Greenback Broadly Steady While Sterling Slides

Pound money on financial figures balance

  • UK industrial output fell by 1.3% in October; German industrial output disappointed
  • Australian data disappointed the markets today too
  • The idea of a February election in Italy seems like a stretch
  • The dollar value of China’s reserves fell by a little more than $69 bln in November
  • Reserve Bank of India unexpectedly kept rates steady; National Bank of Poland kept rates steady, as expected

The dollar is mixed against the majors. Kiwi and the Scandies are outperforming, while sterling and the Aussie are underperforming. EM currencies are mostly firmer. ZAR, TRY, and BRL are outperforming, while PHP, HUF, and THB are underperforming. MSCI Asia Pacific was up 0.6%, with the Nikkei rising 0.7%. MSCI EM is up 0.7%, with Chinese markets rising 0.5%. Euro Stoxx 600 is up 0.7% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is down 1 bp at 2.38%. Commodity prices are mostly higher, with oil up 0.2%, copper up 0.4%, and gold up 0.1%.

The US dollar is little changed against most of the major currencies. Sterling is the notable exception, losing about 0.75% to trade at three-day lows. The currency was on the defensive in early European turnover but got the rug pulled from beneath it by the unexpectedly poor data.

UK industrial output fell by 1.3% in October. The median forecast was for a small increase. While oil and gas took a toll (one of the large North Sea fields was closed for maintenance), manufacturing output slumped by 0.9%. A small gain was expected. The decline was sufficient to push the year-over-year rate into contraction (-0.4%) for the first time since March. Last week’s PMI warned of further slowing in manufacturing in November.

Sterling was near two-month highs yesterday, reaching $1.2775. It was sold off to almost $1.2580 today. It appears to have found a bid, but it may be difficult to resurface above $1.2650. The euro had begun the week at nearly four-month lows against sterling just ahead of GBP0.8300. It traded a little above GBP0.8520 today but is running into offers as the 20-day moving average is approached (~GBP0.8530). The euro has not traded above this moving average since the US election.

German industrial output also disappointed today. The 0.3% increase in October was a little more than a third of what was expected. The September series was revised to show a 1.6% decline rather than a 1.8% fall. The Bundesbank expects growth to accelerate here in Q4, and the PMI supports the optimistic assessment.

The euro has been trapped in about a quarter of a cent range through most of the European morning. Since stalling near $1.08 at the start of the week, the euro approached $1.07 yesterday. The ECB meets tomorrow and is expected to extend its asset purchase program, adjust some self-imposed rules to minimize the scarcity challenge, and ease the securities lending facility to alleviate some pressure in the repo market.

Australian data disappointed the markets today too. The economy contracted by 0.5% in Q3. The median called for a 0.1% contraction. It is the first contraction since 2011 and the largest since 2008. The Australian dollar had been turned back from $0.7500 at the start of the week. That area capped the Australian dollar last week as well. It fell a little below $0.7420 today on the news. It held above Monday’s low by a couple of ticks and recovered to almost $0.7460 in the European morning.

Looking at Italian markets, one would hardly know the extent of the political and economic challenges. Italian bank shares are up 2.7% on top of yesterday’s nearly 9% advance. Local papers claiming the government is considering drawing on an ESM facility has been denied. Meanwhile, there are other reports suggesting the government could buy as much as two bln euros of subordinated debt owned by retail investors in Monte Paschi, and then swap those bonds for equity.

On the political front, the idea of a February election seems like a stretch. Here is the problem in a nutshell. The old electoral law was ruled unconstitutional. The new law that applies only to the lower chamber is under judicial review, and a hearing is not planned until next month. With the broad defeat of the referendum, there is a new electoral law for the upper chamber. It is possible that Renzi does not just stay on for the passage of the 2017 budget, but until the electoral reform can be implemented to prepare for elections.

There is the usual fear-mongering. The defeat of the referendum, some argue, means that the Five Star Movement is likely to head up the next government and quickly seek a referendum on EMU membership. However, there is still good reason to suspect while this is possible, there are more likely scenarios. Consider that 40% voted in favor of the referendum. That was not enough to win the referendum, but it is enough to win a general election in Italy given the fragmentation of the electorate.

The referendum got all of the government’s critics, some within the PD itself, on the same side of the issue. An election is different. Moreover, the electoral reform that the court is reviewing gives the largest vote-getting party bonus seats. This seems to be the only way the 5-Star Movement could secure a majority, as it is weak in finding coalition partners. This component may be struck down and instead, proportional representation re-introduced.

The dollar value of China’s reserves fell by a little more than $69 bln in November. It was the fifth consecutive monthly fall. China’s reserves finished last year near $3.33 bln. As of the end of last month, they stood at $3.051 bln. Part of the decline in reserves, of course, reflects valuation swings. The reserves are kept primarily in fixed income, and November saw a sharp sell-off in global bonds. Also, the dollar appreciated sharply, which reduces the dollar value of the component of reserves invested in euro (-3.6% in November) and yen (-8.4% in November).

To be sure, there were genuine capital outflows as well. On the one hand, China appears to be introducing new capital controls to limit outflows. Foreign companies repatriating profits and proceeds of asset sales are being stymied, according to the front-page story in today’s Financial Times. On the other hand, many expect renewed capital outflows next year when the $50k cap on individual capital exports is renewed.

Reserve Bank of India unexpectedly kept rates steady. The decision was unanimous, and we warned of a potential hawkish surprise. The RBI said that current global volatility stemming in large part from imminent Fed tightening warrants a cautious stance. The RBI surprised markets with a 25 bp cut at its last meeting in October, but it’s clear that two cuts in a row was too aggressive in this current environment. The RBI also said that it needs more information about the impact on the economy of the recent cash ban.

National Bank of Poland kept rates steady at 1.5%, as expected. Inflation is back on the radar, with CPI coming in flat y/y in November. This was the first non-negative reading since June 2014, and base effects are likely to see positive readings in the coming months. For now, the central bank is likely to remain on hold whilst maintaining a bias towards higher rates next year.