Edit
An escalation of threatening rhetoric by
the United States and North Korea emerged as the key driver last week. The US was unable to build on the
success it enjoyed at the UN on August 5 when the Security Council unanimously
voted to impose the stiffest sanctions to date on North Korea. Even if
President Trump’s “fire and fury” threat was more visceral than
strategic initially, there have been several opportunities to backtrack, and
instead, the administration seemed to double down.
the United States and North Korea emerged as the key driver last week. The US was unable to build on the
success it enjoyed at the UN on August 5 when the Security Council unanimously
voted to impose the stiffest sanctions to date on North Korea. Even if
President Trump’s “fire and fury” threat was more visceral than
strategic initially, there have been several opportunities to backtrack, and
instead, the administration seemed to double down.
Many
observers in the US draw parallels with
the Cuban Missile Crisis when the Soviet Union tried to install nuclear
missiles in Cuba. The takeaway
is the need for a forceful US response. However, the alternative analogy
is Iran, as well as a few other countries, that surrendered its nuclear weapons
capability and/or development. It
is a negotiated settlement, not one dictated by military superiority. This is what US allies, such as Germany, and
China and Russia will support.
observers in the US draw parallels with
the Cuban Missile Crisis when the Soviet Union tried to install nuclear
missiles in Cuba. The takeaway
is the need for a forceful US response. However, the alternative analogy
is Iran, as well as a few other countries, that surrendered its nuclear weapons
capability and/or development. It
is a negotiated settlement, not one dictated by military superiority. This is what US allies, such as Germany, and
China and Russia will support.
The US strategy was to deny North Korea
nuclear capability. It
did not work. The US sought to deny North Korea the delivery
mechanism. This did not work either.
It is unfortunate, but the human cost of trying to turn by the clock is
significant. As sour as it tastes, the US must accept a fait accompli and
go from there,
nuclear capability. It
did not work. The US sought to deny North Korea the delivery
mechanism. This did not work either.
It is unfortunate, but the human cost of trying to turn by the clock is
significant. As sour as it tastes, the US must accept a fait accompli and
go from there,
Some military experts argue that North
Korea may not only use its nuclear capability to deter a US (and/or South Korean), but it can be used offensively. One such scenario imagines North
Korea invades South Korea to unite the country and threatens to its nuclear
weapons if US forces join the conflict. Of course one can create
all sorts of scenarios, but this one and many like it, seem to misunderstand
the role of US forces in South Korea (23.5k). They cannot withstand
a full fledged assault by North Korea. Their function is as a
tripwire. Moreover, the US has a large military footprint in Asia,
including 39k troops in Japan, and bases
in Singapore and Guam. On top of this, add
US naval power, including submarines, and aircraft carriers.
Korea may not only use its nuclear capability to deter a US (and/or South Korean), but it can be used offensively. One such scenario imagines North
Korea invades South Korea to unite the country and threatens to its nuclear
weapons if US forces join the conflict. Of course one can create
all sorts of scenarios, but this one and many like it, seem to misunderstand
the role of US forces in South Korea (23.5k). They cannot withstand
a full fledged assault by North Korea. Their function is as a
tripwire. Moreover, the US has a large military footprint in Asia,
including 39k troops in Japan, and bases
in Singapore and Guam. On top of this, add
US naval power, including submarines, and aircraft carriers.
The point is that US forces dominate the
escalation ladder at every rung. Yet the Tet
Offensive, nearly 50 years ago, taught that even in defeat, victory was to be found for the North Vietnamese. Their
military defeat was offset by moral and propaganda victories, that some credit
with turning the tide in the war. What has changed now is that 1) North
Korea’s capability continues to increase, 2) pressure on other countries, like
China, to do more, has yielded limited results, and 3) the Trump Administration
sees this as a test of its resolve.
escalation ladder at every rung. Yet the Tet
Offensive, nearly 50 years ago, taught that even in defeat, victory was to be found for the North Vietnamese. Their
military defeat was offset by moral and propaganda victories, that some credit
with turning the tide in the war. What has changed now is that 1) North
Korea’s capability continues to increase, 2) pressure on other countries, like
China, to do more, has yielded limited results, and 3) the Trump Administration
sees this as a test of its resolve.
