Risk Appetites Challenged After U.S. Equities Tumble

The sharp sell-off of US stocks yesterday has sapped the risk appetite today. Equities are being sold. Hong Kong and the index of mainland shares listed there led the regional decline with 3.2%-3.3% losses. Europe’s Stoxx 600 is off about 0.65% in late morning turnover, the fourth day of losses. US futures are trading with a lower bias as well.

European 10-year bonds are mostly 1-2 bp firmer. The United States 10-Year Treasury is practically flat at 3.53%. The US dollar is mixed against the G10. Sterling and the euro are the strongest, up about 0.3%, while the yen, Norwegian krone and Canadian dollar are off nearly as much.

Emerging market currencies are also mixed, with the Philippine peso and central European currencies leading the advancers. The South Korean won is the weakest, off a minor 0.2%. Gold continues to consolidate near the lows set Monday (~$1766) after reversing from a nearly six-month peak of almost $1810.

Ja. 23 WTI is extending its losses and trading down to $72.75 today, its lowest level since the first half of January. US natural gas is snapping a five-day drop while the European benchmark edges higher too. Iron ore is off 2.3%, its biggest loss in 2.5 weeks. March copper is giving back yesterday’s 0.6% gain and a bit more. March wheat is posting its first gain since the middle of last week.

Asia Pacific

China has made some self-quarantine and reduction of mandatory testing a national policy. It seems two things are likely to result. First, less testing, as we have learned elsewhere, may lead to fewer cases detected. Secondly, the risk that Chinese hospital capacity is overwhelmed, and death may soar. According to various accounts, this could be a late Q1/early Q2 phenomenon.

China's trade surplus increased by 15% to $69.8 bln from $85.2 bln. Exports fell 8.7% year-over-year in November after a 0.3% decline in October. This is seen reflecting weaker international demand. Exports to the US were off by slightly more than a quarter and accounted for 13.8% of China's shipments, down from 15.8% in October. Exports to the EU fell 10.6% and surpassed the US to account for 15.1% of China's exports. Imports fell 10.6% from a year ago. In October, they were off by 0.7%. The drop in imports is likely due to weaker domestic demand and COVID-related disruptions. In volume terms, China imported more commodities, including coal, oil, natural gas, iron ore, copper, and soy. The US supplied 7.3% of China's imports, the EU 10.1%, while Taiwan's share fell to 7.7% from 9.1%.

Meanwhile, the EU reportedly will take its case to the WTO against China for its restrictions on Lithuania (dispute over Taiwan) and its coercive practices to limit patent holders’ legal rights to protections. Lastly, China's reserve for the second consecutive month in November. The $65 bln increase to $3.117 trillion was a little more than expected and followed a $23.5 bln increase in October. The increase in reserves likely reflects valuation shifts, especially the rise in reserve currencies last month. Notably, China's gold reserves rose for the first time in over three years (63.67 mln ounces from 62.64 mln at the end of October).

Australia's economy grew 0.6% in Q3. The median in Bloomberg's survey saw a 0.7% expansion after 0.9% in Q2. The small miss helped push local yields lower, while the Australian dollar extended its loss after the reversal on Monday. The futures market shows no shift in rate hike expectations, and although a smaller move is possible, the market does not have another 25 bp hike discounted until April 2023.

The US dollar's recovery against the yen continues. The greenback bottomed at the end of last week near JPY133.65 and reached JPY137.85 earlier today. This is a little short of the (50%) retracement of the dollar's losses since November 21 and the lower end of the sideways range seen from November 11 to November 30. Support is now seen in the JPY136.80-JPY137.00 area. The Australian dollar posted a key reversal on Monday after reaching $0.6850. It is extending its losses today to $0.6670. The next area of support is seen near $0.6640 and then $0.6590-$0.6600. The dollar is consolidating within yesterday's range against the Chinese yuan and held below CNY7.0 today. The gap created by Monday's sharply lower opening has not been closed. It extends to last Friday's low (~CNY7.0170). The PBOC set the dollar's reference rate at CNY6.9975. The median in Bloomberg's survey was for CNY7.0015. Lastly, India lifted its repo rate by 35 bp as expected, after three 50 bp moves. The dollar initially edged higher against the rupee (INR82.7675) but has retreated to around INR82.40.

Europe

Germany may be slipping into a recession, but it is resisting. Following yesterday's stronger-than-expected factory orders (0.8% vs. -0.1% forecast) and a sharp upward revision to the September series (-2.9% rather than -4.0%), industrial output surprised today. Rather than fall by 0.6% as the median forecast in Bloomberg's survey had it, Germany's industrial production slipped by 0.1%. September's 0.6% gain was revised to 1.1%. Italy reported October retail sales fell by 0.4% rather than the 0.5% expected. In September, they rose by 0.5%. Meanwhile, tensions between the EU and Hungary are escalating. Hungary is blocking an 18 bln euro package for Ukraine and is threatening to block NATO's enlargement.

