PBOC Continues to Check CNY Fall While Euro has Shrugged Off Italy’s Political Turmoil

Overview:  The S&P 500 gapped higher yesterday and posted its largest gain in two months.  Most of Asia Pacific but China and Hong Kong advanced. The three-day recovery in the MSCI Asia Pacific was insufficient to offset the losses at the start of the week, and the benchmark finished lower for the third consecutive week.  Europe’s Dow Jones Stoxx 600 is paring yesterday’s 1.6% gain, which was the largest in almost two months. US shares are trading with a heavier bias in Europe.    The continued stabilization of the Chinese yuan and the recovery in equities took the safe-haven bid away for fixed income. Some signals that Germany may consider issuing new debt to fund climate change-related products saw European bond yields rose yesterday. They are edging lower today except in Italy, where the political crisis has spurred a sharp sell-off of Italian bonds.  The 10-year yield rose 11 bp yesterday as is up more than 25 bp today.   The yield has fallen every week since the end of May, and that streak is ending.  Most of the major currencies, but sterling, are firm against the dollar, while the large emerging market currencies have a heavier bias.  With today’s small gains, gold is poised to close the week over a $60 higher than it began the week, which is the most in at least a couple of years. It has risen in 10 of the past 12 weeks.   Oil is slightly higher, but WTI is nursing a 5.3% fall this week, its largest in two and a half months.  

Asia Pacific

The Japanese economy grew by a better than expected 0.4% Q2 from a revised 0.7% expansion in Q1 (initially 0.6%).   Private spending contributed 0.5 percentage points to growth, and public expenditures added 0.2 percentage points.  Foreign demand subtracted 0.3 percentage points. The GDP deflator rose to 0.4% year-over-year.  To say it is the highest in five quarters does not take away from the fact that it is only slightly positive.  Since the end of the tariff truce between the US and China, the dollar has fallen about 3.5% against the yen. It remains pinned in the trough set in the middle of the week (~JPY105.50).  Of course, Japan has refrained from calling out Trump for manipulating the dollar, but in recent days, Ministry of Finance officials began expressing some concern about the yen’s appreciation.  If the US were to intervene, like some suggest is increasingly likely, buying the yen would very aggressive and Japan would likely feel compelled to respond. 

Separately, the Bank of Japan moved against the flatness of the yield curve by adjusting its bond purchases.  It reduced the amount of intermediate (3-5 years) and long bonds (10-25 years) buy JPY20 bln each and increased the amount of short-term bonds (1-3 years) by JPY20 bln. These are minor adjustments and may not have a tangible impact.   The yen’s appreciation and slowing global growth appear to be a more powerful force.  

China’s reported July CPI and PPI.  Consumer price inflation edged up to 2.8% from 2.7%, which is the highest since February 2018, which itself was the highest since November 2013.  It stood at 2.1% a year ago.  China’s CPI is boosted by food prices, which is 9.1% higher than a year ago.  Non-food prices have risen a modest 1.6% over the past year.  The challenge posed by food prices is not particularly amenable to monetary policy.  A more concerning signal may be emanating from producer prices.  They fell 0.3% from a year ago, the first deflationary reading in three years.  The decline comes from weaker raw material and durable goods prices and tracks corporate profits.  On balance, today’s reports may encourage speculation that the PBOC will move shortly to ease monetary policy.  The fix was set at CNY7.0136, while it is higher for the dollar, but it was below where the models put it (~CNY7.0160). It shows that the PBOC is still resisting the full brunt of market pressures.  Meanwhile, the spread between the onshore (CNY) and offshore (CNH) has trended lower in recent days, but at over 0.0255 it is still well above where it trading in late July.  

For the third session, the dollar is making a lower high against the yen.  It is struggling to push above JPY106, perhaps running into offers related to the $1.1 bln of options struck at JPY105.95-JPY106.00 that expire today.  The week’s low is near JPY105.50, and there may be some intermittent support by JPY105.80.  The Australian dollar is steady around $0.6800 and has been confined to about a 20 tick ranges on either side. There is a roughly A$715 mln option at $0.6800 that will be cut today and another A$565 mln at $0.6780 that rolls off as well.  If it holds on to even small gains today, it would be the first back-to-back advance in almost four weeks.  The Aussie appears to be in a good technical position to continue to recover next week.  


