Currency and bond markets challenge the Bank of Japan

Overview: Asia Pacific equities were mixed China, Hong Kong, Taiwan and the South Korean market were among the major markets to lag after solid performance in the US. Europe is also struggling to maintain the upward momentum that has lifted the Stoxx 600 for the past four sessions. It’s almost flat when this note is written. US futures are firm. Benchmark bond yields are higher and the 10-year Treasury yield is just over 4.05%. European yields are mostly 3-4bp firmer. The greenback has a slight bullish bias despite dollar bloc currencies holding up. Emerging market currencies are slightly lower. Gold has slipped to a fresh monthly low of just under $1640. December WTI settled around $83 after falling almost 3% yesterday. US Natgas is a bit softer after falling more than 11% over the past three sessions, while Europe’s benchmark is down around 30% in four days. It’s up about 5.4% today. Iron Ore gave back half of yesterday’s 1.1% gain. December copper is down 1.2% today, extending its decline into a fourth session. It’s down about 2.75% over the past three sessions. Finally, December Wheat has bounced back (~0.8%) after falling about 1.3% yesterday.

Asia Pacific

Japan’s political challenge intensifies ahead of next week’s BOJ meeting. The yen’s inexorable decline has continued and combined with the rise in global bond yields has put the 10-year JGB yield under pressure with the 0.25% cap. BOJ Governor Kuroda argues that the unilateral move is not good for the Japanese economy, but that seems to imply the need for more, not less, support for the economy. Rumors of a “clandestine intervention” surfaced again yesterday, with a news outlet quoting one person as implying it was a “warm-up” to an essential move. But does that make sense? Late last month, the BOJ intervened with a record amount. Do you really need to warm up? Finance Minister Suzuki announced yesterday that the authorities are stepping up surveillance of the markets and increasing the frequency of detailed inspections. He said officials were “ready to take action if necessary”. As it stands ready to take action, it would seem to imply that it is not. The market took the dollar to new 32-year highs near JPY 149.50. The market is nervous as it thinks the BOJ might step in and can act nervously. Some market participants may try to play on such fears.

Two reports coming out tomorrow are worth highlighting. First, while reports of Yen weakness point almost exclusively to monetary policy divergence, there is another important development that will be underscored tomorrow with Japan’s September trade data. Even if it weren’t for the yawning interest rate differential, the deterioration in its trade balance would be viewed negatively for the yen. Consider that Japan reported an average monthly deficit of JPY 1.53 trillion (nearly US$11 billion) through August. In the first eight months of 2021, the average trade surplus was JPY73.5 billion (~US$565 million). Second, Australia reports September employment numbers. Australia has added 41,000 full-time jobs per month this year, compared with almost 27,000 on average over the same period last year. Unemployment was a generational low at 3.4% in July and stood at 3.5% in August. The Reserve Bank of Australia meets on November 1st and the futures market favors another 25bps hike.

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The market knows it is tempting for BOJ intervention. The dollar is rising slightly and the 3-month implied volatility has risen to over 13.3%. When the BOJ intervened last month, volatility was only slightly higher. Given that the BOJ would act unilaterally and without announcing a policy change, the intervention, and that the intervention would hardly be seen as a surprise, the impact would likely be less than before. This would suggest that dollar buyers could use the intervention as a “dip” to buy. A failed intervention could also encourage the market. The Australian dollar is trading quietly within yesterday’s range (~$0.6265-$0.6340). A break of yesterday’s low could force out some weak longs as momentum wanes. It might be worth another quarter cent or so. The dollar faces its highest close against the Chinese yuan since 2008. In late September, when it posted the intra-session high just above CNY7.25, it closed just above CNY7.20. It is trading north of CNY7.22 in late mainland trade. Meanwhile, the recent pattern (since October 11) remains intact: the PBOC has kept the dollar’s reference rate steady between CNY7.1075 and CNY7.1105. Today’s has been set at CNY7.1105. This means that the cap of the 2% range is 7.2527 CNY. Against the offshore yuan, the greenback hit CNH7.2675 in late September and has since traded at its highest level around CNH7.2475.