UK Prime Minister shows more interest in governing than ruling. Day after diluting the government's stance on house building, it bowed to other pressures among the Tory MPs to end the effective ban on onshore windfarms. It will be left to the local commissions, with the possibility of lower energy bills. Separately, Halifax, a large UK mortgage lender, reported that house prices fell by 2.3% last month, the largest fall in 14 years. It was the third consecutive decline, according to Halifax figures, and the price of the typical property is now almost GBP285.6k (~$346.3k), the lowest since March. Last week, Nationwide Building Society reported its index of house prices fell 1.4% in November., which outside of the pandemic, was the largest decline since the global financial crisis. 

The euro rebounds after setting a new three-day low slightly below $1.0445. It made it to almost $1.05 in early European activity. While some follow-through gains are possible, with the intraday momentum indicators overbought, look for the $1.0520 area to cap it. Sterling also saw some follow-through selling after closing on its lows yesterday. It recorded a three-day low slightly above $1.2105 and recovered to make new session highs in the European morning near $1.2170. The near-term potential extends toward $1.2200. Poland's central bank is expected to remain on hold for the fourth consecutive meeting, with the reference rate at 6.75%. The euro put in the recent low against the zloty at the end of November near PLN4.66 and reached PLN4.7220 yesterday. It is firm near PLN4.70 now. 

America

The Bank of Canada meets today. The market is divided between a 25 bp hike and a 50 bp move. The swaps market has about a 40% chance of a 50 bp hike discounted, while the Bloomberg survey of economists is closer to 50/50. We are more inclined to see a half-of-a-point move but recognize it is a close call in any event. The weakness of the Canadian dollar may be deciding factor. Governor Macklem expressed frustration earlier this year that the central bank had expected the exchange rates to have strengthened in the face of its tightening. The US dollar peaked in mid-October slightly above CAD1.3975 and fell to about CAD1.3225 through mid-November. However, since then, the Canadian dollar has been the weakest of the G10 currencies, falling around 2.6%. The correlation between changes in the exchange rate and changes in the S&P 500 (a proxy for risk appetite) has edged to almost 0.80, the highest in a decade. We also note that the correlation between changes in the exchange rate and WTI has risen to about 0.55 from around 0.40 at the end of Q3.

The US data on tap today is more for economists than market participants. Non-farm productivity and unit labor costs are not measured in themselves but are derived from the GDP figures. The GDP decline in Q1 and Q2 hit productivity while falling by 5.9% and 4.1%, respectively. The 0.3% estimate for Q3 is likely to be revised higher but still poor compared to the pre-COVID pace. Unit labor costs are a mirror of productivity. When productivity weakens, unit labor costs are high (8.5% and 8.9% in Q1 and Q2, respectively). As output recovered in Q3 and productivity rose, unit labor costs eased to 3.5%, which may overstate the case. Today's revision may bring it closer to 3.0%. The US also reports October consumer credit, which will be interesting because, in September, revolving debt (credit cards) usage slowed to $8.3 bln, its slowest pace in four months.

On the other hand, non-revolving credit (think auto and student loans). With wages not keeping pace with inflation, households made ends meet through three channels. First was the drawdown of savings. The second was when homeowners withdrew equity when they refinanced. This channel has dried up as refinancing became less attractive. The third was revolving credit. Consider that it averaged $13.375 bln a month through September this year and $3.9 bln in the Jan-Sept period last year, and $3.25 bln in the first nine months of 2019. A soft number would add to the concern that the consumer is tapped out.

The Canadian dollar remains under pressure. The greenback has risen to its best in a month, reaching CAD1.37. This meets the (61.8%) retracement objective since the high was set on October 13 near CAD1.3975. The intraday momentum indicators are stretched, and early North American traders may be reluctant to sell more Canadian dollars until after the central bank meeting. The performance of US stocks is still important for the Canadian dollar, and the continued sell-off in oil is not helping. After surging on Monday against the Mexican peso, the dollar is continuing to consolidate. So far today, it has been confined to a relatively tight range (MXN19.7350-MXN19.8325). A move above MXN19.8640 would target the MXN20.00 level and then the 200-day moving average (~MXN20.07). Brazil's central bank meets. The Selic rate has been at 13.75% since August and is likely to remain. The swaps market is not convinced it is done and sees scope for as much as 75 bp in the first part of next year. The dollar's recent peak was on November 16, when it reached almost BRL5.53. It fell to almost BRL5.1630 last week and recovered Monday to nearly BRL5.29 before consolidating yesterday.