Sterling Sparkles in Dollar Setback
Overview: Investors have not let the surge of the virus or uncertainty over the UK-EU talks or US fiscal stimulus to stand in their way. Sterling is leading the major currencies higher, returning to the $1.30 area, while global equities are trading higher. In the Asia Pacific region, Chinese shares, and Thailand, where large-scale protests continue, bucked the move higher, led by more than 1% gain in Japan and Taiwan. Europe's Dow Jones Stoxx 600 is pushing higher (~0.5%) for the second consecutive session while the S&P 500 is trading near the pre-weekend high. Bond yields are mostly higher, with the US benchmark up two basis points to 0.76%. European peripheral yields are firmer than the core. Chinese bonds are an exception, and yields slipped a couple of basis points to about 3.18%. The dollar is falling against nearly all the world's currencies. In the emerging market space, the Thai baht is an exception, but the JP Morgan Emerging Market Currency Index is up for a second consecutive session. Gold is near the pre-weekend high as it tries again to re-establish a base above $1900. December WTI is little changed, straddling $41 a barrel.
China's economy expanded by 2.7% in Q3, a little below the Bloomberg survey median forecast of 3.3%, and Q2 growth was revised to 11.7% from 11.5%. It does not change the general view that China may be the only country in the G20 to expand this year. The September data was encouraging. The previous report showed retail sales rose only 0.5%, and Beijing was criticized by some observers for emphasizing supply-side issues over demand. In September, retail sales jumped more than twice the pace economists expected, 3.3% year-over-year. Industrial output also beat expectations, rising 6.9% year-over-year, more than one percentage point higher than expected. Fixed investment ironically was a touch below forecasts, rising 0.8% after a 0.3% decline in August.
Japan reported September's trade surplus of JPY675 bln (~$6.4 bln), which was around three-quarters of what was expected. Exports recovered but not as much as expected and are still off 4.9% year-over-year. They had been expected to improve more after the 14.8% decline in August. The compression of imports was less than anticipated. There were off 17.2% year-over-year in September after a 20.8% contraction in August. The Bloomberg survey showed a median forecast for a 2deepening slide to 21.4%.
A year ago, the fear was China was going to offset the US tariffs by depreciating the yuan. In the Phase 1 trade deal that was struck, China pledged not to do so and to maintain a stable exchange rate. Isn't this what it has delivered? The yuan has appreciated by almost 4% against the dollar this year, making it among the strongest currencies in the world. Precisely how the PBOC is able to achieve this is a bit of a mystery, owing in part to the lack of transparency of Chinese reporting. To be sure, the fact that the banks are state-owned also adds to the opaqueness of what is a commercial transaction and what is the state's activity. Some of the same people who cut their teeth on confronting Japan in the 1980s are leading the charge against China.
Chinese officials are well aware that no matter how much the yen appreciated, it did not satisfy US critics. Many economists attribute Japan's deflationary era, at least in part, to the constant pressure for the yen to appreciate it. In 2019, for the first time since 1994, the US cited China as a currency manipulator. It reversed itself within a few months. There is no doubt that China manages its currency. It sets a reference rate daily around which the dollar cannot move more than 2%, and the extremes are that band are rarely if ever tested. The real question revolves around motivation. Is it doing to boost exports or corporate profits, or is it managing the exchange rate indirectly to promote financial stability and economic stability? Shouldn't the yuan's appreciation be acknowledged as a wholly welcome development rather than condemned because Beijing is not moving fast enough?
Prime Minister Ardern led Labour to a strong victory in national elections that had been postponed due to an outbreak of the coronavirus. It appears Labour secured nearly half of the popular vote and 64 of the 120 seats in parliament. Although Labour can form a single-party government for the first time since proportional voting was adopted in 1996, Labour may continue to include others, such as the Greens. The Reserve Bank of New Zealand meets next on November 11. It has indicated it is prepared to go beyond the NZ$100 bln (~$66 bln) bond-buying program and suggested three measures were under consideration. A negative official cash rate (now 25 bp), low interest-rate loan facility for banks (shades of the ECB's LTRO), and possibly buying foreign bonds (which could look a lot like intervention).
The dollar is in less than a 20 pip range below JPY105.50. It has not been above JPY105.60 for five sessions. Nor has it been below JPY105.00. The Australian dollar is firm near $0.7100. Still, it remains in the lower end of the last week's range set by comments from the central bank, seemingly preparing the market for additional easing moves as early as November 2. Australia's 10-year yield remains below its US counterpart. A move above $0.7130 would help the technical tone. The New Zealand dollar is firm around $0.6635. Last week's high was near $0.6680, and that is the near-term target. The PBOC's dollar reference rate of CNY6.7010, in line with expectations. The dollar fell to a new low for the move of around CNY6.6870. Last year's dollar low was set near CNY6.67.
