by Marc Chandler
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Overview: A GBP130 bln initiative by the new UK government to protect households from the surge in power costs helped lift sterling from 2.5-year lows. The Reserve Bank of Australia delivered the expected 50 bp rate hike, but the prospect of smaller moves going forward saw the Australian dollar sold through yesterday’s lows. The MSCI Asia Pacific Index fell for the third consecutive session yesterday but is mixed today. Japanese markets themselves were mixed, and China, South Korea, and Taiwan advanced. Europe’s Stoxx 600 is steadying today after falling by 0.6% yesterday. US futures point to a firm open but are off their earlier highs. US rates are 6-7 bp higher while most European benchmark yields are a little softer. The 10-year Gilt is pushing above 2.95% and looks poised to push above 3% for the first time since early 2014. Sterling is the strongest of the major currencies, up about 0.6% against the US dollar. The Antipodeans and yen are the weakest of the majors. The yen is trading at new 24-year lows. Emerging market currencies are mixed today, with central European currencies doing best. Asian currencies are mostly lower, except the Indonesian rupiah. The Chinese yuan’s 0.35% loss is the weakest. Gold reached a six-day high near $1727 but has come off to trade below $1712. October WTI briefly poked above $90 but has been turned back and is trading near $87. It has found a base in recent weeks near $85. US natgas fell 5.1% before the long holiday weekend and is trading with a slightly heavier bias. Europe’s benchmark fell 16.4% before the weekend and ahead of Gazprom’s announced cut-off. It rallied 17% yesterday and is off nearly 11% today. Iron ore fell nearly 1% today after rallying almost 3.6% yesterday. It remained below the $100 threshold for the fourth session. December copper edged higher ahead of the weekend, snapping a five-day drop. It is up 1.3% today. December wheat was up 2.1% before the weekend and is off about 0.6% today.
Asia Pacific
The Reserve Bank of Australia delivered its fourth consecutive half-point hike, lift the cash target rate to 2.35%. Although it signaled that its monetary cycle is not complete, as the rate approaches neutral (~2.50%), the RBA may slow the pace. Governor Lowe’s speech on Thursday is the next key event for expectations. The next policy meeting is October 4. The market is pricing in about slightly more than a 75% chance that the next move is 25bp. Australia reports Q2 GDP figures first thing tomorrow, but wages and consumption may be the key for the RBA going forward. The Australian dollar initially extended the recovery that began yesterday, rising to almost $0.6835 before meeting a wall of sellers who drove it back to yesterday’s lows below $0.6775.
Japan’s labor cash earnings and household spending was a little softer than expected. Cash earnings rose 1.8% year-over-year after a 2.0% pace in June. Adjusted for inflation, real wages fell for the fourth consecutive month. Higher inflation and lower real wages weighed on spending. Household spending slowed to a 3.4% year-over-year rate, slightly lower than the 3.5% pace seen in June and well off the 4.6% median forecast in Bloomberg’s survey. This represents a 1.4% decline on month-over-month basis. While Japan is expected to revise up Q2 GDP later this week from 2.2% and it could surpass the pre-Covid size, it is likely driven by capex and government investment, Q3 GDP may soften.
The jump in US yields (6-7 bp) has driven the dollar to new highs against the yen. It reached JPY141.80 in the European morning. It is difficult to talk about meaningful resistance as the greenback has not seen these levels in nearly a quarter-of-a-century. Still, we note that the upper Bollinger Band is found near JPY142.25. Initial support now may be around JPY141.40-50. The Australian dollar is posting an outside down day by trading on both sides of yesterday’s range. A close below yesterday’s low (~$0.6775) is key to the pattern. We have suggested the larger chart pattern warns of a test on the July low (~$0.6680) and likely lower. The PBOC cut reserve requirements on foreign currency deposits yesterday and, again today, set the dollar’s reference rate lower than the median in Bloomberg’s survey (CNY6.9096 vs. CNY6.9253). If the goal is to reverse the yuan’s decline, it is not working. But if the chief objective is too slow in descent, it is arguably working. The dollar rose above CNY6.9525 today, a new two-year high. The yuan is off about 2.75% over the past month, which is about the middle of the pack among emerging Asian currencies and holding up better than the Japanese yen and sterling. The euro is off about 2.3%. The takeaway is that yuan’s weakness is concentrated against the US dollar, but on a trade-weighted basis (CFETS) is well above the lows seen in May.
