by Marc Chandler
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Overview: It is difficult to see the impact of the US midterm election in the immediate aftermath. The dollar is stronger against all the major currencies, but this seems to be mostly position adjusting ahead of tomorrow’s CPI report after a pullback in recent days. While Japanese, Chinese and Hong Kong shares fell, strong foreign buying lifted Taiwan’s shares by nearly 2.2% and South Korea’s Kospi rose more than 1%. The Stoxx 600 in Europe is snapping a three-day advance and its 0.85% decline is giving back yesterday’s gains in full. US equity futures are trading with a heavier bias. US and UK 10-year yields are a couple basis points higher, while most European benchmark yields are off 1-3 bp. Among the G10 currencies, sterling and the New Zealand dollar are bearing the brunt of the greenback’s recovery, while the Japanese yen and Swiss franc are the most resilient. Among emerging market currencies, the South Korean won continues atop the leaders’ board. Central European currencies are among the weakest. Firmer Hungarian inflation (21.1% year-over-year) is dragging the forint lower, and there is some uncertainty ahead of Poland’s central bank meeting outcome that is weighing on the zloty. Gold jumped 2.2% yesterday to move above $1700 for the first time in a month and is holding above there today as it pulls back a bit. December WTI fell 3% yesterday, its biggest loss since mid-October and follow-through selling pushed it to around $87.25. It settled above $91 last week. A few weeks delay in reopening the Freeport export platform sent US natgas prices down 11.6% yesterday and there has been a little additional selling today. Europe’s benchmark rose 4.7% yesterday and is slightly higher today. Regulators extended support to the Chinese property market, and this may have held iron ore and extended its rebound for the seventh consecutive session. On the other hand, December copper is giving back half of yesterday’s 2.2% gain. December wheat is trading softer ahead of the USDA’s World Agricultural Supply and Demand estimates.
Asia Pacific
Japan reported a larger than expected current account surplus in September but a larger than expected trade deficit. The current account rose to JPY909 bln from a revised JPY694.2 bln in August (initially reported as JPY58.9 bln). The trade balance, on a balance-of-payments basis, was JPY1.759 trillion. The median forecast in Bloomberg's survey was for a JPY1.684 trillion shortfall. Japan's current account report includes some details about Japanese foreign investment. We note that after buying US Treasuries in August for the first time in 10 months, Japanese investors returned to the sell side (`JPY2.4 trillion or ~$16.5 bln). While Japanese investors sold most other sovereign bonds in September, they bought a small amount of Swedish bonds.
The dollar value of Japan's reserves fell by $43 bln last month. This is about what one would expect given the intervention (~JPY6.3 trillion). Other aspects of valuation adjustments look to have largely netted out. Most other reserve currencies appreciated against the dollar while bond prices tended to have retreated. Since the end of last year, the dollar value of Japan's reserves has fallen by about $200.5 bln. Most of the decline reflects the sharp decline in bond prices this year and the strength of the dollar against other reserve currencies.
China's October producer prices fell 1.3% year-over-year, the first negative print in nearly two years. Part of the drop in PPI can be explained by the base effect and the surge in prices last year after shutdowns in the US, Europe, and elsewhere ended. In addition, commodity prices have eased this year. The year-over-year decline in construction commodities intensified last month and energy prices (oil and coal) softened. China's consumer inflation slowed to 2.1% in October from 2.8%. Food inflation, the main driver of Chinese CPI slowed from 8.8% in September to 7.0%, though pork prices rose. Core CPI was unchanged at 0.6%. It has been at or below 1% for seven consecutive months. The easing of service prices (0.4% from 0.5%) is thought to reflect weaker demand related to the zero-Covid policy.
Many observers are focused on China's zero-Covid policy that they may be missing new efforts to bolster the economy. Just like the typically LDP policy thrust is for easy monetary and easy fiscal policy, new lending is the go-to-answer for China. Large banks are under pressure to boost lending starting now in Q4 to manufacturing and infrastructure projects. At the same time, local governments are being allocated quotas for 2023 infrastructure bonds. They will launch in January and ostensibly will be used for key prospects in transportation, new/green energy, and infrastructure. Consistent with this could be another cut in reserve requirements. There are two other reasons why the reserve ratio may cut in addition to supporting the economy. First, some are identifying the tightening of the ratio of reserves to deposits. Cutting reserves would help address that. Second, this month, there are around CNY1 trillion of maturing loans from the PBOC to the commercial banks. A 50 bp cut in reserve requirements frees up that amount. The PBOC has also been a bit stingy lately in its reverse repo operations. The funds could be rolling into the Medium-Term Lending Facility, where the rate and volume is expected to be announced in the middle of next week.
