Consolidation in FX and Bonds as Equities Correct Lower

Consolidation in FX and Bonds as Equities Correct Lower

  • The US dollar continues to consolidate after last week’s gains amid greater confidence that the Federal Reserve will likely raise rates next month
  • China reported softer than expected inflation figures
  • Japan reported a smaller than expected current account surplus for September (JPY1.47 trln)
  • Many are talking about a 10 bp cut in the ECB’s deposit rate, which currently stands at minus 20 bp
  • Exports out of the Philippines collapsed in September; South Africa manufacturing production was stronger than expected

Price action:  The dollar is mixed against the majors, but trading in narrow ranges.  The dollar bloc is outperforming, while the Norwegian krone and the euro are underperforming.  The euro is trading softer near $1.0735, while sterling is trading just above $1.5100.  Dollar/yen is trading flat near 123.  EM currencies are mixed in narrow ranges too.  IDR, RUB, and TRY are outperforming, while the CEE currencies are underperforming.  The US equity markets gave back 1% yesterday, and global equities have been dragged down today.  The MSCI Asia Pacific Index was off about 0.7%.  The Dow Jones Stoxx 600 is off 0.6% near midday in London, led by materials, technology and financials.  The MSCI Emerging markets equity index is off about 1.2%, extending its losses for the fourth consecutive session.  China markets were mixed, with the Shanghai Composite down 0.2% and the Shenzen Composite up 0.8%.  S&P futures are pointing to a lower open.  Similarly, after a steep sell-off, major bond markets are recovering today, partly in the face of a push lower in stocks.  The 10-year UST yield is down 3 bp at 2.32%, while European bond markets are mostly firmer.  Commodity prices are mixed.

  • The US dollar continues to consolidate after last week’s gains amid greater confidence that the Federal Reserve will likely raise rates next month, and is little changed today.  Of note, today is the first this month that the dollar has not taken out the previous day’s high against the yen.  The pullback in US bond yields (~5 bp on the 10-year) and weaker equities appear to have given the dollar bulls cause for pause.
  • Japan reported a smaller than expected current account surplus for September (JPY1.47 trln vs. expectations for JPY2.27 trln).  Although trade and income from investors are the two dominant items, what caught our eye was the 47% year-over-year increase in tourism (record 1.6 mln in September) which helps reduce Japan’s service deficit.  The increased tourism may also force an opening up of Japan that officials will likely welcome as preparation for the 2020 Olympics gets under way.
  • The Norwegian krone is the weakest of the majors, off about 0.25%.   Seemingly counter-intuitively, the krone weakened following news of somewhat higher than expected inflation.  Headline CPI rose 0.4% m/m in September (consensus 0.3%) and this lifted the y/y rate to 2.5% from 2.1%.  There were two mitigating factors.  First, the underlying rate, which excludes taxes and energy, eased to 3.0% from 3.1%.  The consensus was for an unchanged reading.
  • Second, while some countries are easing policy to arrest deflationary forces, like Sweden, Norway’s challenge is not inflation but rather growth.  The central bank meets against on December 17, after the ECB and FOMC.
  • China also reported softer than expected inflation figures.  October CPI slipped to 1.3% y/y from 1.6% (consensus 1.5%).  However, the headline rate masks the disinflation pressure that appears to be increasing.  Food prices inflation slowed to 1.9% from 2.7%.  Non-food prices rose 0.9%.  Like other countries, a discrepancy between goods prices and service prices is evident.  Consumer goods prices have risen 1% while service prices are increasing at twice the pace (1.9%).  By way of comparison, note that the recent US CPI showed services prices rising 2.7% year-over-year in September.
  • Chinese producer prices fell at the same pace (-5.9% y/y) as they did in September.  Producer prices have fallen uninterrupted for nearly four years.  The soft inflation figures fan expectations for further easing by the PBOC, perhaps before the end of the year.
  • After selling off sharply to about $1.0720 in response to the US jobs data at the end of last week, the euro has been trapped in its trough.  Yesterday it was unable to resurface above previous support (now resistance) near $1.08.  Today it has been capped near $1.0765.  Reports playing up the risk of a larger cut in the deposit rate next month are weighing on sentiment at the same time that former doves at the Fed like Rosengren warm to the idea of a December rate hike.  Evans, also a dove, will go into the December meeting “open-minded.”
  • Many are talking about a 10 bp cut in the ECB’s deposit rate, which currently stands at minus 20 bp.  However, some reports suggest that a larger cut may be contemplated.  This would do three things.  First, it would get ahead of the curve of expectations, and thereby have greater impact.  Second, it would demonstrate greater resolve in boosting inflation or inflation expectations.  Third, it would increase the range of instruments that can be bought under QE.
  • Currently, bonds with yields lower than the deposit rate cannot be bought.  This means, for example, that German bonds from 2-4 years cannot be bought.  Alternatively, consider the Netherlands.  It sold a 3-year bond today with an average yield of -27 bp, a record low.  It is not available for QE as the yield is too low.
  • The focus on the ECB means that the high frequency economic data from the euro area is having little influence.  Today, French industrial production surprised to the upside after Germany disappointed last week.  The consensus had called for French industrial output to fall 0.4% and manufacturing to fall 0.5% in September.  In fact, industrial production was up 0.1%, and manufacturing output was flat.
  • Italy’s data was more difficult to get one’s head around.  Industrial output rose 0.2%.  The consensus called for a 0.6% increase after a 0.5% decline in August.  However, the year-over-year pace jumped to 1.7% from 1.0%.  The consensus was for a 1.4% pace.  The eurozone aggregate figures will be released on Thursday ahead of the Q3 GDP estimate on Friday.
  • The subdued news stream is expected to persist through the North American session.  The US reports import prices and wholesale trade and inventories.  The former may be used to fine tune PPI expectations for later this week.  The latter may feed into economists’ work on Q3 GDP revisions.
  • Exports out of the Philippines collapsed in September.  They fell -24.7% y/y, against expectations for a decline of only -8.3%, the fastest decline since mid-2011 and the sixth consecutive month of decline.  PHP is brushing off the negative news, falling only slightly against the USD, but underperforming other EM currencies in the region.
  • Hungary’s October CPI came in a touch higher than expected at 0.1% y/y vs. -0.4% in September.  Hungary reports Q3 GDP Friday, and is expected to rise 2.5% y/y vs. 2.7% in Q2.  With deflation risks still high and the economy slowing, central bank officials have turned more dovish recently.  Forward guidance was extended to 2017 (perhaps even longer) and the possibility of unconventional measures was raised.
  • Brazil reports the first preview of November IGP-M wholesale inflation, and is expected to rise 1.21% m/m.  If sustained for the month, the y/y would rise to 10.3% from 10.1% in October.  September retail sales will be reported Thursday, and are expected at -7.3% y/y vs. -6.9% in August.  The economy remains too weak to hike rates any further, though it remains to be seen how markets react to steadily climbing inflation.
  • South Africa’s September manufacturing production surprised on the upside at 0.9% y/y vs. -2.5% y/y expected and vs. -0.2% in August.  SARB next meets on November 19.  With the economy still weak, we think the central bank will find it hard to continue its tightening cycle after restarting it with a 25 bp hike to 6% back in July.  We believe that political realities (unemployment above 25%) and social unrest will prevent tightening for now.  While the weak rand is a concern for the SARB, fiscal policy is also being tightened, putting more headwinds on the economy.