We suspect that at least for the medium
term, investors will have to live with a heightened degree of dramatic rhetoric
by the US and North Korea. There are a few dates that may be noteworthy. First is
August 15, when North Korea implied a potential plan to shoot some missiles
into the waters off Guam as a display of force. One of the technical
challenges for North Korean missiles is thought to be their accuracy. The
risk of miscalculation is grave if a missile lands in the territorial waters of
Guam as that could be seen as an act of
war. The other is the joint US-South Korean exercises that run between
August 21 and August 31. In the past, these exercises included a
“decapitation strike” aimed at the political and military leadership.
term, investors will have to live with a heightened degree of dramatic rhetoric
by the US and North Korea. There are a few dates that may be noteworthy. First is
August 15, when North Korea implied a potential plan to shoot some missiles
into the waters off Guam as a display of force. One of the technical
challenges for North Korean missiles is thought to be their accuracy. The
risk of miscalculation is grave if a missile lands in the territorial waters of
Guam as that could be seen as an act of
war. The other is the joint US-South Korean exercises that run between
August 21 and August 31. In the past, these exercises included a
“decapitation strike” aimed at the political and military leadership.
Foreign investors were significant
sellers of South Korean shares. They sold $810 mln of Korean shares. It was the third
week of net sales, the first such streak since last November. Over the
past three weeks, foreign investors sold $3.1 bln of Korean shares. In
three weeks of liquidation in November, foreign investors sold about $1.3 bln
of Korean shares. Foreign investors appeared happy to take on Korea’s
credit risk and were net buyers of nearly $495 mln of Korean bonds last
week. Foreign investors have been net buyers of Korean bonds for five
consecutive weeks for a cumulative total of nearly $2.4 bln.
sellers of South Korean shares. They sold $810 mln of Korean shares. It was the third
week of net sales, the first such streak since last November. Over the
past three weeks, foreign investors sold $3.1 bln of Korean shares. In
three weeks of liquidation in November, foreign investors sold about $1.3 bln
of Korean shares. Foreign investors appeared happy to take on Korea’s
credit risk and were net buyers of nearly $495 mln of Korean bonds last
week. Foreign investors have been net buyers of Korean bonds for five
consecutive weeks for a cumulative total of nearly $2.4 bln.
The takeaway is that although foreigners
have pared this year’s purchases of Korean shares, they have continued to buy
Korean bonds, arguably blunting the full impact on the currency. The Kospi gapped lower before the
weekend, but technical indicators suggest the market may be near
exhaustion. The won seems to be
suggesting the same thing. The won was under pressure all week. The
dollar recorded its high early Friday but then trended lower and closed on its
lows before the weekend.
have pared this year’s purchases of Korean shares, they have continued to buy
Korean bonds, arguably blunting the full impact on the currency. The Kospi gapped lower before the
weekend, but technical indicators suggest the market may be near
exhaustion. The won seems to be
suggesting the same thing. The won was under pressure all week. The
dollar recorded its high early Friday but then trended lower and closed on its
lows before the weekend.
The yen and the Swiss franc were the
strongest of the major currencies, appreciating 1.5% and 1.2% respectively
against the US dollar.
Although the dollar remained on the defensive, the fact that Swiss franc
weakened against the euro ahead of the weekend also suggests some normalization of
the political tensions. The euro also recovered against the yen ahead of
the weekend.
strongest of the major currencies, appreciating 1.5% and 1.2% respectively
against the US dollar.
Although the dollar remained on the defensive, the fact that Swiss franc
weakened against the euro ahead of the weekend also suggests some normalization of
the political tensions. The euro also recovered against the yen ahead of
the weekend.
It is worth looking closer at the safe haven conventional narrative. We do not think that investors bought
yen or the Swiss franc like they bought gold, for example. There is an
important difference between buying to taken on exposure and buying that is
meant to cover previously sold positions. The Swiss franc and yen were
used as funding currencies, to finance the purchase of other assets. What
we have witnessed is the unwinding of some of these positions.
yen or the Swiss franc like they bought gold, for example. There is an
important difference between buying to taken on exposure and buying that is
meant to cover previously sold positions. The Swiss franc and yen were
used as funding currencies, to finance the purchase of other assets. What
we have witnessed is the unwinding of some of these positions.
Speculators in the futures market covered
nearly 10% of its gross short yen position (~13k contracts) in CFTC reporting
week ending August 8. Speculators added to 3k contracts to the gross long
position. Foreigners have not been particularly large investors in
Japanese bonds or stocks in recent weeks. The four-week moving average of
both is declining. On the other hand, through August 4, Japanese
investors had the strongest three-week buying spree of foreign bonds since
July 2016.
nearly 10% of its gross short yen position (~13k contracts) in CFTC reporting
week ending August 8. Speculators added to 3k contracts to the gross long
position. Foreigners have not been particularly large investors in
Japanese bonds or stocks in recent weeks. The four-week moving average of
both is declining. On the other hand, through August 4, Japanese
investors had the strongest three-week buying spree of foreign bonds since
July 2016.