The JPY145 level is a key support for the dollar. The greenback has not traded below there since October 7. It has been approached several times and has held, though the reaction bounce has become more muted. A convincing break could quickly see JPY143.50-JPY144.00. Initial resistance is seen in the JPY146.00-20 area. The Australian dollar is hovering around yesterday's settlement a little above $0.6500 after reaching its best level yesterday since late September (~$0.6550). Initial support is seen around $0.6480 and near $0.6445. The greenback continues to trade well within the broad range against the Chinese yuan seen last Friday amid speculation that the zero-Covid policy was going to be relaxed. It is within yesterday's CNY7.2210-CNY7.2625 range. The US dollar also remains well below the CNY7.3275 peak recorded last week. The PBOC set the dollar's reference rate at CNY7.2189 compared with the projection (median in Bloomberg's survey) of CNY7.2275.
Europe
While the market is focused on the Fed and where its terminal rate may be, yields in Europe have risen quickly. The yield on the two-year German bund has risen from about 1.95% on November 1 to 2.35% yesterday, though it has pulled back today. The yield is rose for the past six sessions. As prices gapped lower yesterday, the yield gapped higher, and it is the highest since 2008. The gap has not been filled today. The US 2-year premium over Germany posted a two-month peak when the Fed met last week near 2.65%. It has fallen every session through yesterday when it dipped below 2.40%. It had not traded below 2.40% since late September, the 2.35% area may be more important. It is the 200-day moving average and the US premium has not been below the average since June 2021.
We looked for the rate differential to peak before the dollar peaked against the euro. Its two-year premium peaked three months ago near 2.77%. The euro bottomed, so far, in late September around $0.9535. We lean to that being an important low and note that the euro's downtrend line, drawn off he February, March, June, August, and September highs was violated last month but it was not sustained. The euro moved back above it on Friday after the jobs data and amid talk of China changing its Covid policy. The trendline comes today near $0.9850.
The ECB's monthly survey found consumer expectations for one-year inflation edged up to 5.1% in September from 5.0% in August. The median three-year view was steady at 3%. Pessimism over the economic outlook increased as a deeper contraction is now expected over the next 12 months (-2.4% from -1.7%). Separately, a study by the Irish central bank and Indeed, found that wages were 5.2% higher than a year ago in October but appear to have steadied.
Yesterday, the euro took out the October high by 1/100 of a cent as it extended its rally to about 3.5 cents over the past three days. The euro held again, slightly below $1.01. Today it is consolidating in about a fifth of a cent on either side of $1.0065. It approached support, which we peg near the $1.0035 high seen Monday, in the European morning. We had expected the dollar to trade stronger ahead of tomorrow's US CPI figures. Sterling rose to almost $1.16 yesterday. It had risen 4.5 cents over the past three sessions but today has slipped through yesterday's low near $1.1430 in European dealings but found a bid near $1.1420. A break of $1.1400 could see a test on $1.1375. A break of that would be disappointing, though the week's low in another cent lower. Lastly, the central bank of Poland meets, and the market is mixed about the outlook. It paused last month over three dissents and year-over-year CPI rose to a new cyclical high of 17.9% in October. A slight dovish majority led by central bank Governor Glapinski may prevail. In any case, Poland is seen to be at or near its terminal rate.
America
No fewer than nine Fed officials talk between today and Thursday. Williams, Barkin, and Kashkari speak today, but Williams has already spoken in Switzerland, and Kashkari speaks after the markets close. That leaves Barkin. The president of the Richmond Fed, Barkin does not have a vote on the FOMC this year and is a centrist. Barkin is in favor of slowing the pace down while recognizing the Fed’s work is not done. Last week, he said that is it conceivable that the terminal rate is above 5%, but that is not a plan, Barkin admitted. The takeaway for him from last week's employment report is that the labor market remains tight. Barkin also explained that inflation has not eased much because business have not met much resistance from customers or competitors. Some businesses, he said, are still announcing price increases.
Mexico reports its October CPI figures today ahead of Banxico's rate decision tomorrow. The monthly report is expected to show a slower year-over-year rate (8.45% vs. 8.70% in August and September). The core rate is a bit stickier and made a new cyclical higher in September (8.28%) and may have extend it toward 8.45% last month. Almost regardless of the print, Mexico is widely expected to hike its target rates by 75 bp, matching the Fed's move. The new rate will be 10%. Mexico is one of the few countries that have a target rate above the current inflation rate. The swaps market sees the terminal rate in Mexico at around 10.80%. There is some risk, we subjectively put it at around 1-in-3 that there is some discussion of some greater degrees of freedom, even if limited, from Fed policy going forward. The peso is near its strongest level since March 2020.
We have suggested that the US dollar has formed a large head and shoulder pattern against the Canadian dollar broke the neckline at CAD1.35 last week. It projects toward CAD1.30. Yesterday, the greenback briefly traded below CAD1.34 for the first time since September 21. Ideally, in today's consolidation, it will hold below CAD1.3500. The US dollar's downside momentum against the Mexican peso stalled in front of MXN19.43 over the past two sessions. It is bid today above MXN19.57. Initial resistance maybe encountered in the MXN19.60 area. The dollar jumped to almost BRL5.25 yesterday after approaching BRL5.02 on Monday, its lowest level since last August. However, it reversed to settle a little below BRL5.15. The market appears a bit nervous about the composition of the new government and its fiscal plans.
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