Emerging Markets Recover With Equities, Euro and Yen Ease

Emerging Markets Recover With Equities, Euro and Yen Ease

  • The end of a horrendous quarter of equities and emerging markets is generating a sigh of relief that is helping lift those battered markets
  • Investors in Japan are focused on the likely policy response to the downdraft in the data
  • The ADP employment estimate will command attention in the North American session; Canada reports July GDP
  • We note that China’s markets are now closed October 1-7
  • Bank Indonesia said it will start FX interventions in the forwards market, joining the growing number of countries stepping up against currency weakness
  • It will be a busy day for Brazil (government approval poll, congressional vote, Petrobras fuel price hike and budget numbers) and for Mexico (second oil block auction)

Price action:  The dollar is mixed against the majors in narrow ranges.  The antipodeans are outperforming, while the yen and the euro are underperforming.  The euro is holding slightly above $1.12 despite lower than expected eurozone CPI inflation.  Sterling remains heavy and continues to trade just below $1.52, while dollar/yen is trading back above 120.  EM currencies are mostly firmer.  MYR, KRW, and ZAR are outperforming while the CEE currencies are underperforming.  MSCI Asia Pacific rose 2.1%, with the Nikkei up 2.7%.  China stocks were slightly higher ahead of the 1-week holiday, with the Shanghai Composite up 0.5% and the Shenzen Composite up 0.3%.  The Dow Jones Euro Stoxx 600 is up 2.3% near midday, while S&P futures are pointing to a higher open.  The US 10-year yield is up 5 bp to 2.10%, while European bond markets are mostly softer.  Commodity prices are mixed, with oil prices down around 0.5% ahead of the US DOE inventory data.

