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Yuan Rises Despite China’s Move and the Fed’s Course is Set Regardless of Today’s CPI

Overview:  After US equity indices posted their first loss of the week,  Asia Pacific and European equities fell.  While the MSCI Asia Pacific Index fell for the first time since Monday, Europe's Stoxx 600 is posting its third consecutive decline.  US futures are trading slightly firmer.  The US 10-year Treasury yield is up about 1.5 bp to 1.51%, which is about eight basis points higher than it settled last week when the sharp drop in equities saw the yield fall to almost 1.33%, the lowest in three months.  European yields are mostly 1-2 basis points higher today and 5-7 on the week,   Italy and Greek benchmark yields are 12-14 bp higher this week.  The greenback is trading with a firmer bias against most major currencies. However, the Norwegian krone and Australian dollar are the most resilient, while the New Zealand dollar and Japanese yen are the weakest.  The funding currencies have lost ground against the greenback this week, while the dollar bloc and Scandis gained.  Sterling is trading lower.  On Wednesday, it set lows for the year and remains in its trough, straddling $1.32.  Emerging market currencies are finishing the week on a soft footing.  Only the Russian ruble and Chinese yuan are posting gains among the large EM currencies.  The JP Morgan Emerging Market Currency Index is virtually flat on the week after falling a little bit more than 5% in the four-week decline.  Gold is trading at new lows for the week near $1770.  It was turned back from the 200-day moving average (~$1792) in the middle of the week.   It is set for the fourth consecutive weekly decline. January WTI is steady today after falling nearly 2% yesterday.  Still, it is snapping a six-week slide, ~20% slide, and around $71.30, it is up about 7.6% this week.  US and European (Dutch) natural gas prices are firmer, but the divergence is evident in the weekly performance.  The US price is off about 6% this week after falling 24% last week.  The Dutch benchmark is up about 14.5% this week.  In its six-week surge, the price has risen by around 55%.  Iron ore fell for the third consecutive session, to pare this week's gain to 6.3%.  In the four-week rally, it is up about 23%.  Copper prices are firm today and are up about 1.7% as a three-week (~4%) drop threatens to end.  

Asia Pacific

If Chinese officials often act like nannies, they have warned their ward not to wager on the yuan's continued strength.  They drew the market's attention to the divergence of monetary policy and confirmed it was a cut in reserve requirements earlier this week.  It has previously signaled its interest in providing more support for the economy.  It set the dollar's reference rate yesterday sufficiently stronger than expected to raise the proverbial eyebrow. It drove home its point yesterday by raising reserve requirements for foreign currency deposits 2 percentage points to 9%.  This spurred a short-covering squeeze that lifted the dollar by a little more than 0.5%, its biggest advance in six months.  The US Treasury's report was critical of the PBOC for the lack of transparency.  Most recently, it has been very transparent with its views and patience.  

The PBOC underscored its message today.  It set the dollar's reference rate at CNY6.3702.  The gap with market expectations (Bloomberg median) was the widest recorded.  It projected the fixing at CNY6.3523.  The dollar opened in China on session highs near CNY6.3835 and has not looked back.  It slipped to almost CNY6.3620 before steadying.  Officials may be frustrated but perhaps hoping that a hawkish Fed message next week helps.  Meanwhile, note that foreign investors have been significant buyers of Chinese shares in recent days. Despite the defaults in the property sector, there have been reports of new interest in dollar-denominated issues. 

Japan's November producer prices rose 0.6%, a bit more than expected, to lift the year-over-year rate to 9.0% from a revised 8.3% (initially 8.0%).  This is the fastest pace in 40 years.  However, if it weren't for fresh food and energy prices, the CPI would still be negative.  Indeed, the Q3 GDP deflator was -1.1% and has not been positive this year.  Early Monday, the BOJ's Tankan survey will be reported.  Only slight improvement is expected for large companies. The diffusion readings for the small businesses are expected to remain negative.  Capex plans for large companies are expected to be trimmed.  The BOJ meets next week and may extend its emergency facilities without changing monetary policy.  

The dollar is trading quietly in about a 25-pip range on either side of JPY113.50.  The greenback has not been above JPY114.00 for the second consecutive week, while last week's low near JPY112.55 has held.  In fact, today is the fourth session that the dollar has held above JPY113.25.  A jump in US yields after the CPI may lift the greenback, but resistance in the JPY114.00-JPY114.25 is reinforced with a $1.15 bln option expiring at the upper end of that resistance range today.  The Australian dollar's recovery from the year's low set at the end of last week, slightly below $0.6995, ran out of steam in front of $0.7190.  It is consolidating in a narrow range today, around $0.7150.  The highlight next week is the November jobs data, which is expected to be particularly strong after three months of losses. 


