by Marc Chandler
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Overview: It is mostly a quiet start to the new month. Most of Europe is closed for the All -Saints holiday and the week's key events start tomorrow with the Reserve Bank of Australia meeting. News that the Liberal Democrats retained a majority in the lower chamber of the Diet helped lift Japanese indices by 2%. Most of the large regional markets gained, though China and Hong Kong markets fell. US index futures are trading with a higher bias after eking out minor gains ahead of the weekend. The 10-year US Treasury yield is up a couple of basis points to 1.57%. Australian and New Zealand yields pared the pre-weekend surge. Australia's 10-year yield is off 16 bp, and the two-year yield is down 6 bp. New Zealand rates eased five and four basis points, respectively, for the 10-year and 2-year yields. The dollar is a little firmer against most currencies. The yen and Australian dollar are off 0.3%-0.4%, whereas most other majors are off less than 0.1%. Emerging market currencies are also mostly lower. The Turkish lira is trading higher, and ahead of this month's central bank meeting, the Czech koruna is posting small gains. The Polish zloty gave back its initial gains. The markets are less sure that the Polish central bank will hike this week. Gold is consolidating in the middle of last Friday's range. Key support is seen near $1770. December WTI is hovering around $84, and copper is heavy but holding near last week's lows when it lost almost 3%.
Asia Pacific
The Liberal Democratic Party in Japan lost about 15 seats but held on to its majority in the lower chamber of parliament. Its coalition partner, Komeito gained three seats. Together the coalition has 293 of the 465 seats, according to reports. The issue now is the implication of the narrower majority. Some suggest the risk of a series of short-lived governments as Japan experienced previously. We suspect a cabinet reshuffle and, if anything, a larger fiscal stimulus. Separately, the October manufacturing PMI rose to 53.2 from the 53.0 initial estimate. This is the highest since March. September stood at 51.5.
China's official PMI disappointed. The manufacturing PMI eased to 49.2 from 49.6. Power shortages and rising commodity prices weighed on activity and limited the holiday spending. Output fell to 48.4 (from 49.5), the lowest outside of the initial Covid weakness. Seasonal factors did not help. The Caixin manufacturing PMI was slightly better than expected at 50.6, up from 50.0. The official service PMI eased to 52.4 from 53.2. The composite fell to 50.8 from 51.7. Today's report will encourage economists to revise down Q4 growth forecasts. The weaker PMI has rekindled speculation that the PBOC may cut reserve requirements.
The Reserve Bank of Australia meeting concludes first thing tomorrow in Canberra. The lack of much official guidance after not defending its yield curve control unsettled the debt markets last week. Although yields fell today, the wider spread between bid and offer shows that activity has not normalized. The swaps market is pricing in about 80 bp of tightening over the next 12 months. The issue is the extent that the RBA capitulates to the market. Until now, Governor Lowe has argued that the key is wages, and he does not see the conditions for a rate hike until 2024.
After rising about a third of a yen before the weekend, the dollar is up another third of a yen today, to around JPY114.45. The four-year high was set on October 20 near JPY114.70. Since breaking higher, the upper end of the new range is not clear. We suspect it is the JPY114.50-JPY115.00 area, at least initially. The Australian dollar has drifted lower. Thus far, last week's low near $0.7480 remains intact. An option struck there for A$433 mln expires today. It may require a break of the $0.7455 area to confirm a top is in place. The PBOC set the dollar's reference rate at CNY6.4192 compared to the median expectation (Bloomberg) for CNY6.4181. Recall that the greenback rose about 0.22% against the yuan before the weekend, the largest advance since early August. It gave nearly half back today and is unable to sustain the move above CNY6.40.
Europe
On the sidelines of the G20 meeting, the US and Europe reached a deal on the controversial tariffs on steel and aluminum that were imposed on national security grounds. It was important to get an agreement by December 1 when the EU would double its retaliatory tariffs. The gound of the compromise has been floated for some time. It is a combination of quota and tariff. EU steel and aluminum exports to the US below a specific limit would not face the extra tariff, and the shipments above it would have the 25% levy. The particular threshold would be announced later. The deal is only between the US and EU. Other countries, like the UK, will have to strike a separate agreement.
