RBA Jettisons Yield Curve Control But Continues To Resist Market Pressure

Summary

• The third record close of the S&P 500 failed to lift Asia Pacific and European shares today.
• The Reserve Bank of Australia formally abandoned its yield-curve control, and the local debt market was quiet, but the Australian dollar is selling off and dragging the other dollar-bloc currencies lower.
• Gold continues to consolidate within the range set before the weekend but is a bit softer on the day.

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Overview: The third record close of the S&P 500 failed to lift Asia Pacific and European shares today. In Asia, the large bourses fell, except South Korea, which rallied a little more than 1%. Europe's Stoxx 600 is threatening to snap a three-day advance, while US index futures are soft. The US 10-year yield is firm, around 1.56%. European bonds are rallying. Peripheral yields are off 8-9 bp, while core rates are 3-5 lower. The Reserve Bank of Australia formally abandoned its yield-curve control, and the local debt market was quiet, but the Australian dollar is selling off and dragging the other dollar-bloc currencies lower. Only the yen, among the majors, is gaining on the greenback. Emerging market currencies are faring better, led by Asian currencies and most central and eastern European currencies. The JPMorgan Emerging Market Currency Index is rising for the first time in five sessions. Gold continues to consolidate within the range set before the weekend (~$1771-$1801) but is a bit softer on the day. Oil prices are firm, and the December WTI contract is at the upper end of the $80-$85 range that has prevailed since mid-October. Copper initially moved higher but reversed lower, and a break of $432 could signal another two percent decline.

Asia Pacific

The Reserve Bank of Australia formally jettisoned its yield-curve control of targeting the April 2024 bond yield at 10 bp. The market expected this after the RBA had been missing in action as the yield soared. Today, the on-the-run 3-year yield fell six basis points after falling 21 yesterday. It has now returned below 1%. Governor Lowe did not fully capitulate but is trying to hold on to a middle ground. He said the central bank will be patient on rates, and it is still plausible not to raise rates until 2024. However, he acknowledged rates could be lifted in 2023. The swaps market is pricing in almost 80 bp of tightening over the next 12 months, with a 10 bp hike seen in six months.

European and American equities have recovered from the wobble in mid-September that sparked fear that Evergrande's (EGRNF) losses would trigger a Lehman-like event. Yet, the problem with Chinese property developers continues, even though Evergrande took advantage of its 30-day grace period, it serviced its debt. China's high yield bond market is dominated by the property development sector. The yields rose for eight consecutive sessions through yesterday and briefly rose above 20% last week. Estimate debt servicing costs amount to around $2 bln this month. House sales and prices are falling, a separate challenge to the economy than the energy crunch and high commodity prices. It is still unclear whether Chinese officials are prepared to take more decisive action to support the economy, like a cut in reserve requirements. New economic initiatives may emerge from the Communist Party's Central Committee meeting (November 8-11). Officially it will focus on the achievements in preparation for the 20th Congress next year that will likely confirm another term for President Xi but possibly shuffle other senior posts.

The dollar rose to almost JPY114.45 yesterday and has come back offered today. It has slipped below the 20-day moving average (~JPY113.55) for the first time since September 23. Last week's low was closer to JPY113.25. A break of JPY113.00 could signal losses toward JPY112.60 initially. The price action is lending credence to the JPY114.50-JPY115.00 being the top of the new range. The lower end of the range is less clear. The Australian dollar's 4% rally led the majors last month, but it stalled near the 200-day moving average (~$0.7555) and is breaking down today. It has taken out last week's lows (~$0.7465) marginally, but the downside momentum has continued in the European morning. There is near-term scope toward $0.7435 and maybe $0.7410. The PBOC set the dollar's reference rate at CNY6.4009, firmer than the median (Bloomberg) forecast of CNY6.3986. The gap was slightly wider than it has been. The last time the gap was more than 20 pips was October 20. So if it is a protest, it is still faint. Meanwhile, stricter virus curbs took a toll on Chinese equities. The greenback has risen above CNY6.40 on an intraday basis but continues to struggle to sustain it on a closing basis.

Europe

The EMU final manufacturing PMI was slightly lower than the preliminary estimate, owing to a softer than expected Spain reading and a downward revision in Germany. The aggregate stands at 58.3, down from 58.5 initially and 58.6. It is the fourth consecutive decline, but it can hardly be considered weak. Germany's manufacturing PMI was lowered to 57.8 from the 58.2 preliminary projection and 58.4 in September. The French reading was tweaked up to 53.6 from 53.5. It is still down from 55.0 and is the fifth straight loss. Spain disappointed with a 57.4 report. It was projected to be unchanged at 58.1, which seemed optimistic from the get-go. Italy offered an upside surprise. Its manufacturing PMI rose to 61.1 from 59.7. Economists had expected some slippage.