The UK has been struck by a resurging virus, the lack of progress with EU trade talks, and the pre-weekend downgrade by Moody's. The government's efforts to contain the Covid-outbreak is being assailed for not going far enough, and the reluctance some areas to follow Johnson's edicts. The House of Lords takes up the controversial Internal Market Bill that undermines the very Withdrawal Bill that Prime Minister Johnson shepherded through Parliament and ran a successful campaign. The virus's economic consequences are helping underpin expectations that the BOE will move to provide more support at the November 5 MPC meeting. While it is too early to expect negative rates, a rate cut and more bond-buying are anticipated. Moody's downgrade (to Aa3, the equivalent of AA-) matches Fitch's assessment, which is one-step below S&P. Three broad reasons were cited.
1. Weakening economic strength since the last downgrade, three years ago, and deteriorating long-term structural dynamics
2. Erosion of fiscal strength. The UK's debt surpassed 100% of GDP this year, representing more than a 20% increase this year. The deficit of more than 13.5% of GDP this year is expected to fall toward 7.5% next year, which would be at the upper end of the G7.
3. The most subjective and controversial factor behind Moody's decision was what it says has been a weakening of UK institutions and governance in recent years. It claimed that the quality of the legislature and executive have diminished.
Turkey apparently tested the S-400 air defense system procured from Russia, much to NATO and the US's chagrin. The US has already suspended Turkey from the F-35 fighter jet program. The US had refused to sell it the Patriot defense system. Of course, the Russian-made system cannot be integrated with NATO's air and missile defenses. The US has threatened additional sanctions on Turkey if it activated the $2.5 bln Russian-made equipment. However, the Turkish lira, which has fallen for eight consecutive weeks against the dollar, is firmer today. This one-week repo operation later this week is expected to see a jump to 11.75% from 10.25% as CBRT continues to raise funding costs.
The euro is near a three-day high (~$1.1760) in the European morning. An option for a little more than 810 mln euros is struck at $1.1775 expires later today. A lower higher was set each day last week, and last Monday's high was a touch above $1.1825. Note that a 1.4 bln euro option at $1.1745 expires tomorrow. Support was found in the second half of last week in the $1.1690-$1.1695 area. Sterling forged a base near $1.2865 last week and today is poking back above $1.30 after failing to do so before the weekend. Its resilience continues to be impressive. It would be even more impressive if it punched above $1.3040 and last week's high near $1.3085. The euro is heavy on the cross, having been turned back from GBP0.9100 looks poised to test GBP0.9000.
The US economic data were mixed last week. CPI was in line with expectations, while PPI was a bit higher. The October manufacturing surveys from NY and Philadelphia pointed moved into opposite directions. Weekly jobless claims unexpectedly rose, and the number of people exhausting the state benefits and signing up for the federal emergency program. The claims remain skewed by backlogs and the continued problems in California, the largest state. September retail sales jumped 1.9%, more than twice what most economists expected, and an acceleration from 0.6% in August. Retail sales cover around 40% of personal consumption. On the other hand, industrial output surprisingly contracted by 0.6%. The median forecast in the Bloomberg survey called for a 0.5% gain. The 5.6% decline in utility output, reflecting the decline in air conditioning use, did the headline few favors, but the more troubling 0.3% decline in manufacturing. The government's first estimate for Q3 GDP will be reported on October 29. The median forecast in the Bloomberg survey is 32.3% (annualized). The Atlanta Fed's tracker puts it at 35.2%. The St. Louis Fed model sees 19.36%, while the NY Fed's GDP now is at a more modest 13.8%.
In an otherwise light calendar today, six Fed officials speak. These include Chair Powell at an IMF-sponsored discussion of cross-border payments and Vice-Chair Clarida on the economic outlook. The Beige Book, compiled for the November 5 FOMC meeting, will be released on Wednesday. The data highlights of the week are the housing starts and sales and the preliminary October PMI. Canada's economic diary features August retail sales and September CPI. Mexico also reports August retail sales at the end of the week.
OPEC and its allies are meeting this week. Their challenge is weak demand as the virus sweeps across large parts of Europe, the US, and developing countries. Demand is about six million barrels a day, less than pre-pandemic levels. US output earlier this month was about 2.5 mln barrels a day below its peak earlier this year. The US oil rig count has edged higher in the past couple of months, but at 205, it remains it trough compared with more than 200 a year ago. OPEC+ relaxed production curbs by two million barrels a day and have scheduled another boost (1.9 mln barrels a day) in January 2021. Oil prices have recovered but from their April lows but have been moving broadly sideways for three-four months.
The US dollar rose to almost CAD1.3260 on October 15, but the upside momentum has faded. The greenback drifted lower ahead of the weekend and is heavier today. The initial target is the low from October 15 near CAD1.3145 and then last week's low around CAD1.3100. Meanwhile, the greenback is at its lowest level against the Mexican peso in nearly a month. It approached MXN21.05 in the European morning. The high real and nominal yield and the risk-appetites continue to underpin the peso. The peso is easily the best performing currency in the world this month, appreciating around 4.8% against the dollar. The next best among the emerging market currencies is the South Korean won, up 2.4%. The best among the majors is the 1.7% gain by the Swedish krona.