YCL - JPY150 Pierced But Market Is Not Done

2023-10-23 08:08:00 ET

Summary

• The dollar is firmer against the G10 currencies, with the Scandis and Antipodeans the weakest. EM currencies are also mostly softer.
• Gold peaked near $1997 before the weekend and pulled back to about $1964 today before steadying.
• Global equities are weaker. China's CSI 300, Taiwan's TAIEX, and India's main benchmarks are off more than 1% today.
• Europe's STOXX 600 fell 3.4% last week, the most since March. It is extending its losses today and is posting the fifth consecutive decline.
• The S&P 50 fell 2.4% last week, and the NASDAQ was off almost 3.2%. Both are poised to gap lower.

Overview

News that Israel's ground assault on Gaza is being delayed while hostage negotiations continue saw gold and oil ease, but tensions continue to run high. Gold peaked near $1997 before the weekend and pulled back to about $1964 today before steadying. December WTI peaked in front of $90 a barrel at the end of last week and fell to about $86.85 today, but has also steadied. The dollar is firmer against the G10 currencies, with the Scandis and Antipodeans the weakest (off ~0.25-0.65%). Emerging market currencies are also mostly softer. The Mexican peso is the heaviest, off about 0.7%.

Global equities are weaker. The MSCI Asia Pacific Index fell 2.7% last week, the most in two months, and is off to a poor start this week. China's CSI 300, Taiwan's TAIEX, and India's main benchmarks are off more than 1% today. Europe's STOXX 600 fell 3.4% last week, the most since March. It is extending its losses today and is posting the fifth consecutive decline. The S&P 50 fell 2.4% last week, and the NASDAQ was off almost 3.2%. Both are poised to gap lower. These gaps have extra technical significance if they remain open, given that they will appear on the weekly bar charts, not just the dailies. Bonds are also selling off. The 10-year JGB yield reached a new high above 0.86% amid talk that the BOJ may consider adjusting the Yield Curve Control and raising its inflation forecasts at next week's meeting. European benchmark yields are mostly 6-8 bp higher, though we note the peripheral yields, including Italy, are up a little less. The 10-year US Treasury yield is up nearly 10 bp to breach the 5.00% threshold.

Asia-Pacific

Does the yen's price action generate possible insight into the Chinese yuan? Of course, they have two different currency regimes. Although Japan used to be more activist, it now intervenes rarely, and last year's September-October operations were the exception that proves the rule. China uses formal and informal mechanisms to influence the exchange rate. Apparently, using the usual verbal intervention, the JPY150 level has been respected so far. The dollar did spend a few minutes above JPY150 on October 3, and it appears less likely that it was the central bank and more likely that it was the market itself that generated the dramatic swings (the dollar fell to ~JPY147.45 and then rallied back above JPY149). In early trading today, the dollar pushed briefly above JPY150 and quickly pulled back. There are over $3 billion of options at JPY150 that expire today and tomorrow.

Previously, the market buzz was that PBOC was capping the dollar at CNY7.30. The dollar is averaging above it this month, and the average close last week was near CNY7.3135. Now the buzz is that CNY7.35 is the threshold. How would we know? The dollar stopped just shy of CNY7.35 on September 8. It has not traded above CNY7.3355, and that was the following session (September 11). Before the weekend, the dollar had risen to its highest level since then. Just like we suspect that Bank of Japan is not really defending JPY150, we suspect that the PBOC is not defending a specific level. The price action is what one would expect if the PBOC were trying to manage the depreciation of the yuan driven ultimately by the divergence of policy.

In Japan, there were two byelections, and the LDP, which held both seats previously, lost the upper chamber seat but retained in close call the lower house seat. Prime Minister Kishida spoke before the Diet earlier today. He is still touting tax cuts in the face of slumping public support for his cabinet. Subsidies for gasoline, electricity, and household gas, which had previously been extended until the year, have been extended again through Q1. The existing subsidies have shaved more than one percentage point off overall CPI. The end of the subsidies could boost inflation just as the BOJ appears to want to exit its extraordinary monetary policy.

The dollar continues push against JPY150. Last week's 30 bp jump in the US 10-year yield did not do the trick. There was a brief push in thin early Asia-Pacific markets that took the dollar to about JPY150.10. It has mostly stayed below JPY149.95 since, but the market is not done. It has barely traded below JPY149.75 since the higher was recorded. Intervention to curb excessive volatility is justifiable, but in the past three sessions, the dollar has been in a half a yen range below JPY150. Actual one-month volatility has not been this low since Q1 '22. The Australian dollar is pinned to its trough. Last week's attempt on $0.6400 was rebuffed, and it returned to slightly below $0.6300. Last week's low was about $0.6290. There are A$410 million in options at $0.6300 that expire today. For the third session, the Aussie is making lower highs. The pre-weekend high was about $0.6330, and today's high is slightly below $0.6325. The US dollar is firm against the Chinese yuan, but for the first session since Tuesday, October 10, it has not risen above the previous session's high. The pre-weekend high was above CNY7.3185. News of investigation into Foxconn ( FXCOF ), whose founder is running for president of Taiwan as an independent candidate, and the arrest of three employees at WPP, follows other incidents of the arrest of foreign business officials. The PBOC has set the dollar's reference rate at CNY7.1792, slightly lower than last week, compared with the average projection in Bloomberg's survey of CNY7.3111, which is slightly higher than last Friday's projection.

