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Overview: The markets remain unsettled. The surge in energy prices, the fears emanating from China’s property market, and the unresolved US fiscal drama weigh on sentiment. Japan stocks continue to unwind earlier gains. The Nikkei fell for the seventh consecutive session. South Korea and New Zealand markets lost more than 1%. Hong Kong, Taiwan, and India posted modest gains. Europe’s Dow Jones Stoxx 600 and US index futures are posting slight gains. The US 10-year yield is firm near 1.49%, while European yields are mostly 1-2 bp lower. The dollar is firm against most major and emerging market currencies. Sterling is holding its own, while the yen is on the defensive. Central European currencies are underperforming today, led by the Hungarian forint and Polish zloty. The JP Morgan EM FX index is flat after easing by 0.4% yesterday. Oil prices are consolidating in narrow ranges by yesterday’s high after OPEC+ stuck to its plans to boost output by 400k barrels a day next month. Gold was turned back from $1770 to test $1755. Yesterday’s low was a little below $1748. Among industrial metals, iron ore and copper are softer. The CRB Index closed at new highs yesterday, the ninth gain in the past 10 sessions.
Higher energy prices helped lift Tokyo’s CPI above zero for the first time since July 2020. Energy and higher hotel prices offset the decline in mobile phone services. The price of accommodations in Toyko rose 43% year-over-year. Cellular phone charts fell by 45% and took almost a full percentage point off the headline. The headline CPI rose to 0.3% from -0.4%. The core rate, which excludes fresh food, rose by 0.1% year-over-year, ironically disappointing economists who looked for a 0.2% gain (Bloomberg median). Excluding both fresh food and energy, Tokyo’s CPI fell by 0.1% year-over-year, the sixth month below zero.
There were three developments to note from Australia. First, the central bank stood pat, as anticipated. It accepts that the recovery from the pandemic and lockdowns will not be smooth. With a gradual re-opening of Sydney and Melbourne, officials seem confident of stronger economic activity. Second, although the September manufacturing PMI was revised lower last week from the preliminary estimate, the service PMI was revised higher to 45.5 from 44.9 initially and 42.9 in August. The 46.0 composite reading was unchanged from the flash estimate, which is the first gain since April. Third, Australia reported a record trade surplus of A$15.07 bln in August. Coal, natural gas, and gold exports were particularly strong, and overall exports rose 4% on the month. The median forecast in Bloomberg’s survey anticipated a 3% decline. Imports fell by 1%, while economists forecast a 1% gain.
Some link the escalation of China’s aerial harassment of Taiwan to Taipai’s application to join the Comprehensive Progressive Agreement for Trans-Pacific Partnership (CPTPP). Taiwan is a member of the Asia-Pacific Economic Cooperation, Asian Development Bank. It has been a member of the World Trade Organization for nearly two decades. Beijing could have become more sensitive amid overtures to Taipai. The size, composition, and frequency of the sorties were already escalating, and perhaps the flight patterns may have become more aggressive. Moreover, this is the week that the mainland celebrates its National Day, and shows of such power play into the nationalistic moment. Still, it is not over. Double Ten Day, October 10, is Taiwan’s National Day. There could well be another bolder and more frightful display of force. What has been dubbed as “gray zone warfare” is a lower rung in the larger escalation ladder. Since Beijing is dominating this rung, one can accept it, escalate, or gain leverage someplace else. Giving Australia the technology, so it has nuclear-powered submarines in a decade, if not longer, has little impact on this now but shows one’s cards needlessly.
The US dollar has found support near the (38.2%) retracement of its post-FOMC gains found a little below JPY111.00. The greenback is threatening to end a three-day fall. An option for almost $425 mln is struck at JPY111.00 that expires today but has likely been neutralized. A nearby cap is seen in the JPY111.40-JPY111.50 area. The positive developments in Australia may have prevented a more significant pullback, and bids were found near $0.7250. The $0.7300 area, which houses an option for A$570 mln that expires tomorrow, offers resistance. Although there have been several penetrations intraday, the Aussie has not closed above $0.7300 since September 15. The dollar is slightly softer against the offshore yuan. After approaching CNH6.46, the greenback was sold to session lows near CNH6.4420 in early European turnover. The high yield bond market remains under pressure, focusing on Evergrande, Fantasia’s missed coupon payment, and a downgrade of Sinic.
While the German and French flash services and composite PMIs were revised higher, Spain and Italy disappointed. The former outweighed the latter, and the net effect was that the pullback from August was less sharp in the aggregate than the preliminary report suggested. The service PMI stands at 56.4, rather than 56.3, and down from August’s 59.0. The composite stands at 56.2, slightly better than the flash reading of 56.1 after 59.0 in August. Separately, France reported stronger than expected August industrial production figures. The 1.0% rise was 2.5x stronger than the median forecast in Bloomberg’s survey, and July’s 0.3% gain was revised to 0.5%. Manufacturing jumped 1.1% in August, led by pharmaceuticals, autos, and electronics. August trade figures due Thursday will give a sense of how much of the production is for domestic consumption and foreign demand. Lastly, we note that in local elections in several large Italian cities, the center-left did well at the expense of the Five Star Movement and the League. The results may work in Prime Minister Draghi’s near-term favor.
