by Marc Chandler
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Overview: Japanese efforts to curb the weakness of the yen provided drama today. What many suspect was intervention before the weekend was wearing off and officials may have sold dollars again today in front of JPY150. Despite initial success, the dollar is back near JPY149.50 as the North American session is about to begin. The end of the Chinese Congress has seen the yuan weaken to new lows. While the large bourses in the Asia Pacific region rose, China and Hong Kong were notable exceptions and foreign investors sold what appears to be a record of mainland shares today. Europe’s Stoxx 600 is seeing early gains pared, while US futures are pointing to a lower opening. The US 10-year yield is a little softer, slightly below 4.20%, while EMU yields are as much as three basis points lower. With Sunak seen as the next PM and austerity returning, Gilts have rallied, and the 10-year yield is off 17 bp. While the US dollar recovers from its pre-weekend slide, sterling is the best performer by being little changed. The Antipodeans have been hit the hardest and are off 1.3%-1.6%. Led by central Europe and the South African rand, most emerging market currencies are also weaker today. Gold briefly pushed above its 20-day moving average (~$1667) for the first time in a couple of weeks and has been sold off to below $1645. The pre-weekend low was near $1617.50. December WTI is off 1.5% after it rose 0.5% last week. US natgas continues to come off. It is down 2% today, its seventh consecutive decline. It fell 23% last week, which was its ninth consecutive weekly decline. Europe’s natgas benchmark is off 14.8% today, falling below 100 euros for the first time since June. It fell 18.7% last week, its eighth consecutive weekly drop. Iron ore is paring the 1.1% gain seen before the weekend, while December copper has come back offered (~1%) after rallying about 4.5% in the last two sessions. December wheat is off 1.1% today and it is giving back the gains scored in the second half of last week.
Asia Pacific
Japan appeared to intervene in the foreign exchange market earlier today. It injected more volatility. It drove the dollar from JPY149.70 to JPY145.55 but it has resurfaced above JPY149.00. This follows dramatic price action before the weekend. Amid a sharp drop in US two-year yields that many attribute to a newswire article that did not seem to break any new ground but played up the coming debate at the Fed about the trajectory of policy, the dollar reversed lower broadly, but especially against the yen. The market knew it was on thin ice, to speak, as it took the dollar for the thirteenth consecutive session to new highs above JPY150. Officials see the same thing the market participants see when they look at a chart. There is very little in the way of a move to JPY160. One newswire reported intervention, but others suggested the market panicked, given positioning, for a large sell order into the European fix and strong yen buying in the futures market. Japanese officials refused to comment. The dollar did not take out the intervention low set last month (~JPY140.35). It took the market nearly three weeks to take out the pre-intervention high (~JPY145.90).
The dramatic conclusion of the China's Communist Party Congress, with Xi's predecessor being escorted out, encapsulates the key takeaways. Its Xi's Show. A faction within the Chinese Communist Party has taken control of the party, and therefore the state. There are no centers of power that can challenge him. The direction China is moving is more nationalistic, less interested in market reforms, and more strident in its desire to challenge the international order. This also means no abandonment of the zero-Covid policy. Last week, there was a lockdown in an area in Beilun that has large warehouses and container yards, underscoring the ongoing and unpredictable disruptions.
China reported the data postponed by the Congress. Growth in Q3 rose to 3.9% quarter-over-quarter and year-over-year. It helped by a recovery in industrial output (6.3% year-over-year, up from 4.2% in August). Retail sales disappointed, rising 2.5% year-over-year, slowing from the 5.4% pace seen in August. Final consumption accounted for 2.1% of the 3.9% growth. Investment accounted for about 0.8% and net exports added almost 1.1%. Property investment contracted by 8% year-over-year after falling 7.4% in August. Home prices eased by 0.28%. They have fallen every month starting last September. The trade surplus rose to $84.7 bln. Exports rose 5.7%, faster than expected but down from 7.1% year-over-year in August. Imports rose by 0.3%, the same pace seen previously.
Lastly Japan's flash composite PMI rose to 51.7 from 51.0. It is the second monthly increase. The manufacturing component eased slightly to 50.7 from 50.8, while the services element rose to 53.0 from 52.2. Australia's preliminary composite PMI eased to 49.6 from 50.9. It is the first sub-50 reading since January. Manufacturing softened to 52.8 from 53.5, while services slowed to 49.0 from 50.6.
The dollar traded between about JPY146.25 to JPY151.95 before the weekend and has traded between JPY145.55 and JPY149.70 today. The intervention provided cheap dollars to buy. There is some speculation that the BOJ may tweak its yield curve control when it meets later this week but recall that the IMF's regional head endorsed it on the sidelines of the recent annual meeting. One-month implied volatility reached almost 17% today, the highest since March 2020. Three-month implied vol matched the pre-weekend 14.8%, also the highest since 2020. The Australian dollar initially saw follow-through buying after the big outside day recorded ahead of the weekend. It peaked near $0.6410 and fell to $0.6285 by earlier European activity. The intraday momentum is overextended. Resistance is now seen near $0.6350. Note that Australia's new budget will be unveiled tomorrow. The dollar rose to new highs against the Chinese yuan. It reached almost CNY7.2635, or almost 0.5% from Friday's close. After setting the reference rate near CNY7.11 before and during the Congress, it was set at CNY7.1230 today. That put the upper band at CNY7.2655. Separately, but related foreign investors sold about CNY17.9 bln of mainland shares via the exchange links with Hong Kong, which appears to be a new record.
