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Risk Appetites Survive China Keeping Zero Covid Policy

Risk Appetites Survive China Keeping Zero Covid Policy

Overview: Chinese officials denied plans to end the zero-Covid policy and after a brief wobble, risk assets have traded better. Asia Pacific equities rallied, led by Hong Kong and mainland stocks that trade in Hong Kong. Europe’s Stoxx 600 opened lower but recovered and is around 0.5% higher after the 1.8% gain before the weekend. US futures are firm. Benchmark 10-year yields are mostly 2-4 bp softer in Europe and the US. The dollar is mixed. The dollar-bloc, which led the advance before the weekend, is nursing small losses, while sterling and the Swedish krona are up 0.5-0.6%. Emerging market currencies are mostly firmer, led by a 1.3% rally in the South Korean won. The Chinese yuan is giving back around a third of its pre-weekend gains and is the weakest in the emerging market space with a little more than a 0.5% pullback. On the back of a weaker dollar and lower rates, gold rallied 3.2% at the end of last week, its biggest single day advance this year. It is consolidating at the upper end of the pre-weekend range that extended to $1682. Oil prices rallied to their best level since late August at the end of last week and remain firm today. The initial pullback saw December WTI approach the 200-day moving average (~$90.15) and recovered and made new session highs in late European morning turnover. Cold weather in the US Northwest has lifted natgas prices. After a 7.1% gain before the weekend, it has tacked on another 8.4% today. In contrast, Europe’s benchmark is off 2.8% and is lower for the third consecutive session. Iron ore edged up after a 5.2% gain ahead of the weekend. It is the fifth advance in a row. December copper’s pre-weekend 7.56% rally has been pared. It is off 1.5% today. December wheat is giving back its 0.85% gain from the end of last week.

Asia Pacific

Market participants want to believe Beijing is about to jettison the zero-Covid policy. They seem to think that given the harm it is doing to the economy means it cannot be sustained. Yet this is projecting our values onto Xi and his faction that dominates China's Communist Party, and that may not be fair. The risk-on rally ahead of the weekend was more based on hope than actual developments. Modest tweaks are already taking place but not a wholesale change. Some of those adjustments include the acceptance of the BioNTech vaccine for foreigners in China, possibly ending punishments for airlines that bring Covid-stricken passengers, and perhaps adding more international flights. Some reports suggest that inbound travelers' quarantine may be reduced to 7-8 days from 10. Perhaps because of the totalitarian nature of the PRC regime, observers may not appreciate the tension between the central government and regional governments (similar, but different from the tension in the US between the federal government and state governments). Beijing has been critical of the excessive implementation of its zero-Covid policy. Zhengzhou officials apologized over the weekend for the stringent approach. Hohhot, in Inner Mongolia, banned the use of locks, latches, and bolts in sealing hotspots. Still, the Haizhu district in Guangzhou, in Guangdong, has ordered people to avoid leaving their homes for three days as of November 5.

China's October trade surplus edged up ($85.15 bln vs. $84.74 bln), but the key takeaway is that imports and exports fell on a year-over-year basis for the first time since the outbreak of the pandemic. Exports, which the median forecast in Bloomberg's survey called for a 4.5% increase fell by 0.3%. In September, they had risen 5.7% from a year ago. Part of the decline seems to be a post-Covid change in consumption patterns and the shift from goods. Household appliance, furniture, and lighting equipment exports suffered. And shipments to the US, EU, Taiwan, and Hong Kong fell. There were two bright spots to note. First, auto shipments rose 60% year-over-year to 352k. Second, exports of ASEAN countries for by double digits for the sixth consecutive month. Imports fell by 0.7%. Economists in Bloomberg's survey looked for flat report after a 0.3% increase in the year through September. Oil imports reached a five-year high, but gas imports tumble. Iron ore imports fell. Separately, China reported October reserves rose more than expected. The $23.5 bln increase was only the third increase this year. The dollar value of reserves (~$3.052 trillion) are almost $200 bln less than at the end of last year.

The dollar is little changed in relatively quiet turnover against the Japanese yen. Session highs were recorded near JPY147.60 in late Asia/early European turnover, but sellers quickly emerged to send the greenback to session lows around JPY146.65. The pre-weekend low was closer to JPY146.55. Key support is seen around JPY145. It has not traded below there since October 7. After rallying about two cents before the weekend, the Australian dollar initially pulled back from $0.6470 to almost $0.6400, where it found good bids and returned to unchanged levels in the European morning. Intraday momentum indicators are stretched. Last week's high near $0.6490 may provide the near-term cap. The greenback fell 1.6% against the Chinese yuan before the weekend amid speculation that the zero-Covid policy would end. Denials over the weekend saw the US dollar recover from CNY7.1850 at the pre-weekend close to CNY7.2505 today. It is trading quietly now around CNY7.2280. The PBOC set the dollar's reference rates slightly stronger than expected for the first time in more than nine weeks. The dollar was fixed at CNY7.2292 compared with the median in Bloomberg's survey for CNY7.2287. 