Although France and the UK say they want to de-escalate the fishing row, it is not clear that they will manage to do so. The UK claims that 98% of the fishing license applications have been granted. The French say it is only 90%, and nearly all the rejected applications are for French boats. If this is not rectified by tomorrow, France has threatened to tighten restrictions on goods crossing the Channel and prevent British boats from unloading the catches as they do in France. The UK says France has to move first.
Germany reported dismal September retail sales. Economists surveyed by Bloomberg had a median forecast for 0.4% after a 1.2% gain in August. Instead, retail sales tumbled 2.5% and brought the year-over-year pace back below zero. The German government and the Bundesbank recently revised this year's GDP projections down. Separately, the UK's manufacturing PMI edged up to 57.8 from the flash reading of 57.7. It is the first gain since May and stood at 57.1 in September.
The euro dropped a little more than 1% before the weekend, its largest decline since mid-June. The low was about $1.1535, just above the low for the year recorded on October 12, near $1.1525. It has steadied today but has not been above $1.1575. Previous support around $1.1585 is now likely to be resistance. Also, the five and 20-day moving averages are converging near $1.1600. On the downside, we have noted that the $1.1490 area corresponds to the (50%) retracement of the rally that began in March 2020 and peaked, ironically, on January 6, amid the chaos in Washington. Sterling shed a cent at the end of last week, but unlike the euro, it has continued to fall today. It has eased another quarter of a cent today, and the session's low may not be in place. At $1.3625, sterling would have retraced half of its rally from the late September low (~$1.3410). The next retracement (61.8%) is closer to $1.3575. The BOE meets on November 4, and many expected a rate hike. While we recognize the possibility, we suspect that the risk is that it completes its bond purchases and waits a little longer to hike rates. As an aside, note that European clocks were setback an hour this past weekend, while the US daylight savings time ends next weekend.
America
This week's focus is on the FOMC meeting, where the long-awaited tapering announcement is anticipated. The extent of the hawkish message, though, maybe revealed more in how it characterizes inflation. Since April, it has been saying prices have been elevated by transitory factors. Many expect it will be dropped in the statement after the meeting on November 3. Also, the pace of the tapering is important because only when it is over will the Fed hike rates. Chair Powell has said it would be complete around the middle of the year. The Fed funds futures suggest the market sees the risk of no gap between finishing the purchases in June and delivering the first hike then as well.
The US sees the final manufacturing PMI today. Recall that the preliminary reading showed the third consecutive decline (59.2 vs. 60.7). The manufacturing ISM will be reported as well. It has held up better than the PMI, but it is expected to have slipped to 60.5 in October from 61.1. Its price component is expected to make a new high (82.0 vs. 81.2). With Q3 GDP already out, September construction spending will likely be glossed over. Canada gets its manufacturing PMI. It was at 57.0 in September. While the economy appears to have emerged from the soft patch, supply chain disruptions continue to make for an uneven recovery. In any event, the focus is on the more hawkish signals from the Bank of Canada that unexpectedly ended its bond-buying and signaled the possibility of an earlier rate hike. Mexico reports September work remittances. This is an important source of capital inflows in Mexico. They averaged $4.1 bln a month this year through August. In a similar period last year, the average was $3.3 bln, and in the first eight months of 2019, they averaged $3 bln. Brazil gets its manufacturing PMI but also October trade figures. Brazil's trade surplus is one of the country's bright spots. It has averaged $6.27 bln a month after $4.55 bln for the same period last year and $3.01 bln in Jan-Sept 2019.
When the Bank of Canada surprised the market last week, the US dollar traded in a broad range of roughly CAD1.2300 to CAD1.2435. It has remained in that range since then. Rising equities, a wider Canadian premium, and elevated oil prices support the Loonie. Continued consolidation appears to be the most likely near-term scenario. Still, the risk seems to be the US dollar's upside given the broader context and the momentum indicators that have turned higher. Mexico's economy unexpectedly contracted in Q4, we learned before the weekend. The dramatic adjustment to the rate outlook in the Anglo-American economies, especially the US, weighs on emerging market currencies and the peso. The dollar rose 1.9% against the peso last week and is up another 0.5% today, its fourth consecutive advancing session. A move above the MXN20.72 level would target last month's high slightly above MXN20.90.
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