Europe
The US Treasury has queried dealers about a potential buyback program. The idea is that the Treasury would increase the size of its bond offerings and use those new funds to buy back off-the-run, i.e., less liquid issues. The German Finance Agency is dealing with a different but similar problem of liquidity. There is a relatively wide premium of Bunds to swaps. To address it, the amount of securities that the Bundesbank can lend in the repo market was boosted by 54 bln euros ahead of the weekend. This entails raising the amount by 3 bln euros for 18 different issues.
After capital's strike against Truss's fiscal plans, the question is will it strike Italy. The new Italian government is in place. Yet, all the way to the alter, there was bickering and politicking. One cannot help but wonder about its longevity. A key metric is the premium Italy pays over Germany. It peaked in late September slightly below 255 bp and finished last week 20 bp lower. It has not been less than 220 bp since mid-August. The Italian 2-year premium also peaked in late September a little more than 130 bp. It finished last weak below 100 bp and near the lower end of its two-month range. Reports suggest Draghi left behind a cushion of around 9 bln euros that will help the new government address early challenges that may arise. Prime Minister Meloni is expected give an important speech tomorrow.
The eurozone flash October composite PMI fell to 47.1 from 48.1, weaker than expected. It is the sixth consecutive decline and the lowest since May 2020. The manufacturing PMI fell to 46.6 from 48.4 and the services reading fell to 48.2 from 48.8. In Germany, the manufacturing PMI fell to 45.7 from 47.8 and service slipped to 44.9 from 45.0. The composite is at 44.1 (from 45.7). France is holding up slightly better. The composite is at 50.0 (down from 51.2). Manufacturing slowed to 47.4 from 47.7, not quite as bad as anticipated, while services PMI eased to 51.3 from 52.9.
In the UK, Sunak took a commanding lead and could be named party leader (and therefore Prime Minister) as early as tonight. If so, he will oversee a weak economy and fiscal shortfall of an estimated GBP40 bln. Moreover, he is not popular among the members (rank-and-file) and has not won a single election. The problem with calling for a general election is that the polls show the Tories will lose. Meanwhile, the flash composite PMI fell to 47.2 from 49.1. October is the third month below 50 and it is the lowest since January 2021. Manufacturing fell to 45.8 from 48.4 and services weakened to 47.5 from 50.0.
After Friday's big advance, the euro extended its gains to almost $0.9900. It was turned back and recorded a low a little below $0.9820 in the European morning. There are options for nearly 1.5 bln euro at $0.9800 that expire today. If that area offers support, the $0.9865 area offers provides the nearby cap. Sterling briefly traded to almost $1.1410, stalling ahead of last week's high near $1.1440. It has returned to the $1.13 area. A break could see $1.1250 again, but the intraday momentum indicators suggest it might not get there.
America
The Federal Reserve established a reverse repo facility for foreign central banks during Covid. This allows them (and international agencies like the IMF) to have a risk-free cash portfolio that pays interest instead of using T-bills and money market instruments. For the US, it can help minimize the market impact of its withdrawals. Foreign central banks have around $330 bln in this facility. Also, the Fed's custody holdings for foreign officials have fallen by about $77 bln this year through October 19. This may sound like a large number; it is 2.25% of the holdings at the end of last year. This is a much smaller drawdown than one would expect, given the valuation change this year. Therefore, it appears that there has been a modest addition to compensate for most of the valuation change (the Bloomberg US Treasury Index is off about 15% this year).
With the Fed in the quiet period ahead of the upcoming meeting, the focus today is on the preliminary PMI. The composite is expected to have remained below 50 for the fourth consecutive month. The highlight of the week is the Q3 GDP estimate on Thursday. The median estimate in Bloomberg's survey is for 2.3% annualized growth after a 0.6% contraction in Q2. The Atlanta Fed's GDPNow tracker is at 2.9%. Meanwhile, the US Treasury will raise $144 bln in coupons this week, including $24 bln of two-year floating rate note.
Expectations that the Fed will hike by 75 bp on November 2 was virtually untouched before the weekend. What did change was the view of the December meeting. The odds of another 75 bp was scaled back from about a three-quarters chance to a little better than 1-in-3. The news wire article underscored what had been said by officials recently include Brainard and Daly (Friday). Perhaps that is what the data will decide. At the same time, the Fed's staff revised down its assessment of the economy's non-inflationary output speed limit because of the poor productivity numbers and the low labor force participation. If that view is taken aboard, it means that the economy may have to slow further than previously estimated, narrowing path to the proverbial soft landing even further.
There are no Canadian economic reports ahead of Wednesday's Bank of Canada meeting. Expectations for another 75 bp move is strong (fully discounted in the swaps market). After this move, the market has the Bank of Canada slowing dramatically its pace. Mexico report reports CPI for the first half of October. While the two-week pace may have accelerated, the year-over-year rates are expected to be little changed at 8.6% and 8.3%, for the headline and core, respectively. Banxico will match the Fed's hike when it meets on November. This week is Brazil's turn. The central bank meets on Wednesday. The market thinks its tightening cycle is over with the Selic at 13.75%. It was at 9.25% at the end of last year and 2.0% at the end of 2020. The Brazilian real's 4.9% appreciation against the dollar this year makes it the world's best performer.
Initial follow-through greenback selling after the pre-weekend downside reversal, saw it approach CAD1.3600. But the risk off mood took hold and the US dollar has recovered to almost CAD1.3750. This area represents the (38.2%) retracement of the US dollar's pullback from the October 13 two-and-a-half-year high near CAD1.3980. The next retracement (50%) is slightly below CAD1.3800. The intraday momentum indicators are stretched. The US dollar was sold to a new low for the month against the Mexican peso ahead of the weekend around MXN19.8860. It is now near MXN20.00. Last week's high was about MXN20.1760. There may be scope now toward MXN20.05 or a little higher.
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