Europe
The UK has its fourth prime minister in slightly more than six years. Truss is not new as she has served in numerous ministerial posts for the last decade. Still a new cabinet will be appointed, and new initiatives sought. In this iteration, Truss may push for tax cuts and greater government involvement in the energy market. Meanwhile, in a little more than a week’s time, the BOE will meet, and rather than moderate its hikes as recession looms, it may accelerate them. That was MPC member Mann’s call in a speech yesterday. She said that “fast and forceful action was superior to gradual moves.” When specifically asked about a 75 bp hike, she replied that “What we need to be doing is to make sure the medium-term inflation expectations don’t drift.” The swaps market has about an 82% chance of a 75 bp hike. A week ago, it was less than a 50% chance. The new government floated the idea of abandoning the 80% increase in household power prices that was supposed to start next month. It would cost the government around GBP130 bln to pay for the increase to the power companies for the next 18 months. It will also suspend the green energy tax. Power companies seem the like the initiative, which would also avoid the windfall tax.
Germany reported a 1.1% decline in July factory orders, and the small upward revision to the June series (from -0.4% to -0.3%) offered little consolation. German factory orders have been falling since February. Domestic orders were off 4.5%, the most since January 7.2% drop. Foreign orders rose 1.3%, not quite making up for June’s 1.4% decline. The weakness was concentrated in consumer goods orders. Overall, they were off nearly 17%, driven by a 20.7% drop in domestic orders and a 14.3% fall in foreign orders. Tomorrow, Germany reports July industrial production, and after today’s report, the risk appears on the downside of the median (Bloomberg forecast) of a 0.6% decline. The takeaway is that the world’s fourth-largest economy appears to be entering a recession.
There is speculation that Russia could “weaponize” its uranium by only selling it for roubles, as it has for oil. The imbalance between consumers and producers is stark and appears to favor Russia and its allies. Consider that 3/4 of the nuclear power is generated in the high-income countries while Russia, China, Iran, and Pakistan account for a little more than 60% of the uranium ore. Separately, there have been reports since for the better part of six months now that some Russian gas in coming back to the Europe through China. Now, reports suggest some Russian oil is coming back via products through India.
The euro’s recovery from the new 20-year low set yesterday (~$0.9880) seemed to run out of steam today near $0.9985. Initial support is seen now in the $0.9920-40 area. It seems that after making new lows the euro bounces but the bounces appear to be getting smaller and not lasting as long. Sterling’s recovery is only slightly better. It reached a new 2.5-year low about $1.1445 yesterday and rose to almost $1.1610 in late Asian turnover. It has been better offered in the European morning, falling to roughly $1.1550. Initial support is now seen by $1.1520.
America
After the uptick in the US unemployment rate, albeit a function of the increased participation rate (62.4 vs. 62.1) to 3.7% from 3.5%, the US two-year note nearly fully offset the increase over the preceding five sessions. The yield fell 11 bp to slip slightly below 3.39%. The implied yield of the October Fed funds futures eased 4.5 bp to a little below 3%. The Fed funds futures downgraded the chances of a 75 bp hike later this month, but it remains the odds-on favorite and stands near 66% now. It was closer to 68% after Fed chief Powell’s speech on August 26. Today’s data (final services and composite PMI, and ISM services) are not likely to change it much. Next week’s August CPI report (Sept 13) is the next key input. The headline is expected to soften, though still remain at or above 8%, while the core rate proves stickier and could tick up.
The Bank of Canada meets tomorrow. The last string of economic data disappointed, including Q2 GDP and the August manufacturing PMI (48.7 vs. 52.5). Before the meeting outcome, Canada reports the July merchandise balance. In June, it was stronger than expected, a little over C$5 bln. Canada’s merchandise surplus, flattered by rising prices, was nearly C$20 bln in H1 22. In H2 21, it was about $420 mln. In the first half of 2019, Canada recorded a C$12 bln deficit. However, the key for the Bank of Canada is the economy has closed the output gap, price pressures elevated, and the underlying rates may not have peaked. After the 100 bp surprise in July, the market is wary of another. Yet, until the end of last week, it looked as if the market settled on a 75 bp increase. We still think that is the most likely scenario, but the overnight swaps are showing the market is back to about an 80% chance of another 100 bp move.
The US traded between CAD1.3075 and CAD1.3210 in the final two sessions of last week. It remains within that range now. The exchange rate seems to be at the mercy of US stocks. They are trading firmer but off of their earlier highs. The prospect of a 100 bp move tomorrow by the Bank of Canada may deter aggressive selling today, but we are not convinced that such a move would forestall a sell-off after the rate decision. The greenback peaked last Thursday near MXN20.2945 and finished the week slightly below MXN19.9460. It held that low yesterday and so far, today. It may continue to offer support today, and we see the risk to the upside, extending toward MXN20.05-MXN20.10.
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