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Tensions Run High Ahead of ECB Meeting and US Q3 GDP as JPY150 Breached

Tensions Run High Ahead of ECB Meeting and US Q3 GDP as JPY150 Breached

Overview: The market is on edge. Anxiety is running higher. It is partly geopolitics, and it is partly market stresses. The dollar is holding above JPY150 but so far, no reports or signs of intervention. Bank shares are under pressure. An index of Japanese banks has fallen for five of the past six sessions and are off about 8% from the year's high set last month. An index of European bank shares has fallen in six of the past seven sessions and will likely close at a loss for the fourth consecutive week tomorrow. The index has fallen more than 8.5% since the July high. US bank indices are fallen for the past six sessions and are of 20-23% from August highs. More broadly today, equities are lower. Chinese markets are a notable exception, but many suspect the hand of China's sovereign wealth fund. Most large bourses in the region, including Tokyo, Taiwan, South Korea, and India are all off more than 1%. Europe's Stoxx 600 is 0.8% lower, offsetting the gains of the past two sessions in full. US index futures are trading lower after the S&P 500 and NASDAQ closed their lows yesterday, at levels not seen since early June.

The dollar is trading with a firmer bias, but the dollar-bloc currencies are recovering from earlier losses and are trading a bit higher against the greenback. The Japanese yen is trading at little changed levels but is holding above JPY150. Most emerging market currencies are also trading heavier, but a few freely accessible currencies, including the South African rand, Hungarian forint, and Mexican peso are a little stronger. The Turkish lira is softer ahead of its central bank decision, where a 500 bp hike is expected. The 10-year JGB yield rose to a new high near 0.87% today, but European and US bond yields is slightly softer. The 10-year US Treasury yield is near 4.95%. Gold has recovered from about $1954 on Tuesday to approach $1993.50 today. Last week's high was slightly above $1997. December WTI is straddling the $85-a-barrel level after recovering from almost $82 yesterday. 

Asia Pacific

There are two conflicting forces. On the one hand, the resilience of the US economy and the rise of US rates has favored the dollar. On the other hand, many look for change in Japanese monetary policy, which will allow for higher domestic rates and a stronger yen. Japan's Postal Insurance company with JPY63 trillion (~$435 bln) of total assets has indicated that it will reduce its foreign debt holdings. Hedging costs are too great and the prospect of a stronger yen in the coming months discourages investing in unhedged foreign bonds. It admitted to reducing its hedged and unhedged exposures since April. Yet, the weekly portfolio report by the Ministry of Finance shows a different picture:  Japanese investors have been net buyers of JPY8.7 trillion (~$61 bln) of foreign bonds since the start of the fiscal year on April 1. In the 29 weeks of data since then Japanese investors have been net buyers all but nine weeks. Indeed, since the 10-year yield cap was lifted late last December, Japanese investors have purchased almost JPY19 trillion (~$137 bln). For their part, foreigner investors have not been attracted to the higher Japanese rates either. In this fiscal year, they have been net sellers of about JPY2.5 trillion of Japanese bonds, but much better buyers of Japanese equities (~JPY7.1 trillion).

Encouraged by rising US yields and broader gains, the greenback poked above JPY150 in North American afternoon yesterday. Japanese officials cannot rightly point to excess volatility, the dollar was in about a quarter of a yen range yesterday above JPY149.80. The dollar spiked to almost JPY150.80 in Asia Pacific trading today. It might be related to the large options struck at JPY150 that expire today and tomorrow. There are $1.4 bln in options struck at JPY150 that expire today and $3.1 bln on Friday. The Australian dollar posted an outside down day yesterday. It first rallied above Tuesday's high in response to the smaller than expected slowing of inflation in Q3 and the proceeded to reverse lower and settled below Tuesday's low. It held slightly above $0.6300 but was sold to $0.6270 earlier today, a new low for the year. Comments by Reserve Bank Governor Bullock indicated that yesterday's CPI was in line with its expectations and refused to indicate that it boosted the need for higher rates. the Aussie has traded below $0.6300 eight times this month and settled below it once. It is trading near the session high a little above $0.6315 near midday in Europe. The greenback edged higher against the Chinese yuan. It is near CNY7.32. Since returning from the long holiday at the start of the month, the yuan has fallen for the past two weeks and looks poised to settle this week lower as well. The PBOC is fixing the dollar gradually lower as it advances in the spot market. Today's reference rate was set at CNY7.1784, down for the fourth consecutive session. The average projection in Bloomberg's survey was CNY7.3206. The top of the 2% band is about CNY7.3220. The offshore market typically respects the onshore band, but not in recent days. The dollar reached CNH7.3335 today.


The German economy, once regarded as the locomotive of the European economy, has not grown since Q3 22. It appears to have contracted again in Q3 after a flat Q2 performance. The euro zone is expected to have stagnated in Q3. The economy was flat in Q4 22 and Q1 23. It grew by 0.2% in Q2 23. Inflation has been halved this year to 4.3% in September from 9.2% at the end of last year. And another sharp fall is likely when the October CPI is reported next week after last October's 1.5% month rise drops out of the 12-month comparison. The base effect will be considerably less favorable from November through January. The ECB's balance sheet has fallen from a peak last year of about 8.84 trillion euros to 7.04 trillion or from around 69.5% of GDP at its peak to near 50%. It was a little more than 39% of the region's GDP at the end of 2019. Money supply is contracting, and credit conditions are tightening and demand for loans is weak.

