Emerging Markets Recover With Equities, Euro and Yen Ease

The end of a horrendous quarter of equities and emerging markets is generating a sigh of relief that is helping lift those battered markets.   The MSCI Emerging Market is up almost 1.75% prior to the open of the Latam markets.  Its Asian-Pacific Index is up 2.1%.  The Dow Jones Stoxx 600 is up 2% near midday in London led consumer staples and materials.   Core bond yields are firmer, including US 10-year Treasuries, which are back at 2.09% after testing 2.04% yesterday.  

Emerging market currencies are mostly higher today.  The dollar-bloc currencies have also turned higher.    The Australian and New Zealand dollars are the strongest of the majors, gaining about 0.6% against the greenback.  The Scandis are also recovering.  

The yen is weakest of the majors.  It is off 0.4%.  The two drivers, equities and US yields are weighing on the yen.  The economic data was disappointing.   Industrial output fell 0.5% in August.  The consensus was for a 1.0% rise after the 0.8% decline in July.  Contracting output was reported in 10 of the 15 industry groups.  The year--over-year rate stands at 0.2%.  The consensus was for a 1.8% increase.  Retail sales were flat in August, defying expectations for a 0.5% increase.  Inventories are rising (0.4% in August and five of the past eight months).  This understood as a headwind on output. 

The Tankan survey is out first thing in Tokyo on Thursday.  Sentiment is expected to have deteriorated across the board, and capex plans pared.  Friday sees employment data.  The unexpected weakness in today's data, leaving aside housing starts, which rose 8.8% year-over-year, besting expectations for a 7.6% pace, has spurred concerns that Japan's economy may have contracted for the second consecutive quarter.  We note in every year since 2005, Japan has experienced at least one quarter a year of contraction.  In four years, there were at least two quarters of negative growth.  

Investors are focused on the likely policy response.  The risk of a recession (defined as two quarters of contraction) is heightening speculation of a supplemental budget, though Prime Minister Abe has played this down, and changes in the BOJ's asset purchases.  A recent Bloomberg about a third of the respondents expects the BOJ to step up its efforts (from JPY80 trillion a year) as early as next month. 

The dollar is still caught up in the large triangle pattern that it has been carving since late-August.  It tested the lower end of it yesterday, and it held.  The top end of the pattern comes in near JPY120.65 today. 

Last week, investors learned that Japan's core measure of inflation (which excludes fresh food) dipped back into deflation for the first time since April 2013.  Today, investors learned that deflation returned to EMU in September for the first time since March.  The dramatic slide in Spanish prices and softer than expected German CPI yesterday gave strong hints of disappointment today and surveys were not unadjusted to incorporate that information.  Energy prices are likely the main culprit and core inflation was steady at 0.9%.  The ECB officials had warned of the risk of a negative CPI print, so they were likely not surprised by the news.  This in turn suggests that this news may not be sufficient to spur the ECB into altering its asset purchase purchases when it meets next month (October 22). 

The euro has been confined to less than half a cent range thus far today, within yesterday's range.  A break of $1.1190 could see $1.1150, but ahead of the US employment data on Friday, the euro is likely to remain confined to its recent ranges.  

The ADP employment estimate will command attention in the North American session.  The consensus is for a repeat of the August estimate of 190k. Then, small firms and services led the employment growth.  The market may be more sensitive to a weak number than a strong one.   Four Fed officials speak today, with Yellen, Bullard, and Brainard speaking on community banking may not be the stuff that moves markets.  However, this will be Yellen's first speech since she faltered, appearing disoriented, at her lecture at Amherst last week that sparked speculation about her health.  Dudley speaks first on market liquidity.  He has recently endorsed the Fed's position that a rate hike this year is still likely. 

Canada reports July GDP.  The consensus looks for a 0.2% increase.  We see downside risks, and a negative reading would likely hit the Canadian dollar hard.  The 0.5% growth in June, the first positive monthly GDP this year was flattered by the end of the shutdowns and production issues in the oil/gas sector.  It rose by 3.9% and a 9.4% rise in non-conventional oil extraction. 

Lastly, we note that China’s markets are closed now through October 7.  Of particular interest is that officials have succeeded in closing the gap between the onshore (CNY) and offshore (CNH) yuan.  In fact, for the first time since June, the onshore yuan is at a discount to the offshore yuan.  While action by the central bank is thought to have driven the developments, arbitrage between the two has reportedly resumed.  Note that the 20% withholding on forward positions only applies  when the onshore yuan is being sold, not when it is being bought.  The arbitrage then is selling dollars for onshore yuan and then buying dollars against the offshore yuan.  

disclaimer