Markets Looking for a New Focus

new bulbs

  • Spanish assets are rallying following Puigdemont’s attempt to square the circle yesterday by deferring the independence announcement
  • New revelations came from Japan’s Kobe Steel that its deception of its materials extends beyond copper and aluminum
  • The highlight from the US today will be the FOMC minutes from the September 20 meeting
  • MXN is the second worst performer in EM this week (behind TRY) on NAFTA concerns
  • Taiwan reported strong September trade overnight; Brazil August retail sales are expected to rise 4.4% y/y

The dollar is mixed against the majors.  The yen and Nokkie are outperforming, while sterling and Loonie are underperforming.  EM currencies are mostly firmer.  TRY and ZAR are outperforming, while CNY and SGD are underperforming.  MSCI Asia Pacific was up 0.1%, with the Nikkei rising 0.3% despite the widening Kobe Steel scandal.  MSCI EM is up 0.3%, with the Shanghai Composite rising 0.2%.  Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year US yield is down 2 bp at 2.34%.  Commodity prices are mixed, with WTI oil up 0.8%, copper down 0.2%, and gold up 0.1%.

The US dollar is consolidating after retreating since reversing lower following the US jobs data at the end of last week.  While the greenback has largely been confined to yesterday’s ranges against the major currencies, the euro has made a marginal new high, briefly trading through the $1.1830 area noted yesterday.

Spanish assets are rallying following Puigdemont’s attempt to square the circle yesterday by deferring the independence announcement.  He claims he is entitled to make this deferral for a few “weeks,” hoping for talks with Madrid.  Prime Minister Rajoy has called an emergency cabinet meeting for today, and reports suggest he has started the process that could lead to the suspension of the Catalan government.  Madrid is seeking greater closure, but it will likely reject any talks under the threat of secession.  If Puigdemont gives up the drive for independence, what political future has he?

Spain’s 10-year bond yield is off three bp while the comparable yield in Italy is off less than a single basis point, and core bond yields are slightly higher.  Spanish stocks are up 1.3%, outperforming all the major bourses today.  Telecoms and real estate of leading what is a broad advance.  Only consumer staples are lower, and this is due to a sell-off a leading supermarket.

New revelations came from Japan’s Kobe Steel that its deception of its materials extends beyond copper and aluminum to include iron ore powder and an unspecified metal still being investigated.  Kobe Steel saw its share prices fell another 18% after yesterday nearly 22% decline.  Nevertheless, the Nikkei and Topix managed to post minor gains, which were sufficient to lift both to new two-year highs.

The dollar, which briefly dipped below JPY112 yesterday, is trading inside yesterday’s range.  On the one hand, this may suggest a bit of resilience on the dollar’s part, as the US 10-year Treasury yield is off nearly two bp (@~2.34%).  On the other hand, the dollar has not been able to distance itself from the 20-day moving average, which is near JPY112.20.  The dollar has not closed below the 20-day moving average since September 11.  A break is seen testing support near JPY111.50.

The US 10-year yield had risen to 2.40% in the initial response to the jobs data.  This is the upper end of the six-month range.  Some profit-taking on the run up from nearly 2.0% on September 8 should not be surprising nor require a large explanation.  Nevertheless, many accounts see doubts over US tax reform as the proximate driver.

First, several Senators appear to be carving out a position that is critical for various reasons.  Second, there is an ongoing squabble between the White House and Senator Corker, a fiscal hawk, and an early supporter of the President.  Third, Trump himself has indicated he will adjust his tax plan in the new few weeks.  Fourth, the IMF has dropped the prospects for fiscal stimulus from the US next year (though it sees the US economy expanding 2.3% in 2018).

China has announced it will raise $2 bln by selling five- and ten-year dollar bonds in Hong Kong shortly.  It is the first time in more than a decade that the central government is issuing dollar bonds.  Despite the recent downgrade and concern over the country’s debt burden, we suspect there will be strong demand for this offering.

It is a relatively small offering.  There is a scarcity of such paper.  While some emerging market countries that borrow dollars may experience a currency mismatch if they do not have sufficient dollar receivables, but that is not China’s problem.  It is sitting on over $3 trillion of reserves, and have, according to US data, bought more than $100 bln of US Treasuries in the first seven months of the year.

The economic highlight from the US today will be the FOMC minutes from the September 20 meeting, at which it provided new economic forecasts and decided to begin its balance sheet operations.  In some ways, the minutes are old news.  The day before the FOMC meeting concluded, Bloomberg calculated a 53% chance of a hike before year end was discounted.  Now it says there is a nearly 77% chance.  On September 19, the December funds futures implied a 1.23% yield.  Today the yield is 1.265%.  Our work suggests fair value, assuming no chance of a November hike, is 1.29%.

Lastly, we note that the fourth round of the NAFTA negotiations is set to begin.  Although some progress had been reported in earlier rounds, there is a sense of foreboding about the new round, which will discuss domestic content rules that will prove very controversial. Ironically, the US is pushing for a higher minimum wage in Mexico, and Canada wants better labor rights in the US.

Reports suggest the US is arguing that 85% of vehicles must be made in NAFTA countries to count and up to as much as 50% must originate in the US.  Such a demand, coupled with the push for a “sunset” clause (which would end NAFTA at some future date unless explicitly endorsed by all three countries) is seen as part of the “poison pill” strategy, according to the Chamber of Commerce.  The idea is that although Trump backed off from his threat to leave NAFTA, his Administration’s demands will not produce an agreement.

The US Congress will ultimately have to ratify the final agreement.  Just like the White House stance spurred a bipartisan response from Congress regarding sanctions against Russia, North Korea, and Iran, there seem to be bipartisan efforts to resist a disruption of supply chains and trade relations.  This is part of the check and balances, which, at least up until now.

Note MXN is the second worst performer in EM this week (behind TRY), with USD/MXN testing the 200-day MA near 18.84.  Break of 18.59 sets up a test of the April high near 19.2955.  Concerns about NAFTA seem to be the major factor behind peso weakness.  Late yesterday, Mexican Economy Minister Guajardo said Mexico could leave the negotiating table, adding that there is life after NAFTA.  Part of this is posturing amidst ongoing negotiations, but it’s still not a good sign.

Taiwan reported strong September trade overnight.  Exports rose 28.1% y/y, double the expected 13.6% y/y, while imports rose 22.2% y/y vs. 9.8% expected.  The external accounts remain in good shape, and export orders remain strong enough to suggest that this trend will continue.  Taiwan data also suggests upside risks to China’s trade data due Friday.

Brazil August retail sales are expected to rise 4.4% y/y vs. 3.1% in July.  The economy is finally picking up, as is inflation.  This supports the central bank’s intent to slow the pace of easing.  We look for a 75 bp cut to 7.5% on October 25 followed by a 50 bp cut to 7% on December 6 that should effectively end the easing cycle.