The dollar fell to JPY108.75 before the
weekend, a four-month low, but managed to close back above
JPY109.00. It
finished marginally lower to extend the streak to four losing sessions and is
the fourth weekly loss in the last five. A move above JPY109.40 is needed
to stabilize the tone, while a move above JPY110.20 would reinforce lower end
of the range. The US rate premium is not particularly attractive at 213 bp
at the 10-year mark. It is below the 50-day average (218 bp) and 100-day
average (222 bp). At 140 bp, the two-year differential is the lowest in
three months. Nevertheless, for Japanese investors who buy US bonds on an
unhedged basis, and believe that lower end of the dollar’s range will hold, may
still find Treasuries attractive.
weekend, a four-month low, but managed to close back above
JPY109.00. It
finished marginally lower to extend the streak to four losing sessions and is
the fourth weekly loss in the last five. A move above JPY109.40 is needed
to stabilize the tone, while a move above JPY110.20 would reinforce lower end
of the range. The US rate premium is not particularly attractive at 213 bp
at the 10-year mark. It is below the 50-day average (218 bp) and 100-day
average (222 bp). At 140 bp, the two-year differential is the lowest in
three months. Nevertheless, for Japanese investors who buy US bonds on an
unhedged basis, and believe that lower end of the dollar’s range will hold, may
still find Treasuries attractive.
The euro
finished its fifth weekly advance, though it remains a little below the peak of
about $1.1910 set on August 2. It rallied ahead of the weekend, and
0.4% advance was also the weekly gain. The technical indicators did
not respond much to the pre-weekend gain, but many still have their sights set
on the $1.20-$1.22 area, with Draghi’s speech at Jackson Hole anticipated to
provide new cues.
finished its fifth weekly advance, though it remains a little below the peak of
about $1.1910 set on August 2. It rallied ahead of the weekend, and
0.4% advance was also the weekly gain. The technical indicators did
not respond much to the pre-weekend gain, but many still have their sights set
on the $1.20-$1.22 area, with Draghi’s speech at Jackson Hole anticipated to
provide new cues.
The US premium over Germany is a little
above 200 bp. This is near its 20-day average. A
widening premium tends to give the dollar better traction. The 10-year
premium has widened to 180 bp from the year’s low near 170 bp reached in
mid-July, and which incidentally is the weekly average in 2016. Recall that the
US premium peaked last December near 235 bp. Since the end of the last
year, the 10-year US yield has fallen by 25 bp while the German yield has risen
19 bp.
above 200 bp. This is near its 20-day average. A
widening premium tends to give the dollar better traction. The 10-year
premium has widened to 180 bp from the year’s low near 170 bp reached in
mid-July, and which incidentally is the weekly average in 2016. Recall that the
US premium peaked last December near 235 bp. Since the end of the last
year, the 10-year US yield has fallen by 25 bp while the German yield has risen
19 bp.
Economic data in the week ahead include a
second look at Q2 GDP (0.6%) and final July CPI (1.3% headline and 1.2%
core). July
industrial output figures kick off the week,
and the risk is to the downside of the median expectation for a 0.5% decline.
It appears that the economic momentum stalled at the beginning of Q3.
Most likely the data will not alter expectations for the September ECB
meeting.
second look at Q2 GDP (0.6%) and final July CPI (1.3% headline and 1.2%
core). July
industrial output figures kick off the week,
and the risk is to the downside of the median expectation for a 0.5% decline.
It appears that the economic momentum stalled at the beginning of Q3.
Most likely the data will not alter expectations for the September ECB
meeting.
There are some observers who warn of
disappointment then as officials wait for the October meeting to announce its
early 2018 intentions. While that is possible, it seems to us that the ECB will
have the staff forecast update in September, giving it a reason to act. Waiting until the October meeting would seem to break that pattern, and
would be vulnerable to criticisms of waiting until after the German elections
toward the end of next month.
disappointment then as officials wait for the October meeting to announce its
early 2018 intentions. While that is possible, it seems to us that the ECB will
have the staff forecast update in September, giving it a reason to act. Waiting until the October meeting would seem to break that pattern, and
would be vulnerable to criticisms of waiting until after the German elections
toward the end of next month.
Sterling posted a key
reversal against the dollar on August 3 by making new highs (a little above
$1.3265) and then dropping through and closing below the previous day’s
low. A 3.25
cent decline followed to the pre-weekend low of $1.2940, just ahead of the 50%
retracement objective of the low from June 21, the last time it traded below
$1.26. Sterling posted potential reversal ahead of the weekend;
recovering to close almost (1/100 of a cent below) at the previous day’s high.
