Havens Remain in Favor as North Korean Jitters Persist

new arrow

  • The net impact of renewed Korean tensions is to lift the US dollar, yen, and gold 
  • After leaving rates on hold, RBNZ officials said that a weaker currency was “needed” 
  • France and the UK reported industrial production data for June  
  • Bangko Sentral ng Pilipinas kept rates steady at 3.0%, as expected; Mexico and Peru expected to remain on hold too

The dollar is mostly firmer against the majors as markets continue to trade nervously. The yen and Stockie are outperforming, while Kiwi and the euro are underperforming. EM currencies are mostly softer. ZAR and CNY are outperforming, while KRW and RON are underperforming. MSCI Asia Pacific was down 0.4%, with the Nikkei falling 0.1%. MSCI EM is down 0.7%, with the Shanghai Composite falling 0.4%. Euro Stoxx 600 is down 0.4% near midday, while S&P futures are pointing to a lower open. The 10-year US yield is down 1 bp at 2.24%. Commodity prices are mixed, with Brent oil up 1%, copper flat, and gold up 0.2%.

It is difficult to walk back the saber-rattling rhetoric. US Secretary of State Tillerson tried to diffuse the situation, which had appeared to ease nerves in North America yesterday. However, references to the modernization of US nuclear forces, a multi-year project begun last year, spurred a fresh threat by North Korea to fire four intermediate range missiles near Guam in a week’s time. This in turn brought fresh condemnation in from Japanese and Korean officials.

The net impact is to lift the US dollar, yen, and gold. The geopolitical tensions saw more profit-taking in equities. Debt markets are little changed, but US Treasuries are a little firmer. We suspect that like yesterday, North American participants are likely to unwind some of the anxiety-led price action. Some suspect that the US rhetoric is aimed at putting more pressure on China, but others appear see the US visceral response as part of the current administration’s modus operandi.

There is a search for historical parallels, and although many suggest the Cuban Missile Crisis, we suggest a more apropos precedent is Iran. Still, some recall Nixon’s “madman theory,” which is essentially keeping one’s adversary off balance by having them think that one is unpredictable and is capable of anything.

In any event, South Korea bears the brunt of the adjustment. The Korean won fell nearly 0.6% following yesterday’s 0.9% slide. It is the third day this week that the won fell and it is set to extend its down draft for a fourth week. For the better part of the past six months, the dollar has traded between KRW1110 and KRW1160. At the end of July, the greenback tested the lower end of the range. Near KRW1142, the it has approached levels last seen in early July.

Part of the pressure stems from foreign investors selling Korean shares. The Kospi fell 0.4% for its third consecutive loss. Its loss this week of about 1.5% is minor. Foreign investors sold about $230 mln of Korean shares today after selling $270 mln yesterday. Still, we note that the Kospi recovered in late dealing that pared its losses by nearly 2/3 before the close.

Hong Kong and Taiwan shares fell more than Korea today, losing 1.1% and 1.3% respectively. The MSCI Asia Pacific Index fell a little less than 0.5%, on par with Wednesday’s loss as well. It has gained once (Monday) in the past five sessions. European markets are also modestly lower. The Dow Jones Stoxx 600 is off about 0.3%, led by energy and materials. It fell nearly 0.75% yesterday.

The debt markets are narrowly mixed. Most European 10-year benchmark yields are a little firmer, and the two-year sector yields edging higher as well, which is producing a minor bearish flattening of the curve. US yields are a fraction softer. Gold reached almost $1280 yesterday, and the attempt to extended the gains today appears to be fizzling in the European morning.

Of the major currencies, the New Zealand dollar has been the hardest hit. It is off just shy of 1% as the market responded to stepped up warnings by the central bank. After leaving rates on hold, as widely expected, RBNZ officials said that a weaker currency was “needed.” Last time, officials said a weaker currency would be “helpful.” There is some thought that the rhetoric was a prelude to intervention. The New Zealand dollar is recording a large outside day and a close below yesterday’s low (~$0.7310) is needed. We see near-term potential extending toward $0.7200.

