The Tragedy of the Commons

Overview: The dramatic moves spurred by the BOE maintaining the end of the week deadline for its Gilt purchases, which have been quite modest given its wherewithal, have calmed. Sterling is firmer on the day, though long-end Gilt yields are higher. The dollar has pushed above JPY145.90, where the BOJ intervened last month. Risk appetites more broadly appear to have stabilized, but we suggest it may be a modest bout of position adjusting ahead of tomorrow’s US CPI. Except for Japan, Hong Kong, and Taiwan, most of the large bourses in the Asia Pacific region were firmer, and Europe’s Stoxx 600 is snapping a five-session slide. US futures are around 0.75% higher. The US 10-year yield is steady around 3.95%, while European benchmark yields are mostly 6-9 bp higher, with Italian yields leading the rise amid reports confirming the difficulty Meloni is experiencing in putting together the new government. Gold has steadied after falling by about $50 an ounce in the five-day slide that may be ending. December WTI is a little firmer after falling about 3.7% in the past two sessions. US natgas is little changed as it consolidates yesterday’s 2.5% advance. Europe’s benchmark continues to swing sharply. It fell 2.8% yesterday and is up 2.5% today. It is the sixth session of more than 2% net moves. Iron ore extended yesterday’s 2.45% loss and is now slightly lower on the week. December copper is paring the 2.2% gain over the past two sessions. December wheat jumped 6.5% on Monday amid worries about shipments from Ukraine. It fell 4% yesterday and is off another 1% today, ahead of the US world supply/demand estimate.  

Asia Pacific

Early in the North American hours yesterday, China reported strong September lending figures. They are likely consistent with somewhat better economic data (outside of the property market) next week. The 20th Party Congress will compete with the economic data for attention. Although many western critics see little distinction between the Chinese Communist Party and the state, next week's Congress is party event. Xi will have a couple of his party roles extended (Secretary General of the Communist Party and the Chair of the Central Military Commission) but the role as head of state (president) will likely be announced next spring. Appointments to the Politburo and the naming of its standing committee will be scrutinized for clues into future policy.

Aggregate lending rose by CNY3.53 trillion (~$500 bln) in September. It was more than a quarter larger than expected. The formal banking system nearly doubled their lending to CNY2.47 trillion from CNY1.25 trillion. The rest is accounted for by shadow banking, which in China would include the wealth management arms of banks. China will report Q3 GDP next week, and the median forecast in Bloomberg’s, survey calls for a 3.5% expansion after a 2.6% contraction in Q2 (quarter-over-quarter numbers). September industrial production and retail sales look to have strengthen. However, separately, the spending during last week's holiday seemed disappointing.

South Korea delivered the widely expected 50 bp increase in the seven-day repo rate to 3.0%. It began raising rates in August 2021, about a month before the Fed's pivot, and with today's move, the cumulative increase has been 250 bp. However, since last August the CPI has risen by 300 bp, so despite the increases the inflation-adjusted rate is lower than it was before it began its hikes. The won is off around 17% this year. The central bank reported record dollar sales in Q2 (~$15.4 bln) to support the won.

Many pundits accuse the Fed of exporting inflation by raising rates in the US, and the subsequent rise in the US dollar. South Korea, like Japan and Europe have seen the external balances deteriorate sharply. Through August, this year's trade surplus has averaged $1.77 bln a month. In the first eight months of 2021, there was an average monthly trade surplus of $6.75 bln. Moreover, South Korea reported trade deficits in July and August. The performance of South Korea's stock market is among the worst in Asia, falling more than 25% this year. Part of the pressure on the South Korean won may have come from foreign sales of more than $13 bln of its equities this year. Is this really a crisis?  South Korea accumulates reserves in good economic times and sees foreign equity purchases when the semiconductor industry, for example is strong. Now the currency weakens as the semiconductor industry retrenches and foreigners sell South Korean shares. The BOK smooths out the flows by intervention. Rather than a crisis, this sounds simply the turning of the economic cycle. The BOK and the IMF forecast that the South Korean economy will expand by 2.6% this year. 

The dollar rose to new 24-year highs against the yen near JPY146.40, half a yen higher than in late September, when the Bank of Japan intervened. The lack of intervention underscores the idea the intervention was not aimed at a particular level. Three-month implied volatility is about 12%. It had been above 13% late last month. Intervention remains a risk, but it is unlikely to have the same impact as before (~five yen initially). In the near-term the JPY146 area may offer support. The market may tread gingerly as it approaches JPY147. The Australian dollar is falling for the seventh consecutive session, reaching $0.6240, a new low since March 2020. Support is difficult to find, but $0.6200 is the next psychological area. On the top side, $0.6300 offer a sufficient cap. The greenback has traded inside yesterday's range against the Chinese yuan (~CNY7.1450-CNY7.1950). The PBOC set the dollar's reference rate at CNY6.1103. The market (Bloomberg’s survey median) projected CNY7.1750.

