Sterling Continues to Shine

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  • Another North Korea missile launch failed to have much impact in the capital markets
  • Sterling is the big winner of the week
  • US reports a slew of data
  • Israel August CPI is expected at -0.1% y/y; Russia central bank is expected to cut rates 50 bp to 8.5%

The dollar is mostly softer against the majors.  Sterling and Kiwi are outperforming, while the yen and Loonie are underperforming.  EM currencies are mixed.  MYR and PLN are outperforming, while ZAR and MXN are underperforming.  MSCI Asia Pacific was flat, with the Nikkei rising 0.5%.  MSCI EM is up 0.2%, with the Shanghai Composite falling 0.5%.  Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year US yield is up 1 bp at 2.20%.  Commodity prices are mixed, with Brent oil up 0.2%, copper flat, and gold down 0.4%.

Another North Korea missile launch failed to have much impact in the capital markets.  The missile apparently flew the furthest yet, demonstrating its potential ability to hit Guam.  However, there was not an immediate response from the US.  South Korea said it had simultaneously conducted its own drill which included firing a missile into the Sea of Japan (East Sea).

The yen initially popped higher.  The greenback fell to around JPY109.55 after briefly pushing through JPY111.00 in North America yesterday.  The dollar quickly bounced off the 20-day moving average, which also coincided with a 38.2% retracement of this week’s dollar gains (~JPY109.60).  Good buying was seen and the dollar returned to the JPY110.80 by late in the Asia session.

Korea shares rose 0.35%, its fourth advance in the past five sessions, to bring the weekly gain to 1.8%.  The rise came despite continued foreign liquidation.  Foreign investors sold $305 mln worth of Korean shares ahead of the weekend, which was nearly half of the week’s sales.  The Kospi closed near its best levels in a month.  The won, on the other hand, slipped around 0.4% over the past week.  More broadly, the MSCI Asia Pacific Index rose about 0.6% on the week, its fifth weekly increase.  This regional benchmark has had one losing week since early July.

While media trumpets that the Chinese yuan had its biggest weekly fall of the year, it needs to be put in context.  The yuan’s decline was about 0.7%.  Recall that under the old Bretton Woods system, one percent movement was consistent with a pegged regime.  Moreover, the yuan had risen about 2.6% in the previous three weeks.  It was not simply a case of a soft yuan, though the PBOC consistently set the fixing rate lower and removed some disincentives to short the yuan, but the dollar was also generally well bid.  The Dollar Index, for example, rose as much as the yuan fell.  Chinese data disappointed and the Chinese shares traded heavily after the data, giving back the gains scored earlier in the week.

Sterling is the big winner of the week.  The BOE’s hawkish forward guidance sent sterling sharply higher yesterday and it is building on those gains today, reaching $1.3450.  Today, similarly hawkish comments from BOE’s Vlieghe have helped sterling.  Even news of a potential terrorist incident in the London underground earlier today did nothing to deter sterling.  Cable had finished last week near $1.32 and had finished last month near $1.2930.  The implied yield on the December short-sterling futures contract rose 13 bp on the week through yesterday, while the yield on the 10-year Gilt rose 18 bp.

While sterling gained around 1.7% against the dollar (@~$1.3425), the euro slid about 2.6% against it (@~GBP0.8880).  The prospect that the BOE raises rates while the ECB announces an extension of its purchases, which given the sequencing that has been outlined means that the UK could be a year ahead of the ECB in raising rates, caught many participants wrong-footed.

Given the importance the MPC placed on high frequency data, sterling is likely be particularly sensitive to the data flow in the coming weeks.  Interpolating from the OIS, the market appears to be pricing in a greater chance that the BOE hikes this year (~64%) than the Fed (Bloomberg ~47%; our own calculation suggests that a little less than a 40% chance has been discounted).

Ahead of the weekend the US reports a slew of data.  The most important are the August retail sales and industrial output figures.  We suggest there is upside risk to the median forecast that US retail sales rose 0.1% August.  That risk stems partly from prices, like gasoline, and partly from volume, as the Redbook weekly figures have been rising.  The market has already seen that auto sales were softer.

Industrial output is also expected to have risen 0.1%.  Here, although the bar is low, we are concerned about downside risks stemming from auto related output and some slippage from the energy sector.  Manufacturing itself may have fared better.  Recall manufacturing employment rose by 36k in August, the largest increase since August 2013, which itself was the largest since March 2012.  Many economists are puzzled by the lack of more robust investment given the low interest rates.  We are struck by the relatively low capacity utilization given the maturity of the expansion cycle.  Capacity utilization rate was 76.7% in July and is expected to be unchanged in August.

The US also reports the Empire State manufacturing survey for September.  It will be overshadowed by the retail sales report.  Later, the University of Michigan’s consumer sentiment and inflation expectations survey will be released.  The long-term inflation expectation stood at 2.5% in August.  It is expected to be unchanged.  It has not been above 2.6% since March 2016.  It has not been below 2.4% this year.  This seems like the definition of stability.

US rates remain elevated.  The 10-year stands near 2.20%, while the 2-year stands near 1.38%.  The 2-year premium to Germany is around 207bp, nearly the highest since April 10.  Bloomberg estimates the odds of a December Fed hike have risen to 50%.  Today’s data will help determine if these US rate trends can be maintained.

There are some large currency options that expire today that could impact trading.  There are 1.8 bln euros struck at $1.19 that will be cut today.  There are 2.2 bln euros struck at $1.20, which seem less relevant now with the euro around $1.1930.  There are $1.6 bln in options struck between JPY110.50 and JPY110.60 that expire today.  There is a more modest GBP206 mln option struck at $1.34 that roll off today.

Israel August CPI is expected at -0.1% y/y vs. -0.7% in July.  If so, this would still be well below the 1-3% target range.  Next central bank policy meeting is October 19, no change expected then.  Near-term, politics will likely trump economics in Israel as a widening corruption probe keeps investors on edge.

Russia central bank is expected to cut rates 50 bp to 8.5%.  However, the market is split.  Of the 16 analysts polled by Bloomberg, 7 see a 25 bp cut and 9 see a 50 bp cut.  August CPI rose 3.3% y/y, lower than expected and below the 4% target.  As such, we lean towards a 50 bp cut.