Turnaround Tuesday with Bonus Rate Cut

Turnaround Tuesday with Bonus Rate Cut

  • China cut rates
  • Despite a mixed session in Asia, markets woke up in reversal mode in Europe even before the rate cut
  • Hamada, an advisor to Japan PM Abe, fuelled calls for authorities to take more action
  • German August IFO came in on the strong side
  • South Africa’s Q2 GDP came well below expectations 

Price action: The dollar is mixed on the day. The euro has gradually trended lower after its high of $1.1714 yesterday to trade below $1.1500 now. Sterling is outperforming, trading just around the $1.58 level. The dollar bounced back to nearly ¥120.0 currently, compared with yesterday’s flash drop to a low of ¥116.18. Many EM currencies are up sharply against the dollar. This is being led by the oil exporters RUB and MYR but SGD, INR and most other Asian currencies are also up, with the exception of IDR. CNY was down 0.14% to a USD/CNY rate of 6.4128. Nikkei ended down 4.0%, after moving in a range of more than 1000 points, which means its volatility reached the highest since more than 2 years. The Shanghai comp suffered a loss of 7.6%. However, most other EM Asian indices are up, as are majors. For example, Taiwan’s Taiex was 4.6% higher and Turkey’s BIST is up 2.1%. EuroStoxx is up 3.3% led by Greece and Germany. Energy prices are also coming along for the ride. WTI futures up 3.2% overnight to $39.50. Sovereign debt yields for most core markets are up 2-5 bp, recovering from some of yesterday’s declines.

  • Just a few minutes ago China cut its reserve requirement rate by 50 bp. This was the first cut since last November. The 1-year benchmark deposit rate was cut by 25 bp to 1.75%, and the 1-year lending rate was cut to 4.6%, effective tomorrow. This follows the step up its credit injection into the local market. Reports suggest that the bank’s open-market operation overnight have been the largest in six months, with RMB150 bln ($23.4 bln) of 7-day reverse repos.
  • One of the few things we know about Chinese policymaking is that they are not subservient to markets wishes, especially in terms of timing. This was made clear during the episodes of credit crunch in 2013. Back then, local rates spiked higher and the PBOC took much longer to react than many had expected. Some even interpreted it as policymaker’s teaching them a lesson. Similar episodes were seen in FX markets, when the PBOC defied markets pushing the yuan one way or another. It is said that some RMB 25 trln ($3.9 trillion) of bank deposits are locked up, thus there is still a lot that can be tapped into by lowering reserve requirements. But it’s important to note that the choice of instruments is not straight forward as there are many factors to consider, including how closely officials want to manage the ebb and flow of credit.
  • For example, yields for yuan-denominated instruments in Hong Kong have been rising as investors supposedly rush to convert from into HKD or USD. One widely followed Dim Sum bond index saw the yield rise to around 5.39% today, from just under 4.4% at the start of the month. Similarly, the 3-month interbank yuan deposit savings rates spiked to 7.65%, from around 3.30% at the start of the month.  This adds to the already salient risk of capital outflows. But it also argues for officials imposing a more moderate pace of depreciation of the yuan – if there is to be one. Any hint that they are pursuing a concerted effort to depreciate the currency will only increase outflows.
  • The spread between 12-month USD/CNY NDFs and spot continue to widen, suggesting that investors are pricing in the risk of further depreciation down the line. Spot is now at 6.4131 and the 12-month NDF at 6.7246. Using the difference between the two as a rough proxy, this would imply around 4.8% of further depreciation over the next 12 months. Overnight, there were talk that some Chinese government agencies are assuming a yuan rate of 7.0 for this year and 8.0 for the end of 2016.
  • Despite a mixed session in Asia, markets woke up in reversal mode. Some estimates suggest that about $2.7 trln of value has been wiped out from global equity markets yesterday. While this is unlikely to be recovered today, it has been a good effort so far. Chinese markets, the epicentre of the rout, suffered another big sell-off of 7.6% for the Shanghai Comp. Japanese stocks fell for six straight days to its lowest close since February 10, but note that Nikkei futures are already up 2%. The MSCI EM index is up nearly 2.0% today. In Europe, the DAX is outperforming at 3.0% led by the technology and healthcare sectors. The Athens ASE index is the biggest gainer of the day, up 6.7%, though this follows a -10.5% close yesterday. US equity futures are up over 3%.
  • Hamada, an advisor to Japan PM Abe, fuelled calls for authorities to take more action. Hamada said the Japanese economy will need both monetary easing and fiscal stimulus if GDP growth is zero or negative in 3Q. He also suggested that the BOJ should ease further if China policy causes a strong yen. Japanese officials have been much more vocal about the current market situation than most officials in G10. This is due to the perception that a strong yen and weaker Chinese growth could block the 2% inflation target and other Abenomics objections. Private consumption remains tamed even though real income recovers and lower energy prices increase disposable income. This could be in part due to the negative wealth effect of lower Japanese stock prices.
  • German August IFO came in on the strong side. The business climate sub-index rose to 108.3, considerably higher than the 107.6 expected and 108.0 in July. The current assessment index rose to 114.8, the highest since April 2014, while the expectation index ticked down slightly to 102.2. IFO shows the recovery momentum in EZ continues but the pace remains modest. In contrast to the current IFO survey, the German ZEW index was weaker, especially the growth expectations sub-component, which has fallen for the last five consecutive months. While the ZEW is narrower, focusing on some 350 German financial experts, the IFO is made up of around 7000 contributors from a more diverse sector base.
  • The final GDP for Germany came in as expected, confirming that Q2 grew at 1.6% y/y. Exports did a lot of the heavy lifting. Overseas sales rose 2.2%, while private consumption increased only 0.2% and capital investment contracted by 0.4%.
  • South Africa’s Q2 GDP came in at 1.2% y/y, well below expectations for 2.0%. On a quarterly basis, GDP contracted -1.3%, vs. expectations for a +0.6% print. The cycle high for GDP was seen in Q4 of 2010, at 3.4%. The biggest downside risk for the South African economy is the ongoing energy crisis with rolling blackouts, and this looks to be getting expressed in the data. Production of electricity, gas and water are expected to continue declining. Despite the central bank’s hawkish stance, hikes going forward will be increasingly difficult to justify.
  • In the US session, we will get the August preliminary service PMI, which is expected to tick lower to 55.1 from 55.7. New home sales are expected to rebound in July to 510K, after an unexpected fall in June (482K) and Case-Shiller index should continue to show a gradual improvement of housing prices. Then consumer confidence is released and is expected to rise to 93.4 in August from 90.9 in July. Any rebound would be very welcome here after the sharp unexpected decline for the index in July from 99.8 to 90.9, the largest monthly decline since 2011