US Bonds Stabilize and the Dollar Finds Better Footing

Overview: The 13 bp jump in the US 10-year note and 30-year failed to derail the rebounding equities or lend the dollar support.  The surge in US equity indices closed the gap created by the panic attack and Monday's sharply lower opening.  However, the relation trade did not carry into today's activity.  Most equity markets in the Asia Pacific region fell, with the notable exception of Japan, Taiwan, and India.  India's main indices are at record highs.  Recalling the sharp losses after last weekend, some participants moved to the sidelines. Europe's Dow Jones Stoxx 600 is giving back most of yesterday's gains and paring this week's gain, which would be its first in four weeks.  US futures are giving back around half of yesterday's advance.   The US 10-year yield is slightly lower today, and at 1.40%, it is up about four basis points on the week.  Australia and New Zealand's 10-year benchmarks played catch-up and rose 14 bp and 11 bp, while European yields are 2-4 bp higher.  The dollar is recouping some of yesterday's losses.  Yesterday's leaders, the dollar bloc and sterling, are the weakest.  The Swiss franc and euro are nursing small losses.  Emerging market currencies are also finishing the week on a soft note.  After a two-day advance, the South African rand's downtrend has resumed with around a 1.2% drop today.  The large 100 bp rate cut by Turkey's central bank yesterday sent the currency to record lows, and the losses are being extended today.  The JP Morgan Emerging Market Currency Index is off for the third consecutive week.   Gold has snapped back after shedding nearly 1.8% over the past two sessions.  At $1755, it is up less than a dollar on the week.   Brent crude oil moved within cents of this year's high set in early July, near $77.85.  November WTI has edged to a new high for the year today at roughly $73.65.   While iron ore prices are firmer, copper is lower for the second consecutive session.  Without a recovery today, copper will post its first back-to-back weekly loss since May.  The CRB Index has a three-day advance in tow coming into today's session and is rising for its fifth consecutive week.  

Asia Pacific

Japan's headline CPI slipped deeper into deflation.  The -0.4% August reading is the 11th consecutive month of below zero year-over-year.  The core rate, which excludes fresh food, and is the measure the BOJ targets, stands at zero, matching its highest level since March 2020.  However, this is the result of higher energy prices.  The measure of Japan's consumer prices that exclude fresh food and energy is 0.5% lower than a year ago.  Separately, due to yesterday's holiday, Japan's preliminary September PMI was reported today. The manufacturing PMI eased to 51.2 from 52.7, while the services PMI rose to 47.4 from 42.9, showing the contraction is moderating.  The composite is at 47.7, up from 45.5 in August.  The year's high, set in April at 51.0, was the highest since September 2019.   There are no policy implications.  The BOJ met earlier this week, and the focus is the LDP leadership contest next week and a large fiscal package expected later this year.

It is still not clear under what terms Evergrande serviced its domestic debt or what it plans on doing about the $83.5 mln interest payment due yesterday or the $47.5 mln due next week.  Most such contracts include a grace period.  Reports claimed Beijing told local governments to prepare for the collapse of Evergrande. At the same time, a former adviser to the PBOC contended that it will be broken into four parts (real estate development, finance, electric vehicles, and other commercial activity).  Despite Thursday's equity rally in Hong Kong and the mainland, the NASDAQ Golden Dragon Index (tracks China-based companies that trade in the US) fell slightly.  It is off 2.8% for the week coming into today.  At the start of this week, the SEC formally reminded investors about the opaqueness of investing in Chinese companies that trade in the US.  The news and fears surrounding Evergrande are a constructive development for the SEC's campaign.  

Some observers link the PBOC's announcement of a CNY300 bln re-lending program to supporting the banks as they cope with the fallout of Evergrande.  It is true that the PBOC has stepped up its liquidity provisions in a big way this week, but it is also needed given the week-long holiday in early October.  Moreover, it is aimed primarily at the financing condition of the small and micro-sized companies.  There seems to be a large element of Schadenfreude over the Evergrande demise, but the over-the-top one-day reaction, this past Monday, seems to reflect the anxiety of investors fearful that they are skating on thin ice and every crack is the big one.  Real estate and apartments in the large urban centers have been used for investment and speculative purposes.  This mode accumulation may be ending in China.  The larger problem of the cost being increasingly outside the reach of the middle class is not just a problem of socialism with Chinese characteristics.  House prices throughout Anglo-American economies and several Nothern European countries, the same holds true.  Next week S&P CoreLogic Case-Shiller report July US house prices.  In the year through June, they rose by 18.6% to new record levels. 

The jump in US yields gave the dollar a fillip against the Japanese yen.  Recall that the greenback had approached JPY109 in the middle of the week, the lower end of the three-month trading range.  It reached slightly beyond JPY110.55 today, its highest level since early August. The dollar has not been above JPY111.00 since it briefly traded above there in early July.  There is an expiring option at JPY110.50 for $330 mln.   Initial support now is seen around JPY110.20. The Australian dollar traded above $0.7300 yesterday and again today, but it is proving to be tough resistance.  It stalled near the (38.2%) retracement objective of the decline since the September 3 high (~$0.7480).  When everything is said and done, the Aussie is little changed on the week.  It settled at $0.7265 last week.  There is an option for nearly A$1.1 bln at $0.7275 that will be cut today.  The US dollar began the week outside and below the CNY6.45-CNY6.50 range that has dominated for the past three months but has been back in it since Monday.  The PBOC set the dollar's reference rate today at CNY6.4599, spot on expectations.  It continued to provide liquidity into the banking system ahead of quarter-end and the week-long holiday in early October.  Lastly, note that the PBOC reiterated that all crypto-related transactions are illegal in China.  