Many euro bears emphasize not just the aggressiveness of US hikes but also the unwinding of its balance sheet, which stands in contrast with the ECB. Yet, unlike the Fed's balance sheet, the ECB's was grown with loans as well as bond purchases. The rules changed at last month's ECB meeting, and banks have a greater incentive to repay the loans sooner. German and French banks are seen as the most likely candidates for early repayment next month, with amounts of 300-400 bln euros thrown around. Italian banks were among the largest borrowers, and some borrowed funds look to have been reinvested in Italian government bonds. Hence, repayment may reduce the demand for BTPs at the same time that the ECB is not buying as much as they were under QE but reinvesting maturing proceeds with an eye on rate divergence.

Italy's new government has proposed a budget deficit of 4.5% of GDP, somewhat larger than the Draghi government projected (3.4%). However, it still shows progress toward the 3% target, which the EU suspended for next year. That suggests Prime Minister Meloni may have an extended honeymoon and that the real challenge will come next year when the 2024 budget is to show a 3% deficit (or less). More immediately, tensions may raise with the EU over Rome's refusal to allow 100s of migrants rescued at seat to disembark in Italy. Italy is the first port of call, and the technical rules are for the first EU country that the migrant is bears the responsibility, but this clearly puts the burden on border countries whose finances are not as strong.

After a softer start, which saw the euro ease to slightly through $0.9900 after settling at almost $0.9960 at the end of last week, the single currency briefly poked above $1.0000, for the first time in eight sessions. While a new session high is possible, we suspect North American operators may be reluctant to extend the gains much, especially given the stretched intraday momentum indicators and the Thursday's US CPI figures. That said, above $1.0010 there seems to be little on the charts ahead of the late October high, slightly shy of $1.01. A close below $0.9950 would lend credence to this less than constructive near-term outlook. Sterling finished last week on a firm note near $1.1380. It reached $1.1470 in the European morning after it briefly slipped through $1.13 in last Asian turnover. With today's advance, sterling has met the (61.8%) retracement of the pullback from the $1.1650 area high in late October. The intraday momentum studies are stretched, and if the high is not in place for the day, it may have come close.


The key takeaway from the US October jobs numbers was that the labor market is still too strong for the Federal Reserve. Since the September dot plot (Summary of Economic Projections) saw 125 bp rate hikes in Q4, a 50 bp hike in December was the base case. The market had thought the odds of another 75 bp hike were greater, but after the employment data and the FOMC meeting, the market has about a 1-in-4 chance of a three-quarters-point hike next month. Businesses reported a gain of 261k jobs, and revisions were worth another 29k jobs. This is the least number of jobs created in nearly two years but was more substantial than expected and well above the 2018-2019 average. However, the household survey saw a decline of 328k jobs, and the unemployment rate rose by 0.2% to 3.7%. To reconcile the two does not mean to ignore one. The Solomonic solution is to split the difference: the labor market is slowing slowly and has not yet reached a point that will take the Fed off its tightening course.

We have suggested that three developments will get the Fed to stop: First, a dramatic slowing of the labor market, which is not happening. Second, a precipitous decline in inflation. The October CPI figures on Thursday will show that price pressures remain elevated. The third is a challenge to financial stability. While there are liquidity concerns, it has not yet reached a point that will disrupt the Fed's balance sheet unwind.

If US jobs data were mixed, Canada's report was unambiguously strong. Full-time positions jumped by nearly 120k, well above expectations. Average hourly wages rose by 5.6%, accelerating from 5.2% in September. It is the fifth month above 5%. The index of hours worked jumped by 0.7%, the largest since June. This may prompt economists to revise higher Q4 GDP forecasts, which had been near flat. The employment data were strong enough to encourage the market to begin taking seriously the possibility of another 50 bp rate hike next month. Separately, with the 2% tax on buybacks announced last week starting in 2024, next year could see a flurry of activity. Estimates suggest that over the past 12 months, there have been around C$70 bln in share buybacks.

Ahead of the weekend, the Canadian dollar rallied amid the risk-on mood spurred by speculation of the end of China's Covid-zero policy and on the strength of the employment report. The US dollar settled below CAD1.35 for the first time since September 22. This is potentially the neckline of a larger head and shoulders pattern that projects toward CAD1.30. The US dollar bounced to CAD1.3555 in the initial reaction of China's denial of a change its Covid stance. Support was found near CAD1.3465 in the Europe. The lower Bollinger Band is slightly lower. There is little chart support ahead of CAD1.3400. Consolidation may be the most likely scenario in North America today. Meanwhile, the US dollar is approaching the year's low against the Mexican peso, set in late May near MXN19.4135. The greenback saw about MXN19.4590 before the weekend and is consolidating in the lower end of the pre-weekend range. The initial bounce carried the US dollar to almost MXN19.58. The highlight of the week is the October CPI figures on Wednesday and what is expected to be a 75 bp hike from Banxico on Thursday. Brazil reports retail sales (Wednesday) and IPCA inflation (Thursday). Inflation peak in April around 12.1% and is expected to have fallen for the fourth consecutive month to slightly below 6.4% last month. Key dollar support is seen near BRL5.00. 

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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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