  • The end of a horrendous quarter of equities and emerging markets is generating a sigh of relief that is helping lift those battered markets.  The MSCI Emerging Market is up nearly 2% prior to the open of the Latam markets.  MSCI Asia Pacific Index is up 2.1%.  The Dow Jones Stoxx 600 is up over 2% near midday in London, led by consumer staples and materials.  Core bond yields are firmer, including US 10-year Treasuries, which are back at 2.09% after testing 2.04% yesterday.  Emerging market currencies are mostly higher today.  The dollar bloc currencies have also turned higher.  The Australian and New Zealand dollars are the strongest of the majors, gaining about 0.6% against the greenback.  The Scandies are also recovering.
  • The dollar is still caught up in the large triangle pattern that it has been carving since late-August against the yen.  It tested the lower end of it yesterday, and it held.  The top end of the pattern comes in near JPY120.65 today.  The euro has been confined to less than half a cent range thus far today, within yesterday’s range.  A break of $1.1190 could see $1.1150, but ahead of the US employment data on Friday, the euro is likely to remain confined to its recent ranges.
  • The yen is the weakest of the majors.  It is off 0.4%.  The two drivers, equities and US yields are weighing on the yen.  The economic data was disappointing.   Industrial output fell 0.5% in August.  The consensus was for a 1.0% rise after the 0.8% decline in July.  Contracting output was reported in 10 of the 15 industry groups.  The year–over-year rate stands at 0.2%.  The consensus was for a 1.8% increase.  Retail sales were flat in August, defying expectations for a 0.5% increase.  Inventories are rising (0.4% in August and five of the past eight months).  This understood as a headwind on output.
  • The Tankan survey is out first thing in Tokyo on Thursday.  Sentiment is expected to have deteriorated across the board, and capex plans pared.  Friday sees employment data.  The unexpected weakness in today’s data (leaving aside housing starts, which rose 8.8% year-over-year and beat expectations for a 7.6% pace) has spurred concerns that Japan’s economy may have contracted for the second consecutive quarter.  We note in every year since 2005, Japan has experienced at least one quarter per year of contraction.  In four years, there were at least two quarters of negative growth.
  • Investors in Japan are focused on the likely policy response to the downdraft in the data.  The risk of a recession (defined as two quarters of contraction) is heightening speculation of a supplemental budget (though Prime Minister Abe has played this down) and changes in the BOJ’s asset purchases.  A recent Bloomberg survey shows that about a third of the respondents expects the BOJ to step up its efforts (from JPY80 trillion a year) as early as next month.
  • Last week, investors learned that Japan’s core measure of inflation (which excludes fresh food) dipped back into deflation for the first time since April 2013.  Today, investors learned that deflation returned to EMU in September for the first time since March.  The dramatic slide in Spanish prices and softer than expected German CPI yesterday gave strong hints of disappointment today and surveys were not readjusted to incorporate that information.  Energy prices are likely the main culprit, as core inflation was steady at 0.9%.  The ECB officials had warned of the risk of a negative CPI print, so they were likely not surprised by the news.  This in turn suggests that this news may not be sufficient to spur the ECB into altering its asset purchase purchases when it meets next month (October 22).
  • The ADP employment estimate will command attention in the North American session today.  The consensus is for a repeat of the August estimate of 190k.  Then, small firms and services led the employment growth.  The market may be more sensitive to a weak number than a strong one.  Four Fed officials speak today.  Yellen, Bullard, and Brainard speaking on community banking may not be the stuff that moves markets.  However, this will be Yellen’s first speech since she faltered, appearing disoriented, at her lecture at Amherst last week that sparked speculation about her health.  Dudley speaks first on market liquidity.  He has recently endorsed the Fed’s position that a rate hike this year is still likely.
  • Canada reports July GDP today.  The consensus looks for a 0.2% increase.  We see downside risks, and a negative reading would likely hit the Canadian dollar hard.  The 0.5% growth in June, the first positive monthly GDP this year, was flattered by the end of the shutdowns and production issues in the oil/gas sector.  It rose by 3.9%, with a 9.4% rise in non-conventional oil extraction.
  • We note that China’s markets are closed October 1-7.  Of particular interest is that officials have succeeded in closing the gap between the onshore (CNY) and offshore (CNH) yuan.  In fact, for the first time since June, the onshore yuan is at a discount to the offshore yuan.  While action by the central bank is thought to have driven the developments, arbitrage between the two has reportedly resumed.  Note that the 20% withholding on forward positions only applies when the onshore yuan is being sold, not when it is being bought.  The arbitrage then is selling dollars for onshore yuan and then buying dollars against the offshore yuan.
  • The central bank of Indonesia said it will start FX interventions in the forwards market, joining the growing number of countries stepping up against currency weakness. Separately, Trade Minister Lembong was quoted as considering emergency measures, which some may interpret as protectionism. We would downplay his comments for two reasons.  First, it would be out of line with President Jokowi’s push for deregulation and cut in red tape.  Second, we believe that, despite the country’s fragilities, there are some encouraging signs from the external accounts.
  • It will be a busy day for Brazil.  A major polling company will release the latest numbers on the government’s approval ratings shortly.  The last survey was conducted in June and her disapproval rating was at 83%.  A poor number should be expected, but these surveys take an increasing importance now that congress is deciding whether to push forward the impeachment process.  On the positive side, congress is due to vote on the remaining presidential vetoes on spending increases today, and it appears as if the chances of maintaining the vetoes have increased.  This is largely due to the horse trading ahead of the cabinet reshuffle, where President Rousseff is likely to give its rebellious coalition partner, the PMDB, some important ministries.  Separately, Petrobras increased the price of charges refineries late yesterday, hiking gasoline prices by 6% and diesel prices by 4%.  The last time it did this was in November 2014.  The move comes as investors become increasingly concerned about the company’s debt.  Petrobras’ 2024 USD bond, for example, is now trading at a yield of over 12% and its 5-year CDS is over 1000.
  • Lastly, Brazil reports August consolidated budget data, with the primary balance seen at -BRL12.3 bln.  If so, the 12-month total would narrow slightly.  On Tuesday, the central government budget deficit came in narrower than expected at -BRL5.1 bln (vs. -BRL10.7 bln consensus), and so the consolidated could come in better than expected too.  This improvement is likely to prove temporary and linked to delayed expenditures.
  • Mexico will hold its second oil block auction today.  The first auction in July was a flop, and only 2 of the 14 exploration blocks in shallow waters were awarded.  Head of Mexico’s National Hydrocarbons Commission Zepeda said it best:  “The lessons from the first tender were that the consortium rules were too restrictive, the financial guarantees were too high and there was the issue of the timing of disclosure of the minimum price.  The rules are now more flexible, the guarantees lower and the minimum prices were disclosed two weeks before the auction.  We did our homework. This was a learning process, and we have learnt.”
  • On the EM data front, Turkey’s August trade gap came in close to expectations at -$4.9 bln vs. -$7 bln in July.  The 12-month total deficit has narrowed to around -$75 bln from -$79 bln in July.  This is the lowest total since January 2011, and the external accounts should continue to improve near-term.  Exports are contracting, but imports have collapsed even more due to the economic slowdown.  Yet price pressures remain too high for the central bank to ease.  Poland reports September CPI later today and is expected at -0.7% y/y vs. -0.6% in August.  Deflation remains persistent and should prevent the central bank from tightening until well into 2016.  And if the downside risks to the economy increase enough, we would not rule out a resumption of the easing cycle.