Some pressure on the euro appeared to be coming from the cross against the Swiss franc. Since the Fed met in September through the end of last week, the euro fell about 3.35% against the franc. Sight deposits rose steadily in October after falling in the first half of September. Last week's increase was the most in two months as the euro broke below CHF1.08 for the first time since May 2020. The rise in sight deposits is consistent with stepped-up intervention by the Swiss National Bank. Yesterday, the euro fell against the Swiss franc, even as it rose against the dollar. Clearly, the intervention is not arresting the euro's weakness. SNB is more likely moderating the decline. Moreover, if the SNB also seeks to maintain a certain currency allocation of its reserves, it needs to acquire dollars after acquiring euros. And if it does not want to grow reserves like Japan or China, it will sell some of the euros for dollars, minimizing the intervention effect on reserve accumulation. The value of the SNB's reserves declined slightly in the year through September.

The pace of the euro's decline against the franc has accelerated in the past two sessions and closed below the lower Bollinger Band (two standard deviations below the 20-day moving average) for the second consecutive session. Last year's low was set near CHF1.05 and yesterday, and the euro pushed briefly through CHF1.0550. It is now near CHF1.0570. The next technical support may be around CHF1.0250. However, speculators in the futures market see it differently. They have the largest net short franc position (~19.3k contracts) since December 2019 and the smallest gross longs (~1245 contacts) since 2003.

French President Macron is holding back from imposing retaliatory measures against the UK over the fishing license dispute. Reports suggest that Jersey is considering granting temporary licenses to French trawlers. Separately, despite some confusing gas flows yesterday (from Germany to Poland), Russia says Putin's promise to boost gas shipment to Europe starting next week, after Gazprom completely rebuilding its domestic inventories, remains intact. Look for results shortly of the auctions for pipeline capacity.

After falling a little more than 1% before the weekend, the euro bounced back yesterday and managed to close above $1.16. Follow-through buying was limited to about $1.1615, but it has struggled to sustain the positive momentum. There is an option for 1.8 bln euros at $1.1585 that expires today. A break signals a test on nearby support seen in the $1.1540-$1.1560 area. Last week's low was about $1.1535, and the year's low is closer to $1.1525. Sterling is off for the third consecutive session. It reached $1.3630, the lowest level since October 14, which is about the (50%) retracement objective of last month's rally. Some sales may have been related to the GBP316 mln option at $1.3650 that expires today. The next (61.8%) retracement is by $1.3575.

America

Today is the quietest day of the week for North American economic data. However, there is one feature, monthly autos sales. Due to the supply chain disruptions, especially semiconductor chips, auto production has been crushed, and by extension, auto sales. This is not limited to the US by any means. Yesterday, Japan reported that October auto sales off slightly more than 30% year-over-year in October. European auto registrations, a proxy for sales, were down 23.1% year-over-year in September. Last week's Q3 GDP showed that growth was halved to 4% but the problems in the auto sector. In September, US auto sales were about 25.5% below September 2020 sales. Bloomberg's survey found a median forecast for October sales of 12.5 mln vehicles (seasonally adjusted annual basis), which would be the first increase since April. Cox Automotive warns of another decline to 11.8 mln vehicles.

The US Treasury unexpectedly boosted its Q4 borrowing needs to about $1.02 trillion, or around $312 bln more than it anticipated in August. It appears to be largely a function of adjusting its cash balances and the calculations around the debt ceiling. It is projecting Q1 22 borrowing needs at less than half of the Q4 sum. Of course, it is assuming that the debt ceiling will be raised or suspended. Still, tomorrow's quarterly refunding announcement is expected to reduce its coupon offerings for the first time since 2016. Separately, but not totally unrelated, the Democratic Party is still struggling to agree on the infrastructure initiative.

The US dollar continues to consolidate against the Canadian dollar but is enjoying a firmer tone today. The Bank of Canada met on October 27, and it surprised the market by ending its bond-buying program and acknowledging the risk of an earlier hike. The US dollar covered a range of roughly CAD1.2300 to CAD1.2435. It has remained in that range since then. We note that speculators in the futures market switched to a net long position for the first time since early September in the week through last Tuesday. The greenback is knocking on initial resistance in the CAD1.2400-CAD1.2410 area, and a break could signal a move toward CAD1.2430-CAD1.2450. An option for about $900 mln expires tomorrow at CAD1.2450. The greenback has a five-day rally in tow against the Mexican peso. Earlier today, it pushed above last month's high (~MXN20.90), but it has stalled. It is trading little changed on the session around MXN20.8500 as the North American session is about to start. Still, unless it can break below MXN20.80, we look for higher levels. That said, the pace of the dollar's rally is threatening the upper Bollinger Band (~MXN20.95).

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.