Europe

There had been some speculation that the BOE would extend its emergency bond-buying program past Friday's end-date. BOE Governor Bailey put the talk to rest and affirmed that there would be no extension. On Monday, the BOE announced a new liquidity facility that that would run until November 10 that would assist banks in helping their pension fund clients. The BOE would double its daily bond buying capacity of GBP10 bln, half of which was for inflation-linked securities, for which the pension funds are larger holders. Almost a quarter of the BOE's purchases under the program were executed yesterday when it bought GBP2 bln of the inflation-link bonds. Reports suggest that pension funds were pressing for an extension of the current backstop, but they have hardly used it, seeming to prefer to sell riskier assets and hold on to the Gilts. Other reports claim that some market participants thought they heard that the BOE was indeed going to extend its operations, which led to some confusion.

The BOE has stressed in several ways that this bond-buying program is not like QE. It is not meant to depress yields but to provide liquidity to the distressed market. It was limited in time and size. It kept the bonds bought in a different account and indicated it would sell them back to the market as soon as reasonable. The market reaction to the government's budget put the BOE in a difficult position. Based on inflation and its efforts to tighten monetary policy, it was raising rates and planned on reducing its balance sheet by outright sales in addition to the passive roll-off. After the mini budget, the perceived threat to financial stability required it to act.

Adding to the UK woes, the economy unexpectedly contracted by 0.3% in August. Economists had expected a flat month. Weakness was widespread as industrial output fell a dramatic 1.8%, and services contracted by 0.1%. The trade deficit widened. Construction was the one bright spot, but its 0.4% increase missed expectations. The economic calendar lightens up now until next week's inflation report.

The euro is trading quietly in a narrow $0.9680-$0.9735 range, inside yesterday's price action. It had traded up to $0.9775 before the sell-off sparked by BOE Governor Bailey's commitment to the Friday deadline. The euro still looks vulnerable, and a break of $0.9680 could spur immediate losses into the $0.9640 area. The stronger than expected rise in EMU's August industrial output (1.5% vs.0.7% median forecast in Bloomberg’s survey) did the single currency no favors. It is not enough to shake the belief that the area economy is heading for a recession. Sterling posted a big outside down day yesterday, trading on both sides of Monday's range and settling below its low. Follow-through selling took sterling a little through $1.0930, where a GBP475 mln option rolls off today. It stabilized and it appears a bout of short covering helped lift it to almost $1.1080 in the European morning. Yesterday's high in the North American afternoon as closer to $1.1180.

America

Many have expressed concern that the tightening of monetary policy collectively risks driving the world economy into a recession. This is a descriptive statement that has been dressed as a normative claim (what ought to be the case). The world economy is an abstraction. No one sets interest rates or fiscal policy for the world economy. The world economy is the sum of the components. This one aspect of the tragedy of the commons. The pursuit of self-interest might not be transformed into the general good, as Adam Smith would have it, through the invisible hand. The boilerplate part of the statement after the FOMC meetings says that Fed takes into account international developments.

Fed officials have implied that they are willing to risk a US recession to ensure price stability can be achieved. The FOMC minutes from the September meeting due later today will likely drive home this point. Many observers did not seem too bothered by this, but a global recession raises the ire. Moreover, often the idea that the Fed should stop tightening to help the "world economy" is presented as if there are no other alternatives. But there are. For example, South Korea and other emerging market economies would benefit from swap lines with the Federal Reserve like the ones that were arranged during the early days of Covid. Another example is a large SDR distribution. There are calls for another $650 bln allotment. This is not to advocate any course of action here, but rather to recognize the tragedy of the circumstances of nation-states pursuing their national self-interest, which can lead to, can we say, less than optimal results for the world. Also, there are other measures besides changing US monetary policy, with CPI, as we are likely to learn tomorrow, is still running above 8% and the core rate may test the cyclical high of 6.5% seen six months ago.

While it seems like the US has a busy session today, with the PPI, FOMC minutes, Fed speeches by Kashkari and Barr, and the Department of Agriculture WASDE report (World Agriculture Supply and Demand Estimates), it may be more about positioning ahead of tomorrow's CPI report. That position adjusting could give the appearance of risk-on, which is to say firmer equities, which could give the Canadian dollar a reprieve after the greenback set a new two-and-a-half year high yesterday near CAD1.3855. It is trading quietly within yesterday's range with a softer tone. Initial support is seen by yesterday's low (~CAD1.3715). The Mexican peso is steady. The dollar is trading quietly and around MXN20.07 is near the middle of today's range. So far, here in October, the greenback has been in a MXN19.93/4-MXN20.15 range. News that it began hedging H1 23 crude for around $75 had little impact on fx dealings. Today's August industrial production figures (median forecast in Bloomberg’s survey sees a 0.1% decline) may not be much of a market mover either. 

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