Yen and USTs Gain as Risk-Off Impulses Grow

  • Global equity markets remain under pressure today after US equity markets were unable yesterday to sustain early gains
  • Italian officials took a softer line on the budget
  • UK CBI reported October industrial trends
  • Japan reported mixed September supermarket and department store sales
  • The Turkish lira slumped today on domestic political developments
  • Bank Indonesia kept rates steady at 5.75%, as expected; Brazil mid-October IPCA is expected to rise 4.6% y/y

The dollar is mixed against the majors as the equity slump resumes.  Yen and Swissie are outperforming, while the Scandies and dollar bloc are underperforming.  EM currencies are mostly weaker.  MXN and CNY are outperforming, while TRY and KRW are underperforming.  MSCI Asia Pacific was down 2.1%, with the Nikkei falling 2.7%.  MSCI EM is down 1.8% so far today, with the Shanghai Composite falling 2.3%.  Euro Stoxx 600 is down 1.4% near midday, while US futures are pointing to a lower open.  The US 10-year yield is down 5 bp at 3.15%.  Commodity prices are mostly lower, with Brent oil down 1.7%, copper down 0.7%, and gold up 1.0%.

Global equity markets remain under pressure today after US equity markets were unable yesterday to sustain early gains.  Those gains were fueled by the Shanghai Composite, which jumped 4.1% Monday on Chinese stimulus measures.  The weak US close fed into weakness in the Asian markets, and European stocks are also largely in the red today.  Indeed, the Shanghai Composite fell today even after some more (admittedly minor) measures were announced to help calm markets.

The US 10-year yield is trading close to 3.15% on the risk-off impulses that are hitting markets.  We continue to think that a break above 3.25% is needed to get the next leg of the dollar rally.  Today, the Fed’s Kashkari, Bostic, Kaplan, and George all speak ahead of tomorrow’s Beige Book.  No major US data are out today, though we get October Richmond Fed manufacturing index (24 expected vs. 29 in September).

Italian officials took a softer line on the budget, promising the EU that it will act to prevent the deficit from breaching the -2.4% of target.  Finance Minister Tria said he wants “constructive” talks with the EU.  Elsewhere, Prime Minister Conte hinted that some of the most controversial spending plans might not be implemented until later next year, which would help limit the deficit.

We are still early in the process.  However, the EU is widely expected to issue a negative opinion on the budget draft today.  If so, Italy will have three weeks to revise the draft for resubmission to Brussels.  We note that if the EU eventually finds Italy is persistently breaking the budget rules, it can open a so-called excessive deficit procedure that would lead to penalties of up to 0.2% of GDP.

The euro still feels heavy.  The single currency broke back below $1.15 Monday and tested last week’s low near $1.1430 today.  A break below that area would set up a test of the mid-August low near $1.13.

UK CBI reported October industrial trends.  Total orders and selling prices rose to 2 and 15, respectively. However, business optimism worsened to -4 from -3 in September and likely reflects ongoing Brexit uncertainty.  The CBI said that UK manufacturers are cutting back on investment, which it said is likely to be reduced at the fastest pace since July 2009.

With regards to Brexit, there really is no new news today.  It appears that a compromise solution of extending the transition period may be enough of a “can kick” to please all sides.  Stay tuned.  Sterling remains heavy and broke back below the $1.30 level Monday to trade at the lowest level since October 4.  That day’s low near $1.2920 is up next but break of the $1.2980 already has set up a test of the September low near $1.2785.

Japan reported mixed September supermarket and department store sales overnight.  Supermarket sales accelerated to 1.9% y/y, but both nationwide and Tokyo department sales decelerated.  Indeed, nationwide sales contracted -3.0% y/y vs. -0.2% in August.

USD/JPY remains choppy and has reversed lower because of the risk-off impulses.  It had finally caught a bid and was trading yesterday at the highest level since October 10.  With today’s drop, the pair is once again threatening the 112 area.  That said, we think that yen gains are due more to global risk-off sentiment building today rather than from Japan-centric developments.

The Turkish lira slumped today on domestic political developments.  Press reports suggest that the nationalist coalition partner MHP is dropping its electoral alliance with the ruling AKP ahead of local elections March 31.  It remains to be seen if MHP drops its support for the AKP at the national level, as AKP does not hold a majority in parliament on its own. That said, Erdogan granted himself sweeping executive powers and so the loss of MHP may not have much impact.

Still, the news gave the markets an excuse to sell the lira as it was due for a correction.  We have been unable to justify the lira’s recent gains in light of still-poor economic fundamentals.  The central bank meets tomorrow and is widely expected to keep rates steady.  Even a last-minute bout of lira weakness is unlikely to force the bank’s hand so soon.

Bank Indonesia kept rates steady at 5.75%, as expected.  A handful of analysts were looking for a 25 bp hike to 6%.  CPI rose 2.9% y/y in September, below the 3.5% target and in the bottom half of the 2.5-4.5% target range.  With the rupiah stabilizing, we think the bank was right to stand pat this month.

Brazil mid-October IPCA is expected to rise 4.6% y/y vs. 4.3% in mid-September.  If so, inflation would be slightly above the 4.5% target but within the 3-6% target range.  Market is less confident of a COPOM hike in 2018 but it becomes more likely in Q1.  Next COPOM meeting is October 31, no change is expected then.