Sterling’s Slide Extended on Dismal Industrial Output Figures

  • A subdued Chinese session, with the yuan little changed and local equities securing minor gains, let market participants look elsewhere for directional cues
  • Like Germany and France, the UK reported an unexpected drop in November industrial output
  • Many reports note the hidden hand of Chinese officials behind the powerful short-squeeze in CNH (offshore yuan) today that following a similar move yesterday
  • Turkish markets remain jittery after reports of an explosion in Istanbul’s tourist district
  • South Africa reported weak November manufacturing production; India reports November IPPrice action: The dollar is mostly stronger against the majors. The Scandies are outperforming, while sterling and the Antipodeans are underperforming. The euro is trading flat near $1.0850 after being unable to break above $1.09, while sterling is making new cycle lows around $1.4440. Dollar/yen trading flat 117.80. Most EM currencies are weaker. ZAR, BRL, and TRY are outperforming while MYR, PHP, and IDR are underperforming. MSCI Asia Pacific was down 1.7%, with the Nikkei falling 2.7% after returning from a holiday. MSCI EM is flat after earlier making a new cycle low, as the Shanghai Composite was up 0.2% and the Shenzen Composite up 0.4%. Euro Stoxx 600 is up 1.6% near midday, while US futures are pointing to a higher open. The 10-year UST yield is up 1 bp at 2.19%, while European bond markets are mostly softer. Commodity prices are mostly lower, with oil, iron ore, and copper all down.

A subdued Chinese session, with the yuan little changed and local equities securing minor gains, let market participants look elsewhere for directional cues. The new lows in oil, near $30 a barrel, and the bankruptcy filing of Glencore’s US subsidiary Sherwin Alumina seemed to weigh on the dollar-bloc currencies.

However, it is sterling today that has the distinction of being the weakest of the majors. It is off about 0.4% near midday in London following disappointing BRC sales (0.1 vs. 0.5% expectations) and then a dreadful industrial production report.

Like Germany and France, the UK reported an unexpected drop in November industrial output. The 0.7% drop compares with a flat consensus expectation and is the largest fall since January 2013.   Adding insult to injury, the October gain of 0.1% was revised away. This means that the year-over-year pace is half of what it was (0.9% vs. 1.7%).

Ironically, and this may be picked up in the US industrial report for December due later this week, the unseasonably warm weather weighed on energy output. Electricity, gas and steam output fell 2.1%. This is not to minimize the negative impulse emanating from the manufacturing sector, however. Manufacturing output fell 0.4% for the second consecutive month. UK manufacturing on a year-over-year basis has been contracting since July (-1.2% vs. -0.2% in October). We note that there appeared little in the manufacturing PMI that prepared investors for the disappointment. The November reading of 52.5 matched the six-month average.

The Bank of England meets later this week. No change in policy or guidance is expected, even if McCafferty, the lone advocate of an immediate rate hike, abandons his dissent and rejoins the fold. The economy is slowing, and inflation has yet to show upward pressure. The pendulum of market expectations continues to swing away from a rate hike this year.

The December short-sterling futures (3-month deposit) has rallied to new contract highs, implying 78 bp 3-month yields in 11.5 months’ time. This is a 26 bp decline since the end of last year. Sterling has lost 1.8% this year, only outdone by the dollar-bloc among the majors. It is trading at a new 5.5 year low near $1.4465. The next chart point of note is another cent lower though the 2010 low is found near $1.4230.

The US dollar is trading slightly firmer against the other major currencies. Emerging market currencies are enjoying a firmer tone, perhaps encouraged by the lack of disturbance from China, where officials have denied seeking a large devaluation. Both Fed officials that spoke yesterday (Kaplan and Lockhart) explained that while the labor market enjoys favorable momentum, the four rate hikes of the dot plot are not a promise or commitment. Yesterday, the implied yield on the December Eurodollar futures contract fell to 101.5 bp, the lowest since early November.

Many reports note the hidden hand of Chinese officials behind the powerful short-squeeze in CNH (offshore yuan) today that following a similar move yesterday. This has succeeded in nearly closing the gap between the onshore and offshore markets. It is not clear that this can be sustained in a stronger US dollar environment.

As North American dealers return to their posts, the dollar is little changed against the euro and yen. The greenback needs to establish a foothold above JPY118 by finishing the session above there. Intraday technicals suggest it may make new highs on the session, but a close above JPY118 may require new developments.

After pushing toward $1.0970 yesterday, the euro reversed lower. Asia marginally extended those losses to almost $1.0840. Additional slippage is likely in North America, but the $1.08 seen after the strong US employment report may be sufficient to stem the fall.

We note that the greenback has made new multi-year highs against the Canadian dollar (~CAD1.4270). The continued drop in oil prices keeps it vulnerable, while the dismal business outlook, reported yesterday (with the weakest investment and employment plan since 2009) keeps many anticipating a rate cut. The implied yield on the March BA futures contract has fallen 10 bp in the past week to 70 bp and is at three-month lows. Some profit-taking was triggered late in the European morning. Look for buyers to reemerge in the $1.4150-CAD1.4170 area.

Turkish markets remain jittery after reports of an explosion in Istanbul’s tourist district. The blast today reportedly killed 10 and injured 15. Two bombs in the capital of Ankara killed more than 100 people back in October, which was blamed on an ISIS-affiliated group. This is a grim reminder that political risk remains high in Turkey, despite the AKP’s surprise win. Coupled with weak fundamentals, the lira is likely to underperform in the coming weeks and trade at new all-time lows.

South Africa reported November manufacturing production at -1.0% y/y vs. the expected -0.3% y/y. The economy remains weak, and yet the SARB will feel compelled to continue tightening in light of the plunging rand. The next policy meeting is January 28. If the rand remains weak, then another hike then is likely. Such a move won’t help the rand, but it would help limit second round effects of currency weakness. Please see our recent report entitled “South Africa Flash Crash A Sign of Things to Come.”

India reports November IP, and is expected to rise 2.0% y/y vs. 9.8% y/y in October. India also reports December CPI that day, and is expected to rise 5.5% y/y vs. 5.41% in November. It then reports December WPI Thursday, and is expected at -1.2% y/y vs. -2% in November. Price pressures are rising, even as the recovery continues. As such, the RBI may find it hard to continue tightening in 2016. The next policy meeting is February 2.