Several financial centers were closed today, October 9, for different national holidays. Markets were closed in Japan, Taiwan, Korea, and Canada, and there was a partial holiday in the US.
1. Chinese markets reopened after the national holiday last week. The equities rallied in a bit of catch-up, following the cut in reserve requirements for lending to small businesses announced at the start of the holiday period. The yuan fell 0.4% against the dollar, which had appreciated against most major and emerging market currencies while Chinese markets were closed.
China reported that its reserves rose by $17 bln in September. This extends the streak to eight months and brings the year-to-date increase to $98 bln. Note that the TIC data that extends through July shows China’s holding of Treasuries increased by $108 bln this year. This does not include the use of financial centers, like Belgium, which in the past some analysts have argued reflected Chinese activity, which for the record is off $21 bln through the first seven months of the year
2. After suffering its biggest loss in a year last week, sterling bounced back on Monday. It overshot the upper end of the resistance band we identified at $1.3160 and made it up to nearly $1.3185 late in the European morning before sellers emerged. We note that the Commitment of Traders showed that the net speculative position in the futures market was as long sterling as it has been in three years. Disaggregating the data showed that the more than 15k contract surge was largely a function of short-covering (profit-taking?) than new longs being established.
Sterling’s recovery from its test on $1.30 before the weekend was helped by a report suggesting the UK Prime Minister May is considering a cabinet reshuffle following the EU Summit on October 19-20. There was speculation that Johnson could leave, but this speculation, like Tillerson in the US, is chronic grist for the rumor mills. It is difficult to know the veracity, but beside a short-term impact, the UK’s challenges are so much larger than this or that cabinet official.
Despite the 30 Tory MPs that are said to seek a leadership challenge, there seems to be a general recognition that ousting May could have disastrous consequences. In the first instance, it would deal a setback to Brexit negotiations. In the second, it would open the door to a Labour government, which according to recent surveys, enjoys greater popular support than the Conservatives.
While political concerns help explain recent sterling movement, we think that the underlying direction is driven by economic considerations. Here the news that may have been obscured by the political drama is that ONS revised up Q2 UK labor costs to 2.4% from 1.6%. This may be an important consideration for monetary policy. Specifically, it makes a rate hike more likely.
On the other hand, there may be more than meets the eye in tomorrow’s report by the UK Office for Budget Responsibility. It is expected to show new research that shows how it over-estimated productivity growth for the past seven years. While this sounds like old news, and it is, the implication is new.
It means that the GBP26 bln fiscal cushion that Chancellor of the Exchequer Hammond secured last year is not so secure. Slower growth means it will be considerably less exactly at the moment when there is greater domestic pressure to lift the austerity pay cap on public sector workers, lower the debt burden for students, and build more homes.
The UK government seemed to appreciate the early signals from the Trump Administration of 1) support for Brexit and 2) encourage expectations for a friendly trade policy and a free-trade agreement. This was always going to clash with the American First thrust of the new US administration. The Trump Administration has made a couple of preliminary rulings against a Canadian airplane manufacturer who employs 4000 in Northern Ireland. Reports suggest May, who depends on the Unionists from Northern Ireland in Parliament, appealed directly to the US President. The US has also joined several other countries who do not want the EU and UK to decide how the allowable subsidies will be divided when the UK leaves the EU.
3. The dollar tended to strengthen against the liquid and accessible emerging market currencies on Monday. The Turkish lira led the pack with a net loss of a little more than 3%. The sell-off was likely exaggerated by the lack of liquidity in early Asia, which got the first chance to respond to the suspension of visas between Turkey and the US. The proximate cause was the arrest of an employee at the US Embassy for involvement in the coup, which ostensibly has snared thousands of people. After closing near TRY3.6150 before the weekend, Bloomberg shows the dollar pushed through TRY3.85 in early Asia. As European activity drew to a close the dollar was trading on the first side of the range it saw in Europe near TRY3.73. The diplomatic crisis continued to appear to be escalating.
4. The final count in the recent New Zealand election gave Labour and Greens an extra seat apiece. This shifts the tide a little. A coalition of Labour, Greens, and New Zealand First would have a three-seat majority. A coalition between the National Party and New Zealand First would have a single seat majority. New Zealand First has given an Oct 12 deadline to form a coalition. These political issues, in the face of the growing expectations of a Dec Fed rate hike, have weighed on the New Zealand dollar. With today’s losses (0.35% @~$0.7075), the Kiwi has fallen for a third session to trade at its lowest level since early June. It has retraced more than 61.8% of this year’s rally after peaking near $0.7560 in late July. A note of caution comes from the fact that the New Zealand dollar is straddling the lower Bollinger Band (~$0.7075).
5. The euro fell to $1.1670 before recovering smartly ahead of the weekend. There was a little follow-through buying on Monday. The euro entered an important technical band of resistance that extends to $1.1770. It also houses the top of the downtrend channel we identified ($1.1760 at the start of the week).
Catalonia’s standoff with Madrid continues. It is if the collective breath is being taken. Will Catalonian leaders declare independence? If they do not, have the popular passions and expectations been so aroused as to render the situation controllable? The brinkmanship tactics require going to the brink, and the brink is at hand. Investors seem to expect Catalonia to blink. Spanish bonds and stocks performed well on Monday, and the sovereign credit default swap slipped.
Germany’s Finance Minister Schaeuble attended his last Eurogroup meeting of finance ministers. He is expected to become the Bundestag President next week. If he is the first casualty of the recent German election, Merkel’s weekend compromise with her Bavarian counterparts in the CSU is the second. She agreed to cap migration, including asylum seekers to a net 200k annually.
Meanwhile, it took 208 days, but a new coalition government appears to have been agreed. Rutte remains Prime Minister, and the coalition includes the D66 (progressive), the CDA (moderate Christian party), and the Christian Union (a more conservative party, that previously wanted to exit EMU). Despite the range of political views represented, an agreement reportedly has been reached on tax, sick pay, welfare for refugees, and defense and education spending. There does not appear to be much market impact. Over the past six months, the Dutch premium over Germany has halved to 10 bp. Dutch stocks have marginally underperformed Germany 4.3% vs. 6.15% over the past six months but did nearly twice as well the Dow Jones Stoxx 600 over this period.
6. The dollar peaked against the yen near JPY113.45 after the US jobs data and then sold off. It continued to fall to a little through JPY112.25 on Monday before rebounding to trade near JPY112.75 in thin dealings after European markets closed on Monday. With the US Treasury market closed, a powerful driver of the yen was not available, and the US equities were subdued. The head of the Party of Hope and Governor of Tokyo Koike is due to formally submit the party’s candidates for this month’s election. Her own name will most likely not be listed. This means that she will not directly challenge Abe. As this has become clearer, it appears her party has lost some momentum.