There does not appear to be a compelling reason for the ECB to hike rates today. And, indeed, the swap market sees practically no chance of a move. The pricing in the swaps market suggests the market is fairly convinced that the ECB is done. The market has slightly more than a 90% chance of a cut by the end of the first half of next year and another reduction by the end of Q3 24. ECB President Lagarde, however, is unlikely to confirm market expectations. There are several hawkish members that need to be accommodated. She can achieve this may indicating flexibility and readiness to hike rates again if price pressures do not ease. Yet, as we discuss a bit lower, the market did not really find this argument compelling by the Bank of Canada and may be just as incredulous with the Lagarde.

The euro traded heavily since reversing lower from almost $1.07 on Tuesday after the disappointing PMI. and underscored the divergence with the US. The euro's losses extended to almost $1.0565 yesterday, near the 20-day moving average (~$1.0560) that is has closed above for five consecutive sessions. Follow-through selling pushed the single currency slightly below $1.0535 today. It has taken out the trendline off the month's low (~$1.0550), and $1.0540 where options for nearly a billion euros that expire today. Sterling is also trading poorly. It was sold below last week's low around $1.2090 and tested the $1.2070 area. The lower Bollinger Band is near $1.2050 and the low set earlier this month was closer to $1.2035. Initial resistance now may be around $1.2100-15.


The markets seem braced for a strong Q3 US GDP. The Atlanta Fed's GDP tracker, which tends to be fairly accurate this late in the cycle is for 5.4% growth at an annualized pace, while the median forecast in Bloomberg's survey is for 4.5% growth. Consumption has been particularly strong. The 4% annualized increased the median forecast in Bloomberg's survey projects follows a soft 0.8% increase in Q2 and would match the strongest since Q2 21. There are good reasons to suspect it will not be sustained. First, consumption has been outstripping income. Over the three months through August, consumption rose by a cumulative 1.7%, while income rose by 0.8%. Second, the resumption of servicing student loans, will likely weigh on consumption. Third, the draw down in savings, tighter consumer credit standards, amid rising delinquency rates also acts as a headwind. Inventories and trade also likely contributed to Q3 growth. The improvement in trade is not because of stronger exports. Exports have fallen for the five consecutive months through August but rather because imports have fallen faster. Exports are off about 1.2% over the period (~$36 bln), while imports have fallen by around 2.5% (~$100 bln). The contribution from trade cannot be assumed in Q4. Some of the inventory growth may be in the auto sector ahead of the strikes and may be run down in Q4. A little more than a quarter of the $2.02 trillion federal budget deficit for the fiscal year that ended last month was due to a decline in revenue--with individual income tax receipts much lower given the lack of capital gains in equities and fixed income. Still, government spending recent peak was in Q4 22 at 5.3% annualized rate. It slowed to 4.8% in Q1 23 and 3.3% in Q2. It likely eased further in Q3 (maybe a little less than 2%) and set to slow further in Q4.

The Bank of Canada left the overnight target rate at 5.0%, as widely expected. It acknowledged the weakening growth impulses but also recognized price pressures may be more resilient than it had thought. It revised down its growth projections and lifted its inflation forecasts. This year's GDP was cut to 1.2% from 1.8% and next year's was reduced to 0.9% from 1.2%. Growth in 2025 was tweaked up to 2.5% from 2.4%. Notably, the Bank of Canada anticipates 0.8% growth in Q3 and Q4. The market is less sanguine. In Bloomberg's survey, the median is for the 0.5% GDP in Q3 and 0.4% in Q4. This year's CPI forecast was raised to 3.9% and 3.0% next year from 3.7% and 2.5%, respectively. The median forecast in Bloomberg's survey was at 3.9% this year and 2.6% next year. In 2025, CPI is seen at 2.2%, up from 2.1% previous forecast and slightly higher than median market forecast in Bloomberg's survey is for 2.0%. The Bank of Canada said it was prepared to raise rates again, if necessary, but the market doubts it. The odds of December hike were virtually unchanged a little above 20%.

The Canadian dollar fell to new seven-month lows yesterday after the Bank of Canada left rates on provided more challenging economic forecasts. The US dollar traded up to CAD1.3810, where options for almost $545 mln expire today, and frayed the upper Bollinger Band. The greenback made a marginal new high today near CAD1.3820. Like the other dollar-bloc currencies, the Canadian dollar recovered to post minor gains in the European morning. There is another set of options (~$730 mln) that expire Friday at CAD1.3835, ahead of the year's high set in March near CAD1.3860. The risk-off environment weighed on the Mexican peso too. The US dollar rose to a new high for the week near MXN18.3950 yesterday and edged slightly higher today but held below MXN18.40. The high set before last weekend was around MXN18.4665 and MXN18.4860 earlier this month. Initial support is seen in the MXN18.25 area. 

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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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