Markets Look For Direction

Aug. 17, 2022 8:00 AM ETFXA, FXC, CYB, EROTF, ULE, EUO, FXE, FXY, JYNFF, YCL, YCS, FXF, FXB, GBBEF, UUP, USDU, UDN
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Marc Chandler
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Summary

  • The two US rivals, China and Russia, have been hobbled by their own actions, while the two main US economic competitors, the eurozone and Japan, are experiencing a dramatic deterioration of their external balance.
  • Although the UK economy contracted in Q2 and the BOE sees a sustained contraction beginning soon, the market recognizes that the monetary policy will continue to tighten.
  • Retail sales are reported in nominal terms, which means that the 13% drop in the average retail price of gasoline will weigh on the broadest of measures.

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Overview: The biggest development today in the capital markets is the jump in benchmark interest rates. The US 10-year yield is up five basis points to 2.86%, which is about 10 bp above Monday's low. European yields are up 9-10 bp. The 10-year German Bund yield was near 0.88% on Monday and is now near 1.07%. Italy's premium over German is near 2.18%, the most in nearly three weeks. Although Asia Pacific equities rallied, led by Japan's 1.2% gain, but did not include South Korea, European equities are lower as are US futures. The Stoxx 600 is struggling to extend a five-day rally. The Antipodeans are the weakest of the majors, but most of the major currencies are softer. The euro and sterling are straddling unchanged levels near midday in Europe. Gold is soft in yesterday's range, near its lowest level since August 5. While $1,750 offers support, ahead of it there may be bids around $1,765. October WTI is pinned near its lows around $85.50-$86.00. The drop in Chinese demand is a major weight, while the market is closely monitoring developments with the Iranian negotiations. US natgas is edging higher after yesterday's 6.9% surge to approach last month's peak. Europe's benchmark is 4.5% stronger today after yesterday's 2.7% pullback. Iron ore fell (3.9%) for the fourth consecutive decline. The September contract that trades in Singapore is at its lowest level since July 22. September copper is a little heavier but is still inside Monday's range. September wheat is extending its pullback for the fourth consecutive session. It had risen in the first four sessions last week. It is moving sideways in the trough carved over the past month.

Asia Pacific

The Reserve Bank of New Zealand delivered the anticipated 50 bp rate hike and signaled it would continue to tighten policy. It did not help the New Zealand dollar, which is posting an outside day by trading on both sides of yesterday's range. The close is the key and below yesterday's low (~$0.6315) would be a bearish technical development that could spur another cent decline. It is the RBNZ's fourth consecutive half-point hike, which followed three quarter-point moves. The cash target rate is at 3.0%. Inflation (Q2) was stronger than expected rising 7.3% year-over-year. The central bank does not meet again until October 5, and the swaps market has a little more than a 90% chance of another 50 bp discounted.

Japan's July trade balance deteriorated more than expected. The shortfall of JPY1.44 trillion (~$10.7 bln) from JPY1.40 trillion in June. Exports slowed to a still impressive 19% year-over-year from 19.3% previously, while imports rose 47.2% from 46.1% in June. The terms-of-trade shock is significant in both Japan and Europe. Japan ran an average monthly trade deficit of about JPY1.32 trillion in H1 22 compared with an average monthly surplus of JPY130 bln in H1 21. The eurozone reported an average shortfall of 23.4 bln euros in H1 22 compared with a 16.8 bln average monthly surplus in H1 21. The two US rivals, China and Russia, have been hobbled by their own actions, while the two main US economic competitors, the eurozone and Japan, are experiencing a dramatic deterioration of their external balance.

The 11 bp rise in the US two-year yield between yesterday and today has helped lift the US dollar to almost JPY135.00, a five-day high. It has met the (50%) retracement target of the downtrend since the multiyear peak in mid-July near JPY139.40. The next target is the high from earlier this month around JPY135.60 and then JPY136.00. Initial support now is seen near JPY134.40. After recovering a bit in the North American session yesterday, the Australian dollar has come under renewed selling pressure and is trading at five-day lows below the 20-day moving average (~$0.6990). It has broken support in the $0.6970- 0.6980 area to test the trendline off the mid-July low found near $0.6965. A break could signal a move toward $0.6900-0.6910. The gap created by yesterday's high US dollar opening against the Chinese yuan was closed today as the yuan recovered for the first day in three sessions. Monday's high was CNY6.775 and yesterday's low was CNY6.7825. Today's low is about CNY6.7690. For the second consecutive session, the PBOC set the dollar's reference rate a little lower than the market (median in Bloomberg's survey) expected (CNY6.7863 vs. CNY6.7877). The dollar has risen to almost CNH6.82 in the past two sessions and still trading a little above CNH6.80 today but was sold to nearly CNH6.7755 where it has found new bids.

Europe

The UK's headline CPI accelerated to 10.1% last month from 9.4% in June. It was above market expectations and the Bank of England's forecast for a 9.9% increase. Although the rise in food prices (2.3% on the month and 12.7% year-over-year) lifted the headline, the core rate, which excludes food, energy, alcohol, and tobacco rose to 6.2% from 5.8% and was also above expectations (median forecast in Bloomberg's survey was for 5.9%). Producer input prices slowed, posting a 0.1% gain last month for a 22.6% year-over-year pace (24.1% in June). However, output prices jumped 1.6% after a 1.4% gain in June. This puts the year-over-year pace at 17.1%, up from 16.4% previously. The bottom line is that although the UK economy contracted in Q2 and the BOE sees a sustained contraction beginning soon, the market recognizes that the monetary policy will continue to tighten. The market swaps market is fully pricing in a 50 bp hike at the mid-September meeting and is toying with the idea of a larger move (53 bp of tightening is discounted).