France and the UK reported industrial production data for June. France disappointed. French industrial output fell 1.1% in June, while the median Bloomberg forecast was for a 0.6% decline after May’s 1.9% gain. It suggests a possible loss of momentum as Q2 drew to a close, and is consistent with the July PMI that showed a slower start to Q3.

Although it has not emerged as a market factor, we think Macron’s waning support (below US President Trump’s support in the US) is important. It will impact Macron’s ability to push his reform agenda, which we note that his two predecessors were also stymied in their reform efforts. It will also impact the Franco-German relations after next month’s German elections.

The UK reported better than expected industrial output figures but the impact on Q2 GDP estimates is minor. Industrial output rose 0.5% instead of 0.1% as many economists expected. The May series was revised from-0.1% to flat. The year-over-year rate stands at 0.3%. In May it was -0.2%. However, the rise in UK industrial output was a bit of a fluke.

Manufacturing output was flat and the fact that the North Seas producers did not shut for the normal summer maintenance appear to be behind the better report. Vehicle production fell 6.7%, the largest drop in 3.5 years. Construction output fell 0.1.%. The median forecast in the Bloomberg survey was for a 1.4% gain. On the other hand, the May series was revised to show a 0.4% decline rather than the original 1.4% fall.

Separately, the UK reported that its trade balance deteriorated in June. The visible deficit (merchandise) increased to GBP12.7 bln from GBP11.3 bln in May. The overall deficit (combines with service surplus) was GBP4.56 bln from GBP2.51 bln in May. UK exports (by volume) was off by 0.7%, while the total value was off 2.8%. Imports rose 3.3%.

The J-curve effect, whereby a depreciating currency first cause deterioration in the trade balance before improving, is thought to be nearly over. The weakness of sterling (even if not against the dollar) is expected to generate import-substitution behavior by consumers and businesses, and this was picked up in the recent BOE recent agent survey.

The euro seems to be in nearly a cent range–$1.1680-$1.1770. There are 515 mln euro options struck at $1.17 that expire today. A break of $1.1680 would target $1.16. The dollar also appears to be confined to a little less than a big figure against the yen (~JPY109.50-JPY110.40). A break of JPY109.40 would target JPY109. Sterling has flirted with the week’s low near $1.2950. Additional support is seen near $1.2930, which is a retracement objective of the rally since late June, and a convincing break could spur another cent decline. There are options struck at GBP0.9050 (~612 mln euros) that will be cut today.

Meanwhile, the Canadian dollar has fallen out of favor. Recall it fell every day last week and is off for the third day (0.2%) this week. The US dollar is at its best level in nearly a month (~CAD1.2735). Near-term potential extends toward CAD1.2770-CAD1.2810). The Australian dollar is consolidating within yesterday’s ranges, but it looks poised to retest yesterday’s highs near $0.7920.

The US reports weekly jobless claims and July PPI (2.2% y/y headline and 2.1% y/y core expected. NY Fed President Dudley holds a press briefing.

Bangko Sentral ng Pilipinas kept rates steady at 3.0%, as expected. This was Governor Espanilla’s first meeting at the helm. The bank raised its 2017 and 2018 inflation forecast to 3.2% from 3.1% and 3.0%, respectively. Note CPI rose 2.8% y/y in July, below the 3% target but within the 2-4% target range. We think the central bank will remain on hold into 2018.

Banco de Mexico is expected to keep rates steady at 7.0%. July CPI rose a slightly higher than expected 6.44% y/y, up from 6.31% in June. With price pressures showing signs of picking up, the central bank will have to sound hawkish but for now, we believe the tightening cycle is still on hold.

Peruvian central bank is expected to keep rates steady at 3.75%. CPI rose 2.9% y/y in July, above the 2% target but within the 1-3% target range. Since the easing cycle started in May, the bank has been cutting every other meeting. Since it cut in July, we think it will likely remain on hold this month and cut at the September 14 meeting.