Europe

Falling fuel prices were not enough to offset higher food prices in the UK last month. As a result, headline inflation rose 0.5% to 10.1% yoy. Food prices rose by 1.1% over the last 12 months, up almost 15%. Services, which make up almost half of the CPI, are up 6.1% year over year. Core CPI rose to 6.5% from 6.3%, marking a new cyclical high. Producer price inflation slowed, but not as much as expected, with input prices up 15.9% yoy and output prices up 20%. The Bank of England meets on November 3rd. In the late September turmoil, the swap market had priced in a 150 basis point hike. Government fiscal policy was reversed and the BOE stepped in and bought gilts. The net result is that the market has downgraded its rate hike expectations. They are now pricing in about an 80% chance of a 100bp move. Note that settlement of the BOE balance sheet will also resume in early November.

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Next week the ECB may discuss unwinding its own balance sheet from next year. Meanwhile, government bond auctions could tighten if Germany’s experience is any guide. Yesterday’s seven-year bond auction saw a record-low bid for that term since it was first offered two years ago. Recent sales of 10- and 30-year bonds also received weak reception when they were offered through syndication earlier this month. The ECB meets on October 26th and the swap market has almost fully discounted 75bps. Separately, the Eurozone current account for September will be released tomorrow. Like Japan, the euro zone has seen a sharp deterioration in its external balance this year, reflecting in large part the energy shock. It records an average monthly deficit of almost EUR 3.9 billion. In the first eight months of last year, it reported a surplus of just over EUR 29 billion. As we’ve noted, while the euro is down about 13% against the dollar this year, it’s down nearly 2.5% on a trade-weighted basis.

The euro is trading a bit heavier today but yesterday’s low just below $0.9815 holds. A break of $0.9800 could stimulate some option related selling with big expirations tomorrow and Friday. On the upside, resistance is seen in the $0.9860-$80 range. For its part, the sterling remains within the range set on Monday (~$1.1150-$1.1440).. It recorded the session low so far in early European volume near $1.1250. Intraday momentum indicators appear in late morning activity. A move above $1.1300 could help raise the tone, but consolidation is likely to continue.

America

The US is reporting that September housing starts today and it is likely to break the string of favorable economic news that started with the jobs report and retail sales and ran through yesterday’s industrial production numbers. The third quarter appears to have ended firmly and later today the Atlanta Fed will update its GDP tracker, which came in at 2.8% on Oct. 14. Housing starts have been volatile this year and in the first eight months there have been three monthly swings of over 10%. After a 12.2% rise in August, a 7.2% decline is the median forecast from the Bloomberg survey. The Fed’s beige book will be released this afternoon. The headlines can stir the market, but there is little doubt that the Fed will make another 75 basis point hike on November 2nd. The Fed’s Kashkari speaks again today, but his views are clear. He is an activist who tends to be among the most moderate members in an easing cycle and among the most restrictive members in a tightening cycle. Bullard and Evans speaking late today after markets close.

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A formal announcement from the US Strategic Petroleum Reserves is expected today. There are 15 million barrels left in ongoing operations. At the end of last week, the SPR held 405 million barrels with a capacity of 714 million barrels. The oil’s release is part of an attempt to lower gasoline prices, but the price of crude accounts for about 50% of the cost. The other comes from refining, and that’s where the shortage seems to be more acute. At the same time, there is also discussion about where the government plans to buy back the crude oil. Biden had said $80 a barrel, but that was taken back. New reports point to $67-$72 a barrel.

Canada reports September CPI figure today. Key interest rates peaked in June at 8.1%. It is expected to slow to 6.7% from 7.0% in August. If accurate, it would be the lowest game since February. However, the problem lies with the core rates, and they remain stable. The three averaged 5.2% in August. They are expected to be little changed on average in September. Despite signs that the economy has lost momentum seen earlier this year, the Bank of Canada is focused on inflation. Still, the market is eyeing a 75 basis point hike next week. Late last week the market had priced in a little over 75% chance of a three quarter point move. By yesterday’s close, the probability had been downgraded to around 40%.

The US dollar peaked just above CAD$1.3975 on Oct. 13. It slipped marginally through $1.3660 from yesterday’s low, trading below its 20-day moving average (~$1.3780) for the first time in a month. Momentum has faded and the greenback is firm, holding below CAD$1.3785. Support is seen ahead of CAD 1.3700 today. The Mexican peso remains remarkably stable. The dollar continues to trade within the range set last Thursday (~MXN 19.95 to MXN 20.1585). To date, it’s roughly in the MXN20.01-06 range. The narrow trading range deters short-term traders who typically need to see more volatility. At the same time, the stable exchange rate is conducive to carry trades, and long peso short yen are popular with some commodity trading advisers.

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