There are two main developments in Europe to note today.  The first is more disappointing data from Germany (trade) and France (industrial production).  The second is the political turmoil in Italy, as League leader and Deputy Prime Minister Salvini seeks snap elections.  Germany’s June trade surplus narrowed to 16.8 bln euros from 20.6 bln.  Exports were a little weaker than expected, though the May series was revised higher.  Still, German exports have fallen 8% year-over-year.  Imports were a bit firmer on the month, but are off 4% year-over-year.  Next week (Aug 14) Germany reports Q2 GDP.  The risk appears to be on the downside of the consensus forecast for a 0.1% contraction.  Not to be outdone, France reported dismal industrial production figures. The decline of 2.3% was almost twice what economists projected and offsets in full the 2% increase in May.  It was the largest decline since January 2018, and it was led by a 2.2% drop in manufacturing output, which matches its largest contraction in five years.   

After making repeated overtures, Salvini called for elections.  It is not entirely his call, but that does not mean he does not exert serious pressure.  The opinion polls suggest the League is drawing around 40% support, which could be enough to give it a majority.  The senior coalition partner, the Five Star Movement, has consistently been outflanked by the junior member. M5S leader and Deputy Prime Minister Di Maio appears reluctantly accept the inevitable but wants to enact the political reform that reduces the number of Deputies in the lower chamber.  The first step is a vote of confidence in Prime Minister Conte.  Another coalition may be hammered together, which excludes the League, though it may be difficult.  A vote could be held later this month.  A potential election date being discussed is October 13 or October 23, just before the UK is to leave the EU. Note that the drop in Italian yields has done little for Italian bank shares.  An index of them fell 5.2% last week and are off 5.5% this week, the biggest two-week drop since last Sept-Oct, and stand at new three-year lows today.  

The euro has been confined to about a fifth of a cent range today in quiet turnover despite the macro developments.  Some bids were found near the 20-day moving average (~$1.1180), while offers seem to deter a push through $1.12, where a nearly 975 mln option is struck that expires today.  For the third session, the euro is trading within Tuesday’s range (~$1.1170-$1.1250).  There is little indication of a breakout ahead of the weekend.  The euro rose this week to new two-year highs against sterling (~GBP0.9265 this week) and is consolidating just below as it extends its advancing streak for the 14th consecutive week.  The cross last fell in the week ending May 3.  Against the dollar, sterling remains pinned near its lows.  It is managing to hold just above last week’s low of about $1.2080, but a new low ahead of the weekend ought not surprise.   The market may be gearing up for a test on the $1.20 area next week.  


The North American economic calendar is full ahead of the weekend.  The US producer prices may be the least important.  Both the headline and core rates are expected to be unchanged at 1.7% and 2.3% respectively.  Next week the US reports CPI figures, which often seem to elicit more of a market reaction that producer prices.  Canada reports housing starts and permits, but more notable is the employment report.  Canada is expected to have grown around 20k full-time positions, and average hourly wage growth of permanent workers is forecast to have accelerated to 3.8% from 3.6%, which would the fastest since May 2018.  It may allow the Canadian dollar to extend the recover after bottoming in the middle of the week at its lowest level since mid-June.  Mexico reports June industrial production figures, and with Q2 GDP already reported, it may not have much impact on the market.  However, the central bank meets next week, and there has been increased speculation that a rate cut could be delivered. This appears to have been one of the factors to have weighed on the peso.

Indeed, the peso is set to finish lower for the fourth consecutive week.  The dollar pulled back yesterday but found support ahead of the 200-day moving average (~MXN19.36) and the (50%) retracement of this month’s surge (~MXN19.34).  Initial resistance is seen near MXN19.55.  It could also be the fourth week the greenback has risen against the Canadian dollar but here the gains are more precarious.  Near CAD1.3220, it is up less than 0.15% on the week ahead of the Canadian employment figures.  Barring a disappointment, the US dollar could fall toward CAD1.3180.  Coming into North America, the Dollar Index is poised to snap a three-week advance.  It is off about 0.5% this week, which if sustained, would be the biggest loss since the week ending June 21.  It continues to consolidate and has not made a fresh low since Tuesday. 

There are two overriding technical patterns in the S&P 500.  The first is a double bottom set near 2825 on Monday and Wednesday.  The neckline would be Tuesday’s high near 2885, projecting a measuring objective near 2950.  The measuring objective of the double bottom corresponds to the (61.8%) retracement of the sharp decline experienced since the record high was set on July 26. It closed yesterday at session highs around 2938, and come in softer today.  Arguably more striking and significant than the double bottom is the three-day island bottom.  The S&P 500 gapped lower on Monday and gapped higher on Thursday.   Assuming yesterday’s gap (~2892.2-2894.5) holds, the benchmark may be on its way to new highs.  


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