The UK's October GDP disappointed.  Rather than grow by 0.4%, as economists expected, economic activity nudged ahead by 0.1%.  Industrial production unexpectedly fell (0.6% vs. median forecast in Bloomberg's survey for a 0.1% expansion).  It is the second consecutive decline in industrial output.  Construction output slumped 1.8%, well undershoot the median forecast for a 0.2% gain.  Services output rose by the expected 0.4%, and the trade deficit was smaller than expected.  The net takeaway is to reinforce the shift in expectations away from a rate hike next week.  The UK reports November CPI and employment figures ahead of the BOE meeting on December 16.  While CPI is expected to have accelerated, the labor market reading may be regarded as dated news given the new work from home protocols announced this week.  Some estimates suggest maybe a drag of as much as 1% off growth.  

Meanwhile, the UK is ignoring today's EU deadline for fishing licenses. Apparently, the issue is about 100 licenses to primarily French fishing boats that cannot provide evidence of fishing in for a handful of days in the 2012-2016 period.  It comes as the British and French clash over the Channel crossings, and as of yesterday, the UK was still threatening to invoke Article 16 in the Northern Ireland Agreement. France, which holds national elections in the Spring, takes over the rotating EU presidency for six months starting in January.  Tensions will likely rise and could be exacerbated by not only the French domestic political situation, but the latest polls give UK Labour its largest lead over the Tories in several years.   

The short-squeeze in the middle of the week lifted the euro to $1.1355, where it faltered.  It is trading lower ahead of the US CPI.  The session low near $1.1265 has been recorded in the European morning.  There is a 930 mln option at $1.1250 that expires today.  The week's low was set on Tuesday a little through $1.1230.  The euro may find it difficult to sustain upticks ahead of next week's FOMC and ECB meetings, where the policy divergence will be on display.  Since sterling recorded the year's low on Wednesday a little above $1.3160, it has not been above $1.3245.  Today, it has held below $1.3235.  There are options for almost GBP865 mln that expire today at $1.32 and about GBOP410 mln at $1.3250.  On Monday, the $1.32 level holds expiring options for GBP560 mln and around GBP460 mln at $1.3150.  


Since the October jump in CPI to 6.2%, the shift in the Fed's rhetoric means that the disappointing headline non-farm payroll number and today's CPI don't really mean that much.  The Fed needs to put itself back in the game.  By not finishing its bond-buying until the middle of 2022, it essentially took itself out of the game for H1 22.  If it was once the optimal strategy, it is no longer. While retail gasoline prices have eased by around 2% from seven-year highs, it is probably too recent, as President Biden suggested, to be picked up by the November CPI report. Last November 0.2% increase will drop out of the 12-month comparison and be replaced with a 0.7% increase (median forecast in Bloomberg's survey).  Since early this year, economists (median) have mostly under-estimated the monthly CPI increase.   Even with the modest drop in gasoline prices, the year-over-year pace may accelerate this month, too, as the last December's 0.2% rise is replaced with a higher number.  The smallest month-over-month increase this year has been 0.3%.   The base effect will be more pronounced in the core rate.  In November 2020, it rose by 0.2%, but it was flat the next two months before increasing by 0.1% in February.  Thus, the risk on the core rate is clearly on the upside for the next few months.   

Every five years, the Bank of Canada's mandate is reviewed.  The review is due any day, likely next week.  There had been speculation that the 2% inflation target could be modified, and there was some talk that it was sympathetic to the Fed's average rate approach. That said, the period that the average was to cover has not been specified, and the average approach seems to have been jettisoned by the jump in prices, which both Powell and Yellen still expected to ease in H2 22.  In any event, reports suggest that the 2% medium-term target will remain. Still, the Trudeau government will likely include some language that requires more consideration be given to the labor market.  Still, it may not be the full dual mandate as the Federal Reserve's remit.  Note that Canada's labor market has returned to pre-Covid levels by several metrics.  

The US dollar is recovering for the third session against the Canadian dollar.  Near CAD1.2730, it is has recouped about half of what it lost since settling near CAD1.2845 last week.  The next retracement (61.8%) is near CAD1.2760.  We continue to be struck by the fact that the swaps market has 125 bp in hikes discounted for the Bank of Canada over the next 12 months.  It is difficult to imagine a more hawkish trajectory.  Indeed, the risk that the market is wrong seems asymmetrically biased toward a less hawkish stance.  Despite what many perceive as a non-commital Bank of Canada statement this week, rate expectations are unchanged. This is also reflected in the December 2022 BA futures, where the yield has fallen by a single basis point this week.  Mexico reported stronger than expected November CPI figures yesterday (7.37% vs. 6.24% in October).  Today's October industrial production report should show a recovery from the 1.5% decline in output in September.  The central bank meets next week, and most expect a 25 bp increase. The swaps market has 87 bp of tightening discounted over the next three months, suggesting the risk of a 50 bp move somewhere along the way.  The dollar has found a base around MXN20.90 since the middle of the week after settling last week near MXN21.2740.   Brazil's central bank delivered the promised 150 bp hike this week and committed to another when it meets again in February.  This year, it has been the most aggressive central bank even though the economy contracted in Q2 and Q3.  Today's IPCA inflation report will underscore why.  Brazil's CPI is expected to have accelerated to near 11% from 10.67% in October.  Its Selic rate of 9.25% is still negative in real terms.  Year-to-date, the Brazilian real is off 6.8% coming into today, while the Mexican peso is off a little more than 5%.  

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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