200 bp. It has widened for the past six consecutive weeks. Italy's two-year premium began the year near 50 bp and recorded the low for the year in mid-January near 27 bp. It spent most of Q2 and Q3 around 60-70 bp. It reached nearly 92 bp yesterday, the largest premium since last October and has narrowed by a few basis points today. The Spain's 10-year premium has also widened recently. The low for the year was reached in mid-June near 91 bp. The high since last October was set yesterday, almost 115 bp. It has narrowed slightly today. Most of the time, the widening of the core-periphery spreads has been euro negative, but the rolling 60-day correlations are now positive.

The euro had the dubious distinction of being the only G10 currency (along with the Danish krone that shadows it) to have lost ground to the US dollar. It tested the $1.0520 area in Europe and then again in early North American turnover yesterday and recovered back toward session highs by late in North America (~$1.0570). Follow-through buying today has lifted through $1.06 and above the 20-day moving average for the first time since the end of August. The next target is near $1.0640, then $1.0700. Sterling also traded quietly inside last Friday's range, but recorded session highs late in the day and settled well, and above $1.2230. Like the euro, sterling looks like it is carving out a bottom. It has moved above the 20-day moving average (~$1.2255) for the first time since late August. Nearby resistance is seen in the $1.2300-10 area. 

America

The wholesale trade and inventories data and the results of the Fed's survey of consumer inflation expectations are typically not market movers. The main data point this week is the September CPI, where the headline rate is expected to slow for the first time in three months. This week also sees almost a dozen Fed officials speak, though the views are largely known. The takeaway is that the futures market as about a 20% chance of a hike when the next FOMC meeting concludes on November 1. The market is discounting almost a 37% chance of a hike before year-end. The FOMC minutes from last month's meeting will be released tomorrow. Remember that the new economic projections showed 12 of the 19 Fed officials still thought another hike this year would be appropriate. The others expected to stand pat. The median "dot" for 2024 Fed funds was raised to 5.1% from 4.6%. This implies two cuts rather than four was previously signaled in the June iteration. Note that the January 2025 Fed funds futures imply a 4.57% yield. The current effective rate is 5.33%. This suggests the market is discounting three cuts next year.

The US dollar extended its pullback against the Canadian dollar. Recall it had surged to a six-month high last Thursday near CAD1.3785. It reversed lower and continued to fall after the jobs data and settled around CAD1.3660. Yesterday, it marginally pushed to almost CAD1.3580. The greenback's decline extended marginally to CAD1.3570 today before new bids were found, lifting it back to nearly CAD1.3620. The recovery could extend toward CAD1.3640-50. The said, a break now of the CAD1.3550 area could signal a return toward CAD1.3400. Mexico's September inflation was largely in line with expectations as headline and core rates continued to slow. However, the peso completely recovered from the early slide that lifted the greenback almost to MXN18.42. The US dollar settled around MXN18.21. Colombian peso was the strongest in the region, gaining about 0.5%. A combination of slowing inflation that is fanning speculation that Colombia could join others in the region (but not Mexico) in cutting rates. Also, the jump in oil was seen as benefitting Colombia the most. Meanwhile, the dollar was sold to MXN18.1475 today but has returned to MXN18.20-21 area. Nearby resistance is seen in the MXN18.30 area.