- The bellicose rhetoric from the US and North Korean officials is the main driver today
- US data today is minor and unlikely to have any market impact
- The RBNZ decision will come out at 5 PM ET today
- China and Czech July inflation were reported; Brazil and Mexico report later today
The dollar is mostly firmer against the majors as markets trade nervously. Swissie and yen are outperforming, while Aussie and Stockie are underperforming. EM currencies are mostly softer. HKD and CNY are outperforming, while KRW and MXN are underperforming. MSCI Asia Pacific was down 0.4%, with the Nikkei falling 1.3%. MSCI EM is down 0.9%, with the Shanghai Composite falling 0.2%. Euro Stoxx 600 is down 0.9% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 2 bp at 2.24%. Commodity prices are mixed, with oil up 0.4%, copper down 0.2%, and gold up 0.5%.
The bellicose rhetoric from the US and North Korean officials is the main driver today. We would qualify that assessment by noting that first, the market moves are rather modest, suggesting a low-level anxiety among investors. Second, that the pre-existing trends have mostly been extended.
US intelligence has concluded that North Korea has recently developed the capability to produce a nuclear warhead that would fit on to the intercontinental ballistic missile that it has been developing. This, coupled with claims that North Korea was moving to make active defensive weapon systems, spurred an escalation of rhetoric between the US and North Korea. President Trump threatened North Korea with a ” fire and fury” as the “world has never seen.” North Korea reportedly responded by revealing that it was considering a preemptive strike against US forces in Guam.
The US has threatened to use force to deter North Korea, but it prefers to use multinational efforts and sanctions. Despite the rhetoric of unilateralism, the Trump Administration is attempting to find an alternative to a US-North Korea confrontation. China has taken modest steps, but it has no desire for unrest on its borders, and it fears that a united peninsula would be dominated by South Korean interests, which means the US.
There have been many op-ed pieces comparing the current situation with the Cuban Missile Crisis. This tends to be cited by those who sense the Rubicon is imminent and want decisive action now. On the other hand, the experience with Iran may be more apropos. It is a marathon, not a sprint. There was the creation of an incentive structure that was ultimately persuasive for Iran.
There is also a good reason why time is on America’s side. Its missile defense system continues to become more sophisticated. Remember, the US spends roughly as much on defense as the rest of the world combined. South Korea has begun installing a US missile defense system and this has antagonized China, which sees it as a forward projection of US power to its border.
Turning to Asia first, the Korea’s equity market fell 1.1%. The Kospi has fallen for the past two weeks (~2.2%). Through July it was up eight months in a row. However, as we had noted previously, foreign investors had begun taking some profits since July. In the first six months of the year, foreigners bought nearly $9 bln worth of Korean equities, and here in Q3 they have sold almost $1 bln. The Korean won fell 0.9% today. The US dollar has edged 0.6% higher against the won over the past two weeks. The dollar fell 2.2% against the won in July.
The MSCI Asia Pacific Index was off 0.4% today. It has risen once in the past five sessions. The Nikkei suffered a slightly larger decline than the Kospi (-1.3%). The rising yen (the dollar sold through JPY110) may have also weighed on Japanese equities. The Nikkei has fallen for the past three weeks, and has posted a decline in five of the past six weeks.
The price of gold has risen 0.6% today on top of yesterday’s 0.25% rise. It had fallen 0.9% last week, which ended a three-week advance. The price of gold is up $10 an ounce this week and $27 an ounce since the end of Q2.
European shares are lower as well today, with the Dow Jones Stoxx 600 off 0.65% in late morning turnover in Europe. The benchmark rallied 1.1% last week, though it had lost 3.1% in the back-to-back decline in June and July. Financials and materials are the hardest hit today, but all sectors are lower.
Bond yields are lower. European 10-year benchmark yields are mostly 3-4 bp lower, while the US 10-year yield is off 2 bp to dip below 2.24%. Among two-year tenors, the demand for Germany is clear, with the yield off nearly three basis points to 70 bp. Spanish and Italian two-year yields are 1-2 bp higher.
There have been two economic reports to note. First was China’s July inflation readings. July consumer prices eased to 1.4% year-over-year from 1.5%. Food prices fell 1.1%, while non-food prices rose 2.0%. On the month, CPI rose 0.1%. Producer prices remained at 5.5% for the third month.
Second, Italy reported a considerably stronger than expected June industrial production report. This will likely lift expectations for Q2 GDP, which will be reported in a week’s time (0.4-0.5%?). Flattered by transportation and energy, Italian industrial output jumped 1.1% in June. The market had been looking for around a 0.2% gain. It follows a 0.7% rise in May.
Industrial production rose an average of 0.5% a month in Q2 after falling 0.3% a month in Q1. Q3 comparisons may be difficult as last year Italy posted some strong increases. Still, the favorable news follows on the heels of better than expected employment and retail sales data.
Late yesterday, API reported a sharper than expected drop in US oil inventory. The nearly 7.9 mln barrel draw down contrasts with expectations for around a 2.2 mln barrel decline. The EIA (DOE) estimate today will be looked upon for confirmation. For the sixth session running, the September light sweet crude oil futures contract looks to trade comfortably between $48 and $50 a barrel.
Besides the EIA oil data, other US data today is minor and unlikely to have any market impact. Weekly mortgage applications, Q2 nonfarm productivity and unit labor costs, and June wholesale traded and inventories will all be reported. There are no Fed speakers. Canada reports housing starts and building permits.
The RBNZ decision will come out at 5 PM ET today, just as North American markets are wrapping up. No change is expected, but rhetoric from the Antipodean central banks recently has been on the dovish side. The Kiwi has fallen four straight days, seven of the past eight, and ten of the past thirteen days. The July low near .7200 is the next target, but the key level is .7100. Break below would suggest a test of the May low near .6820.
South African President Zuma survived the no confidence vote, as expected. However, the 198-177 vote (with 9 abstentions) was very, very close. With over two dozen ANC lawmakers voting against Zuma, the vote suggests a bruising battle ahead for the ANC leadership this December. Bottom line: we think the rand will continue to underperform.
Czech July CPI rose 2.5% y/y vs. 2.3% expected. This is near the cycle high and remains above the 2% target. We believe this justifies further rate hikes after the CNB started the tightening cycle last week. Next policy meeting is September 27, and another hike then seems likely.
Brazil July IPCA inflation is expected to rise 2.65% y/y vs. 3.0% in June. If so, this would be the lowest since February 1999 and falls below the 3-6% target range. Next COPOM meeting is September 6, and dovish signals suggest another 100 bp cut to 8.25% is likely then.
Mexico July CPI is expected to rise 6.37% y/y vs. 6.31% in June. Banco de Mexico then meets Thursday and is expected to keep rates steady at 7.0%. Price pressures are showing signs of topping out, and so we believe the tightening cycle is over for now. Mexico reports June IP Friday, which is expected to rise 0.2% y/y vs. 1.0% in May.