Overview
There is nervous calm in the capital markets today. The weakness of US shares yesterday is taking a toll today. An exception in the Asia Pacific region is the Hang Seng and the index of mainland shares that trade there, which is up around 3.5% today on the easing of some Covid protocols. Europe’s Stoxx 600 is off for a fifth day, its longest losing streak in nearly two months. US futures are posting minor gains.
Benchmark 10-year yields are mostly little changed. The exceptions are Italy, where the 10-year yield is up about 2.5 bp and the US Treasury, where the yield is up nearly three basis points to almost 3.45%. The dollar is mostly a little firmer against most of the major currencies.
The Norwegian krone and Australian dollar are slightly firmer. Sterling’s 0.35% decline leads the others to the downside. Rising tensions with the EU and a jump in inflation are a drag on the Hungarian forint, which is nearly 1% lower. The JP Morgan Emerging Market Currency Index is slightly softer after two days of gains. Gold’s recovery stalled near $1790 yesterday and it is a bit softer today, trading near $1783 in Europe.
January WTI has steadied after falling to $71.75 yesterday. The year’s low set on January 3 was almost $69. US natural gas is up 1.75% to build on yesterday’s 4.6% rally after falling for the previous five sessions. Europe’s benchmark is 2% higher on colder temperatures and additional maintenance in Norway. Iron ore rose nearly 3%, while March copper is edging higher. March wheat is around 0.4% better after a 2.8% rally yesterday ending a four-day drop.
Asia Pacific
Japan's economy contracted less than previously estimated (-0.2% rather than -0.3%). At an annualized rate this means a -0.8% contraction instead of -1.2%. The weaker consumption (-0.3% vs. -0.1%) was offset by an inventory build (0.1% vs. -0.1%) and a slightly smaller drag from net exports (-0.6% vs. -0.7%). The economy is expected to rebound here in Q4, helped by the fiscal stimulus measures. However, the recent data point to a soft start and weaker demand from the US and Europe may limit exports. Separately, Japan reported its first monthly current account deficit since January. The October shortfall was JPY64.1 bln (~$475 mln) from a JPY909 bln surplus in September. The deterioration was mostly a function of a widening trade deficit (JPY1.875 trillion from JPY1.760 trillion) and primary income (income from investments, dividends, interest, royalties, licensing, etc.).
Australia also reported October trade figures. It was slightly larger than expected at A$12.2 bln (~$8.2 bln) though a touch smaller than September (A$12.4 bln). Exports and imports slipped by about 1%. Coal, Australia's top export, slipped, Natural gas, a close second, increased, and a small increase in iron ore shipments helped offset the decline in coal. The decline in gold shipments (~A$1.5 bln from A$2.2 bln) tilted the scales. The report highlights a critical challenge Australia faces. China is by far its largest trading partner. Two-way trade accounted for A$27.1 bln in October, more than twice as large as its second biggest trade partner Japan (A$12.9 bln). The US is its fourth largest trading partner (A$5.9 bln). Yet, as is well known, Australia's foreign policy and security interests are tightly linked to the US and its allies.
The yen continues to track the US 10-year yield. Yesterday's decline in US yields coincided with a modest pullback in the dollar against the yen, while today's firmer US yield has seen the greenback climb back above JPY137. Yesterday's high near JPY137.85 may contain today's recovery. The Australian dollar is in a narrow range (~A$0.6700-$0.6740) in the upper end of yesterday's range. This ~$0.6745 area has capped the Aussie since Tuesday's key downside reversal. Note that the five-day moving average is poised to cross below the 20-day for the first time since October 25. Also, options for a little more than A$785 mln at $0.6700 expire today and another set for A$790 mln roll off tomorrow. The Chinese yuan continues to consolidate in a narrow range since jumping higher to start the week. On Monday, the dollar gapped below CNY7.0 on ideas that reduced vaccination checks and some modifications in quarantine protocols amounting to a policy reversal and an opening up. It has not traded above CNY7.0 since last Friday. Today's range is roughly CNY6.9650-CNY6.9820. The PBOC set the dollar's reference rate at CNY6.9606 today, slightly lower than the median in Bloomberg's survey (CNY6.9636). Separately, the news yesterday that the PBOC boosted its gold holdings for the first time in three years last month sparked talk of reserve diversification. Maybe, consider the relative amounts. The US Treasury data shows China with around $933 bln of US bonds at the end of September. The cost of the gold was likely around $1.65 bln. A proverbial drop in the bucket.
Europe
The European economic calendar is light and three political developments are the talking points. First, Putin again referred to Russia's nuclear arsenal after strikes by Ukraine at some missile bases inside Russia. Russia refuses to rule out the first use of nuclear weapons. Consider, in contrast, India, which reportedly demonstrates its pledge not to use it its nuclear weapons first, by keeping the key components separate. The US also has a partial no-first-use policy. It says it will not use its nuclear weapons against countries that do not possess nuclear weapons or other weapons of mass destruction.
Second, Germany foiled what is said to be an elaborate coup attempt. More than two dozen people were arrested, and another 27 individuals are under "initial suspicion" of being involved with a plot to strong the Reichstag (parliament) and overthrow the government. Reports suggested the raid involved 3000 police in 11 of Germany's 16 states. A former MP in the AfD party who is now an active judge was one of the arrests and the barracks of a unit of Germany's Special Force Command (KSK) was raided. Of course, parallels between the events on January 6, 2021, in the US are being drawn.