Given that the market had been pricing in around 40 bp of UK tightening next year, the great uncertainties, signs that the economic momentum is waning, and the prospect for the tightening of fiscal policy next year, we had thought the BOE would be somewhat less hawkish.  Instead, the comments fanned expectations and seemingly opened the door to a possible hike this year, even before completing its bond purchases.  The implied yield December short-sterling futures contract rose five basis points yesterday and is up another one today (to about 19 bp while the base rate is at 10 bp). The March 2022 short-sterling futures contract jumped 10 bp yesterday and is up a little more today to yield 45 bp. For context, consider that the implied yield of the December 2022 Eurodollar futures contract rose about seven basis points since Tuesday, the day before the FOMC meeting concluded. Recall that the last BOE cut was for 15 bp.  Yet, the central bank moves in 25 bp increments.  Therefore, it seems like a consensus is forming for the first move to be 15 bp to lift the base rate back to 25 bp before resuming the 25 bp increments.  A little less than 6% of the UK workforce were on the furlough program at the beginning of this month, a program where the government subsidizes part of the wages of employees, where works have been disrupted by the pandemic. Not only is the market bracing for tighter monetary policy, but next month's budget is expected to remove some fiscal support as well.  

Germany's September IFO survey showed softening investor confidence.  The assessment of current conditions slipped to 100.4 from 101.4, which is where it was in July.  The expectations component eased to 97.3 from 97.8.  It is the third consecutive decline.  This left the overall assessment at 98.8 compared with 99.6 in August. The third monthly decline leaves it at its lowest level since April.  Germany goes to the polls Sunday, and the election appears to have tightened.  Rather than a sharp break from Merkel's era, we expect strong continuity even if a likely center-left coalition is forged.  Finance Minister Scholz backs the "black zero" and rejects the use of fiscal policy for cyclical aggregate demand purposes.  As the last debate showed, there seems to be a consensus for a more activist foreign policy.   

The euro had fallen to about $1.1685 in the middle of the week, after the FOMC meeting, but it rebounded yesterday and stalled near $1.1750. It continues to offer nearby resistance.  We note that the US 2-year premium over Germany settled last month near 93 bp.  It set a September high yesterday near 96 bp and is back now at 94. The euro settled around $1.1725 last week.  The BOE's hawkishness stands out, and yet sterling has underperformed.  In fact, it joins the yen as the only major currency to be lower on the week. Sterling held important support at $1.36 and recovered to $1.3750 yesterday, almost the halfway mark of the slide from the September 22 high near $1.3915.  Initial support is now around $1.3680.  Despite a mid-week push above GBP0.8600, the euro remains inside the GBP0.8500-GBP0.8600 range that has confined the price action since mid-August.  


Anticipating that the Fed wants to maintain a maximum amount of flexibility, we had envisioned the tapering to be completed by mid-year.  We made a case for front-loading the slowing a little to allow for a proper tapering as opposed to a sharp halt.  Also, to preserve a credible option of two hikes next year, even though this is still a minority view (3 Fed officials anticipated in September up from 2 in June), it is important that the first hike is priced in for September 2022.  For the sake of the example, assume that the effective average of Fed funds remains at 8 bp where it is today, and on September 21 next year, the Fed hikes 25 bp.  That equates to a fair value of almost 15.5 bp ( (8* 21) +(33*9)/30).  The contract implied 13.5 bp at the end of August and 13 bp at last week, and now is at 15 bp.  The December 2022 contract now implies about a 20% chance of two hikes next year.  

The sky-is-falling camp saw a jump in US long-term yields and cried, "taper tantrum," but surely it is more complicated.  First, the yields were recovering from the sharp drop earlier on the week when many of the same folks were talking about a Lehman moment. Second, the major indices had recovered and closed the gaps created with Monday's sharply lower opening.  Third, emerging market equities and currencies seemed fairly resilient.  Of course, Turkey, which surprised with a 100 bp rate, was punished with a new record low.  Fourth, there was a surge in mortgage origination (~$14 bln), and the related convexity sales and hedges also contributed to the pressure.  

There is much interest in the Quad meeting today (US, Australia, India, and Japan).  It was a largely defunct club before President Trump resurrected it.  The new AUKUS security pact likely reduces the military dimension of the Quad, allowing it to focus on economic and climate cooperation.  However, India has launched efforts to overhaul its military and, in particular, re-organize it to allow for greater collaboration and coordination between the branches. 

With the FOMC meeting over, Fed officials take to the stage again.  Today sees no fewer than six Fed officials speaking, mostly in the US morning.  Powell, Clarida, and Bowman are hosting a "Fed Listens Event."  Bostic speaks on equity community development.  Mester is the only one who directly will address the economic outlook.  Mexico reports July retail sales.  A small gain is expected after a 0.6% fall in June.  Yesterday's bi-weekly CPI reading was firmer than expected, and many expect a rate hike next week.  Brazil's central bank pre-committed to another 100 bp hike next month, which could take the sting from today's inflation report that is expected to show price pressures are approaching 10%. 

The US dollar peaked on Monday near CAD1.29 and fell back to CAD1.2635 yesterday, helped by the continued recovery in stocks and commodities.  It has stalled today as equities slip.  A move above CAD1.2700 targets CAD1.2735.  There is an option for $875 mln at CAD1.2650 that expires today.  Watch equities for the immediate directional cue. Efforts to push the US dollar below MXN20.00 have faltered this week.  The greenback seems poised to challenge the week's high, which is also the month's high MXN20.20.  A move above MXN20.22 could signal a further near-term advance toward MXN20.32. 


US Bonds Stabilize and the Dollar Finds Better Footing US Bonds Stabilize and the Dollar Finds Better Footing Reviewed by Marc Chandler on September 24, 2021 Rating: 5
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