Europe

Greece's 10-year yield has fallen about 15 bp this year coming into this week (to 4.35%). The 10-year Bund yield is up 33 bp (to 2.89%). Italy's 10-year yield has risen 24 bp (to 4.92%). Greece's discount to Italy is a record. Ahead of the weekend, S&P became the first major rating agency to recognize Greece as an investment grade credit (BBB-) and a stable outlook. It will not impact the use of Greek bonds as collateral for ECB operations, but it brings the country a little closer to be included again in industry investment-grade benchmarks used by used by asset managers. Last month, Moody's upgraded Greece by two notches, but it is still one step below investment-grade. Fitch's review is due December 1. It currently rates Greece at BB+, the equivalent of Moody's. A bigger problem is looming. S&P maintained Italy's rating two steps above investment-grade, but potential threat comes from Moody's, which has a negative outlook for its rating, one step into investment-grade. Its review is expected on November 17. Italy's government does not expect a budget deficit to meet the 3% target until 2026, a year later than initially planned.

For the past two weeks, the euro has mostly traded in a $1.05-1.0640 range. The brief exception was October 13, when it slipped but held above $1.0495. This broad sideways movement needs to be placed in the context of the 11 consecutive weeks of losses that ended in the first week of October. The key issue is whether the price action is "nesting" before another leg lower or whether a base is being forged. The week's key events (US Q3 GDP and the ECB meeting) are not until Thursday. The euro has not closed above $1.0600 since October 11. So far today, the euro has approached but not taken out last week’s high set on Thursday slightly above $1.0615. Sterling closed near session highs before the weekend, but after last Monday's high near $1.2220, it has been making lower highs. The currency snapped that streak today, rising to about $1.2185. The pre-weekend high was $1.2170. It had appeared to be forging a base around $1.2120, but this yielded, and sterling found bids near $1.2090. It recovered but has been unable to resurface above $1.2200. The Swiss franc is little changed after the weekend election that is expected not to produce much of a change in the governing coalition or in economic policy.

America

Four developments are notable. First, the US Treasury be selling almost $170 billion in coupons, including $26 billion of two-year floating rate notes and $218 billion of bills, without counting four-month bills and the four- and eight-week bills. Last week's 20-year bond auction did not tail as the previous week's refunding did. Partly, this may be due to the relatively smaller size and the concession that was given (the dramatic rise in yields ahead of the auction).

Second, the implied yield of the December 2024 Fed funds futures rose by 16 bp in the first three days of last week. The 10-year yield rose a little more than 30 bp at the same time. Hence, it seems reasonable to conclude that half the rise in the long end was accounted for by the adjustment in Fed expectations. However, in the last two sessions, the implied yield of the December Fed funds futures contract fell by about 15 bp, leaving the yield up a single basis point on the week at about 4.70%. The 10-year yield was flat in the last two sessions, settling the week up 30 bp. As the Fed Chair noted, if it is sustained, it would imply a tightening of financial conditions through the term premium that does some of the Fed's work. Related to this is the dramatic shift in the US 2-10 year curve. It was inverted by about 76 bp around the FOMC meeting last month and settled around -44 bp on October 13 and -16 bp last week. That is the least since July 2022. Contrary to conventional wisdom, it is not the inversion of the curve that has coincided with recessions, but the re-steepening.

Third, surging long-end yields sent bank shares reeling. Recall that early last week, the index of large bank shares and regional bank shares were at the best levels for the month. They reversed sharply. The index of large bank shares fell nearly 7.7% in past three sessions and settled last week at its lowest level since May. The index of regional bank shares fell by 8.2% from last week's high to the lowest since June 1. Financial conditions have tightened dramatically over the past month and are back to less since in last April. While the economy and the labor market seem resilient in the face of higher rates, the Achilles' heel is the financial sector. Last week, Fed Chair Powell seemed to play down the banking stress that led to a new emergency facility - its use has been steady around $107-108 billion in recent months - and risks arising from commercial real estate exposure. Still, the dramatic tightening of financial conditions is worrisome even if the economy boomed in Q3.

Fourth, the inability of the dollar to rally in the context of the heightened geopolitical tensions, the surge in long-term rates, the greater US two-year premium, and a series of stronger-than-expected real sector data is notable. Moreover, as we noted in the weekly commentary , the Dollar Index and euro, its largest component, saw the five-day moving average cross the 20-day moving average for the first time since July. The one-week/four-week moving average may be a helpful tool in identifying trend and a proxy for a particular market segment, but it is not perfect. In the Dollar Index, there have been seven crosses this year before last week and only one whipsaw (July). Not responding to favorable news, the moving average cross is sending cautionary signals. The price action has yet to confirm. For that, the Dollar Index must push below the 105.50 area. The comparable level for the euro is around $1.0640-50.

The US dollar settled last week above CAD1.37. The uptrend looks intact, and there is little standing in the way of a rest of the seven-month high set earlier this month near CAD1.3785. The proximity of Wednesday's Bank of Canada meeting may deter much new position-taking. The pre-weekend low was about CAD1.3670. Last week's high was about CAD1.3740, and this looks likely to be challenged in North America today. The fact that the greenback held below the month's high near MXN18.4860 and proceeded to sell off more than 1.5% has spurred talk of a possible double top, which would project to back toward MXN17.00. However, to confirm a double top, the dollar must be sold through the "neckline," which is near MXN17.7550. Instead, it looks more likely that the US dollar will rechallenge the recent highs and negate the talk of a double top. Above MXN18.50, the initial risk may extend to MXN18.80. Lastly, in Argentina, Economy Minister Massa did unexpectedly well in yesterday's election, garnering about 37% of the vote. This set the stage for a run-off next month against Milei, a libertarian who received 30% of the vote. The results are expected to weigh on local asset prices.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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