The UK’s service and composite PMI were better than expected. What had been the fourth consecutive decline in the service PMI was revised away. The final reading came in at 55.4, up from the preliminary estimate of 54.6, after 55.0 in August. Similarly, the composite rose to 54.9, up from the flash estimate of 54.1 after 54.8 in August. On the other hand, car registrations (a proxy for purchases) posted their weakest September in nearly a quarter of a century and were off almost 34.4% year-over-year. However, note that EV sales were strong.
We had thought that the dollar may be correcting the rally since the disappointing August jobs report released in early September. However, perhaps the move that was being “corrected” was the leg up since the FOMC meeting. The euro was turned back after meeting the (38.2%) retracement objective of the decline since September 22, slightly above $1.1635 yesterday. It is straddling the $1.1600 area in the European morning. An option for 465 mln euros there expires today, and some of the to and fro may have come from the hedging activity. Last week’s (and year) low was set a little below $1.1565. The (50%) retracement of the euro’s rally from last year’s low is found close to $1.1490. Sterling is posting gains for the fourth consecutive session. If sustained, it would be its longest advance since last July. It is testing a trendline drawn off the mid-September high near $1.3915, the late September high around $1.3720, and yesterday’s high about $1.3640. It comes in now by $1.3620. Above there, resistance is likely in the $1.3665 area, which corresponds to the (50%) retracement of the cable’s downtrend since the mid-September high, and the 20-day moving average is found closer to $1.3685.
Before discussing it with Chinese officials, the US took its case public that China has not made good on its trade commitments. It had agreed with the Trump administration in 2019 to boost imports of US goods by $200 bln on top of 2017 levels by the end of 2021. Estimates suggest it has fallen short by more than a third. US Trade Representative Tai will reportedly speak with China’s Vice Premier Liu, who negotiated the agreement for Beijing. After months during which the Biden administration said it was reviewing and considering how to deal with China, it has apparently decided to tweak a couple procedural issues. Tai said the administration was turning the page on “impulsivity and reactivity.” The Biden administration will re-open a process that it had previously allowed to expire for businesses seeking an exemption to some trade restrictions. Not only are “Trump’s tariffs” remain in place, but Biden is threatening to expand them, depending on how Beijing responds to missing its targets.
US Commerce Secretary Raimondo sent a similar warning shot to Europe by continuing the Trump administration’s rhetoric that protecting US steel manufacturing was a national security issue. She noted that the US capacity utilization rate was never above 80% for a decade before the tariffs. As tracked by the Federal Reserve Board, the US broader capacity utilization rate stood at 76.4% in August and has not been greater than 80% since the run-up to the Great Financial Crisis. The general problem is the surplus capacity (which we argue is another dimension of surplus savings) and how to address it. Last month, Nucor and US Steel announced plans to build two new mini-mills that use scrap steel and boost capacity by around six million tons.
Protection under the cloak of national security sets a dangerous precedent. Moreover, it pits domestic steel producers against steel consumers. Some US companies complain that the European and Canadian governments’ incentives to lower carbon emissions give European producers an unfair advantage. Still, of course, tariffs are not the only recourse. Also, the uneven economic recovery from the pandemic has seen demand for steel surge, lifting prices and boosting operating capacity well north of 80%. If the steel industry needed protection three and a half years ago, is it still needed? Yet, if some arrangement with Europe cannot be found shortly, the conflict will escalate. The EU, having delayed once to give the Biden administration some extra time, will go forward on December 1 with an increase of its retaliatory tariffs. The EC says to ratify an agreement, it needs to be concluded by early November.
The final PMI (services and composite) and the ISM services for September provide updated survey data for the US, while the August trade balance comes from the real sector. US economic activity has slowed, and the flash composite reading had fallen for the fourth consecutive month, and at 54.5, it was the lowest since last September. The ISM services report peaked in July at 64.1 before easing in August (61.7) and is expected to have slipped below 60 in September for the first time since February. Meanwhile, the US trade deficit has averaged $69.7 bln through the first seven months of the year. The average for a similar period last year was $50.5 bln, and in 2019, it was $50.1 bln. In the Jan-July period in 2018, the average shortfall was $45.8 bln, and in 2017 $42.5 bln. The pattern is clear. Canada also reports its August trade figures. A small surplus is expected, but supply chain disruptions hold the potential for a negative surprise. Separately, note that Ottawa is formally seeking the Biden administration’s involvement to resolve a pipeline dispute that has seen Michigan try to shut down a pipeline under the Straits of Mackinac that delivers oil to Wisconsin.
The US dollar fell to its lowest level in nearly a month against the Canadian dollar slightly below CAD1.2560 yesterday. Although it closed below CAD1.2600, the break of a potential neckline of a head and shoulders pattern was not convincing, and it continues to hover near there today. As noted yesterday, there are a couple of chunky options that expire today. One is for almost $900 mln at CAD1.2615, and the other is for about $1.25 bln at CAD1.2625. We suspect the greenback will be challenging this area in the North American morning. Despite last week’s rate hike and the suggestion that more will be forthcoming, the Mexican peso remains pinned near last week’s lows. The dollar is chopping in an MXN20.40-MN20.60 range for the most part. Yesterday’s high was near MXN20.62. This area has held on the initial test in the European morning, and the first area of support is near MXN20.50. Today, Mexico has a light economic calendar, while Brazil reports August industrial production and sees September PMI (service and composite). The dollar closed firmly against the Brazilian real yesterday. The August 20 high, which was revisited at the end of last week near BRL5.4750, may offer the initial target. Should it break, which looks likely, there is little chart resistance ahead of BRL5.60, last seen in April.