What a year of reversals for Germany. After years of pressure from the United States and some allies in Europe, Germany finally nixed the Nord Stream 2 pipeline with Russia. Putin also got Germany to do something that several American presidents failed to achieve and that is to boost its defense sending in line with NATO commitments. The energy crunch manufactured by Russia is forcing Germany to abandon its previous strategy of reducing coal and closing down its nuclear plants. Ironically, the Greens are in the coalition government and recognize little choice. A formal decision on three nuclear plants that were to be shuttered before the end of the year has yet to be made, but reports confirm it is being discussed at the highest levels.

Germany's one-year forward electricity rose by 11% to 530.50 euros a megawatt-hour in the futures market years, a gain of more than 500%. France, whose nuclear plants are key to the regional power grid, is set to be the lowest in decades, according to reports. France has become a net importer of electricity, while the extreme weather has cut hydropower output and wind generation is below seasonal norms. The low level of the Rhine also disrupts this important conduit for barges of coal and oil. Starting in October, German households will have a new gas tax (2.4-euro cents per kilowatt hour for natural gas) until 1 April 2024. Economic Minister Habeck estimated that for the average single household the gas tax could be almost 100 euros a month, while a couple would pay around 195 euros. Also, starting in October, utilities will be able to through to consumers the higher costs associated with the reduction of gas supply from Russia. This poses an upside risk to German inflation.

The euro held technical support near $1.0110 yesterday and is trading quietly today in a narrow (~$1.0150-$1.0185) range today. Yesterday was the first session since July 15 that the euro did not trade above $1.02. The decline since peaking last week a little shy of $1.0370 has seen the five- and 20-day moving averages converge and could cross today or tomorrow for the first time since late July. We note that the US 2-year premium over German is testing the 2.60% area. It has not closed below there since July 22. Sterling held key support at $1.20 yesterday and traded to almost $1.2145 today, which met the (50%) retracement objective of the fall from last week's $1.2275 high. The next retracement (61.8%) is closer to $1.2175. The UK reported employment yesterday, CPI today, and retail sales ahead of the weekend. Retail sales, excluding gasoline, have fallen consistently since last July with the exception of October 2021 and June 2022. Retail sales are expected to have slipped by around 0.3% last month.

America

The Empire State manufacturing August survey on Monday and yesterday's July housing starts pick up a thread first picked up in the July composite PMI, which fell from 52.3 to 47.7 of some abrupt slowing of economic activity. The Empire State survey imploded from 11.1 to -31.3. Housing starts fell 9.6%, more than four times the pace expected (median Bloomberg survey -2.1%). It was small comfort that the June series was revised up 2.4% from initially a 2.0% decline. The 1.45 mln unit pace is the weakest since February 2021 and is about 9% lower than July 2021. However, offsetting this has been the strong July jobs report and yesterday's industrial production figures. The 0.6% was twice the median forecast (Bloomberg's survey) and the June decline (-0.2%) was revised away. The auto sector continues to recover from supply chain disruptions, and this may be distorting typically seasonal patterns. Sales rose in June and July, the first back-to-back gain in over a year. To some extent, supply is limiting sales, which would seem to encourage production. Outside of autos, output slowed (year-over-year) for the third consecutive month in July.

Today's highlights include July retail sales and the FOMC minutes. Retail sales are reported in nominal terms, which means that the 13% drop in the average retail price of gasoline will weigh on the broadest of measures. However, excluding auto, gasoline, building materials, and food services, the core retail sales will likely rise by around 0.6% after a 0.8% gain in June. The most important thing that many want to know from the FOMC minutes is whether the bar is set to another 75 bp rate hike. The Fed funds futures market has it nearly 50/50.

Canada's July CPI was spot on forecasts for a 0.1% month-over-month increase and a 7.6% year-over-year pace (down from 8.1%). However, the core rates were firm than average increased. The market quickly concluded that this increases the likelihood that the central bank that surprised the market with a 100 bp hike last month will lift the target rate by another 75 bp when it meets on September 7. In fact, the swaps market sees it as an almost 65% probability, the most since July 20. Canada reports June retail sales at the end of the week. The median forecast in Bloomberg's survey is for a 0.4% gain, but even if it is weaker, it is unlikely to offset the firm core inflation readings.

The dollar-bloc currencies are under pressure today, but the Canadian dollar is faring best, off about 0.25% in late morning trading in Europe. The Aussie is off closer to 0.75% and the Kiwi is down around 0.5%. US equities are softer. The greenback found support near CAD1.2830 and is near CAD1.2880. Monday and Tuesday's highs were in the CAD1.2930-5 area and a break above there would target CAD1.2985-CAD1.3000. However, the intraday momentum indicators are overextended, and initial support is seen in the CAD1.2840-60 area. The greenback has forged a shelf near MXN19.81 in recent days. It has been sold from the MXN20.83 area seen earlier this month. It has not been above MXN20.05 for the past five sessions. A move above there initially targets around MXN20.20. The JPMorgan Emerging Market Currency Index is off for the third consecutive session. If sustained, it would be the longest losing streak since July 20-22.

Original Post

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

This article was written by

Marc Chandler profile picture
15.21K Followers
Marc Chandler has been covering the global capital markets in one fashion or another for 25 years, working at economic consulting firms and global investment banks. A prolific writer and speaker he appears regularly on CNBC and has spoken for the Foreign Policy Association. In addition to being quoted in the financial press daily, Chandler has been published in the Financial Times, Foreign Affairs, and the Washington Post. In 2009 Chandler was named a Business Visionary by Forbes. Marc's commentary can be found at his blog (www.marctomarket.com) and twitter www.twitter.com/marcmakingsense

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