Third, the EU is preparing its ninth package of sanctions on Russia. This package seeks to deny Russia access to drones, and sanctions three more banks, including Russia's Regional Development Bank, four media outlets, 136 individuals, and another 42 entities.
The euro is trading quietly in a narrow range of less than half-of-a-cent, well within yesterday's range. The session high was set in late in the Asian session near $1.0530 (yesterday's high ~$1.0550) and found some bids in early European turnover around $1.0490). There are options for nearly 810 mln euros at $1.0450 that expire today but they may have been neutralized yesterday when the euro slipped through $1.0445. Sterling is confined so far today to a little more than half-of-a-cent range below $1.2215. Yesterday's high was closer to $1.2235. The intraday momentum indicators suggest follow-through losses in the North American morning will likely be limited.
America
The US 2–10-year yield curve is the most inverted yesterday since 1981, at around -85 bp. Other parts of the curve are inverted as well. Earlier this year, Fed Chair Powell played down the significance of the 2–10-year curve and drew attention to the spread between the 3-month bill in 18 months’ time and the three-month bill yield. At first, he suggests the inversion of that would signal a recession. However, he latter softened his position and said it could also reflect a sharp drop in inflation expectations. His preferred curve went inverted on November 10, the same day the US reported softer-than-expected CPI and the dollar was sold aggressively. The inversion reached 45 bp on December 1. It recovered almost half by this past Monday and has eased. The 2-year breakeven has fallen from 2.77% on November 9 to nearly 2.30% on November 18. It recovered to almost 2.63% after the US employment data last week but has since fallen back and dipped below 2.35% yesterday. The 10-year breakeven bottomed at the end of September near 2.10%. It reached a peak on October 24 a little above 2.60%. It found support near 2.25% in the second half of November before bouncing back to 2.45% after the jobs data. It retested the 2.25% yesterday.
While inflation expectations, measured here by the breakevens have fallen, the risk of a recession appears to be rising too. The layoffs announced capture imaginations in a way that hiring does not. Remember, the nonfarm payroll is a net figure. Every month there are layoffs and new employment, and despite the sense may get from the media coverage, as of last month, there continue to be more people hired than fired. Still, fears of a recession are increasing. At the beginning of this year, the Bloomberg survey showed a median expectation of a recession in 12 months at 15%. It was steady from there from October 2021 through February 2022. The Russian invasion of Ukraine, the subsequent energy shock saw the odds rise. Even in July, after two-quarters of negative growth, the median still put the odds at less than 50%. As of last month’s survey, put the odds at 62.5%.
Today's US economic data consists of weekly jobless claims, PPI, wholesale trade and inventories, the preliminary University of Michigan consumer sentiment and inflation expectations, and changes in household net worth (Q3). The market may be the most sensitive to the PPI and University of Michigan survey. Headline PPI is expected to extend is slowing streak for the fifth consecutive month and seven of the past eight. It peaked in March, coinciding with the first Fed hike, at 11.7%. The median forecast in Bloomberg's survey is for a 7.2% year-over-year rate in November. If so, it would be the lowest since May 2021. The core rate has slowed since the 9.7% peak in March without failure. It is expected to have slowed to 5.9% last month, which would also be the lowest since last June. Consumer inflation expectations for the 5–10-year period has been between 2.7% and 3.1% since the start of 2021. It was at 3.0% in November and may have remained there in the preliminary results for this month. Note that the NY Fed's own survey of consumer inflation expectations will be reported Monday, though is often not on economic calendars.
The Bank of Canada delivered a 50 bp hike yesterday to lift its policy rate to 4.25%. Even though many expected a quarter-point move, it was a dovish hike because the Bank of Canada said this may be it. The statement read that the central bank "will be considering whether the policy rate needs to rise further to bring supply and demand back into balance and return inflation to target." There will be two more inflation reports before the BOC meets again on January 25 (November's CPI will be reported on December 21 and the December CPI will be reported on January 17). Barring a major data surprise, the Bank of Canada will likely reaffirm its pause. The swaps market is about 50/50 about a 25 bp hike early next year.
Mexico reports November CPI today and the year-over-year rate is expected to slip below 8% for the first time since June. The challenge for businesses, consumers, and policymakers is that the core rate is still accelerating. It is expected to make a new cyclical high of almost 8.6%. The central bank is expected to match what has been tipped as a half-point hike by the Fed next week. The market expects some separation between the Fed and Banixco later next year. While the swaps market has the Fed raising 100 `bp between now and the middle of next year, it has about 80 bp priced in for Mexico. As widely expected, Brazil's Selic rate was left at 13.75% by the central bank yesterday. Today, Brazil reports October retail sales. A small gain is expected after a heady 1.1% increase in September. Lastly, the dollar soared against the Peruvian sol yesterday as President Castillo tried to dissolve Congress. He was impeached and arrested instead. Vice President Dina Boluarte is the new president and the dollar reversed lower and settled at a new low for the week.
A 50 bp hike by the Bank of Canada in what seemed to have been a close call did not help the Canadian dollar very much though it settled little changed on the day. The possibility that the monetary cycle is finished and the weakness in US stocks may have deterred buying. Initial support today is seen around CAD1.3640. The risks though are for a weaker Canadian dollar if US stocks continue to unwind the rally that began in mid-October. After jumping on Monday, the greenback is carving a range against the Mexican peso. A shelf has been carved around MXN19.6200-50. And a cap has been formed around MXN19.86. Within that range, a break of MXN19.63-MXN19.75 may signal the near-term direction.