Collective Sigh of Relief?

Overview:  Chinese stocks extended the pre-weekend recovery, with the major indices up 4%+, the biggest advance in three years.  Most markets in the region rose, and the MSCI Asia-Pacific Index has a good start to snap the four-week drop.  European shares are also higher, and the Dow Jones Stoxx 600 is 0.5% higher through late morning, led by Italy and Spain, whose bond yields are extended the decline that began in the waning hours of last week’s activity.  The US dollar started slowly but as the session progressed it is finding better traction.  It is firmer against most of the major currencies but mixed against the emerging market complex.  Oil and gold are consolidating in narrow ranges.  

China: Chinese officials have launched a full court press of official comments and material support to stem the equity market slide, which threatened undermine key support of China’s leveraged financial system.  In recent years, China has nursed the state-owned enterprises, which appeared to have grown relative to the private sector.  President Xi gave strong vocal support to the private sector today and the government suggested it is considering personal tax cuts to provide economic support.  That said, the reversal in Chinese shares seemed to have, at least in part, been fueled by ideas that the central government and local governments were taking controlling stakes in several companies to support share prices.  Consumer shares and brokerages did well today as Chinese equities extended their recovery from four-year lows before the weekend.  The yuan was slightly softer.  US Treasury Secretary Mnuchin, whose department report last week did not cite China as a currency manipulator indicated he was open to changing the criteria.   Takeaway:  Don’t resist Beijing, yet. 

Italy:  Like China, the recovery seen in Italy before the weekend has carried into today’s action.  The 10-year generic yield fell from a little above 3.80% at its worst on Friday to close the week at 3.44% and slipped to 3.30% today before bouncing back toward 3.40%.  Moody’s became the first major rating agency to cut Italy’s credit rating below BBB.  At Baa3 (or BBB-) Moody’s judges Italian debt the lowest of investment grades.   However, that it only cut one notch and returned to a stable outlook was seen by many as not as bad as it might have been.  We remain concerned that Italy’s confrontation with the EU is still in the early days.  Specifically, tomorrow the EU may take the unprecedented step and formally return Italy’s budget proposals and demand revisions.  Italy will have three weeks to submit a revised draft.  Of course, it helps that League leader and Deputy Prime Minister Salvini rules out leaving the EU or EMU, but remain issue now is not redenomination risk but greater supply.  Both the Italian government and the EC rhetoric is showing restraint, but the Italian government seems to be in no mood to sacrifice its campaign promises.  In a local election over the weekend, the League saw its share rise to 11% from 2.5% in 2013.  The Five-Star Movement drew less than  3%.   Takeaway:  What appears to be a short-squeeze on Italian assets will likely be short-lived.  

Brexit:  It is like a scissor, the closer one end becomes the further the other end grows apart.  Reports suggest Prime Minister May is prepared to accept the EC’s demand for an indefinite backstop to ensure that there is no hard border between Northern Ireland and the Republic.   This would seem to overcome the last hurdle to an EU-UK agreement.  However, May risks further alienating parts of her party.  There is some suggestion that as many as 46 Conservative members of Parliament have signed a letter seeking a leadership challenge.  Ostensibly, two more signatures are needed to force the issue.  This is not the first time that a leadership challenge to May looked likely.  However, we remain struck by the fact that there hasn’t been a formal challenge yet.  We suspect it is because of a combination of two considerations:  none of the potential candidates think they can win or succeed in meeting the conflicting demands of the EU, the Conservative Party, and Parliament.  Takeaway:  The risks of a Brexit with no deal remains high and investors should not confuse “no agreement” with a hard Brexit. 

Saudi Arabia:  Saudi stocks continued to sell-off on Sunday and at one point the main index was off 3.5%.  Talk of buying by state-linked funds may have helped fuel the recovery, according to press accounts.  The less than 0.2% gain was given back earlier today with a nearly 1% decline, leaving the market off about 6% since October 2.   Data from the stock exchange shows that foreign investors, who have only been allowed to invest in local shares for a little more than three years, sold a record amount (~SAR4 bln or ~$1.07 bln) in the week ending October 18.

US Dollar:  After a slow start in Asia, the US dollar has turned better bid.  The euro recovered from $1.1430 before the weekend to $1.1550 today, where an option for almost 525 mln euros expires today.  There is another option (1.6 bln euros) at $1.1500 that also expires today.  Today’s advance fulfilled a retracement objective of last week’s down move that began near $1.1620 on October 16.  Sterling is trading within the previous session’s range, and although the expiring options are not particularly large, their strikes ($1.30 and $1.3080 for ~GBP210 mln) likely denote the range that will confine the bulk of today’s price action.  The euro is testing the upper end of its recent range against sterling near GBP0.8835, which is also where the 200-day moving average is found.  There is a GBP1.3 bln euro option expiring today struck at GBP0.8800, that still could be in play today.  The dollar is edging higher against the yen.  The JPY112.75 area was a retracement target of the dollar’s drop from JPY114.55 on October 4.  The next target is JPY113.00-JPY113.10 and then JPY113.45. 

Dollar-Bloc Currencies:   The US dollar reached a one-month high against the Canadian dollar before the weekend on the back of disappointing retail sales and softer inflation reports.  The Bank of Canada is the only major central bank that is expected to hike rates this week (the ECB, Norway’s Norges Bank, and Sweden’s Riksbank also meet).  The greenback has pulled back from CAD1.3130 to CAD1.3080 today,.  Additional support is seen near CAD1.3060 (100-day moving average is ~CAD1.3070).   Contrary to conventional wisdom, the Australia dollar found no succor from the largest rally in Chinese shares in a few years.  The Aussie marginally took out last week’s lows but remains in a consolidative mode.  The New Zealand dollar managed to slightly extend its two-week rally and reached almost $0.6620 before reversing lower after the pre-weekend outside up day.  The price action warns of the likelihood that a consolidative or corrective phase, which could see $0.6500-$0.6520.   

The US economic calendar has a slow start, but the Treasury will sell more than $200 bln in debt this week.  Today starts with  $84 bln in three- and six-month bills, followed by tomorrow’s four-and eight-week bills, and $38 bln two-year notes.  Wednesday’s sees a small ($19 bln) two-year floating rate note sold and $39 bln five-years notes ahead of Thursday’s $31 bln offering of seven-year notes.  The settlement of bills is thought to be a factor that is keeping the average effective Fed funds rate firm.  If this pressure is sustained, the Fed may make additional operational adjustments, as it did previously (e.g., lower the rate it pays on reserves.  


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