A move above $1.3050 would lend credence to our suspicions that the
corrective low is in place.
reversal against the dollar on August 3 by making new highs (a little above
$1.3265) and then dropping through and closing below the previous day’s
low. A 3.25
cent decline followed to the pre-weekend low of $1.2940, just ahead of the 50%
retracement objective of the low from June 21, the last time it traded below
$1.26. Sterling posted potential reversal ahead of the weekend;
recovering to close almost (1/100 of a cent below) at the previous day’s high.
A move above $1.3050 would lend credence to our suspicions that the
corrective low is in place.
The economic reports in the
days ahead are unlikely to alter the general understanding of the UK
economy. Growth
has downshifted, and consumption has
slowed. The labor market is robust, but wage growth is slow and slower than inflation, which remains a
firm and above target.
days ahead are unlikely to alter the general understanding of the UK
economy. Growth
has downshifted, and consumption has
slowed. The labor market is robust, but wage growth is slow and slower than inflation, which remains a
firm and above target.
The BOE’s preferred
inflation measure (CPIH) is expected to tick higher to 2.7%, though for the
second consecutive month prices were likely flat. The past depreciation of sterling
appears to be a key factor, and therefore, it is still reasonable to expect
price pressures to peak in the coming months.
inflation measure (CPIH) is expected to tick higher to 2.7%, though for the
second consecutive month prices were likely flat. The past depreciation of sterling
appears to be a key factor, and therefore, it is still reasonable to expect
price pressures to peak in the coming months.
Meanwhile, the UK claimant
count has been gradually rising since Q4 16, but the unemployment rate (likely
remaining at 4.5% for the three months through June) is the lowest more than 40
years. Wage
growth, similar to what is being experienced
in many other countries, remains limited. Average weekly earnings in June
are not expected to have changed from the 1.8% (and 2% excluding bonuses)
reported for the three-month year-over-year period through May.
count has been gradually rising since Q4 16, but the unemployment rate (likely
remaining at 4.5% for the three months through June) is the lowest more than 40
years. Wage
growth, similar to what is being experienced
in many other countries, remains limited. Average weekly earnings in June
are not expected to have changed from the 1.8% (and 2% excluding bonuses)
reported for the three-month year-over-year period through May.
UK retail sales are volatile
month-to-month. A
moving average helps smooth it out to see the trend It has clearly slowed. Last year the retail
sales rose an average of 0.4% a month. In the first half of 2017, the pace has been halved. The median forecast in the Bloomberg survey was for a
0.1% rise in July after a 0.9% gain in June, and the first back-to-back
increase since last summer.
month-to-month. A
moving average helps smooth it out to see the trend It has clearly slowed. Last year the retail
sales rose an average of 0.4% a month. In the first half of 2017, the pace has been halved. The median forecast in the Bloomberg survey was for a
0.1% rise in July after a 0.9% gain in June, and the first back-to-back
increase since last summer.
Investors seem skeptical of
the UK. Sterling
was not rewarded when the recent PMIs were generally
stronger than expected. To the contrary, thoughts that the BOE may begin
normalizing policy has been unwound.
The implied yield on the December
short sterling futures contract has fallen 17 bp to 35 bp since the end of
June. It had finished 2016 near 47 bp.
the UK. Sterling
was not rewarded when the recent PMIs were generally
stronger than expected. To the contrary, thoughts that the BOE may begin
normalizing policy has been unwound.
The implied yield on the December
short sterling futures contract has fallen 17 bp to 35 bp since the end of
June. It had finished 2016 near 47 bp.
However, the place to
express that skepticism may not count
against the US dollar, which has its own
challenges. On
a trade-weighted basis, sterling has fallen 4.5% in the past three months.
Sterling’s weakness is seen through
the euro. Since the days before Macron won the first round of the French
presidential contest, the euro has risen 9.5% against sterling. The euro
poked through GBP0.9100 briefly at the end of last week. It was near
GBP0.8300 in mid-April. The technicals look stretched and the euro is bouncing
against the upper Bollinger Band, but short-term participants will want to be
particularly attentive to potential reversal patterns.
express that skepticism may not count
against the US dollar, which has its own
challenges. On
a trade-weighted basis, sterling has fallen 4.5% in the past three months.
Sterling’s weakness is seen through
the euro. Since the days before Macron won the first round of the French
presidential contest, the euro has risen 9.5% against sterling. The euro
poked through GBP0.9100 briefly at the end of last week. It was near
GBP0.8300 in mid-April. The technicals look stretched and the euro is bouncing
against the upper Bollinger Band, but short-term participants will want to be
particularly attentive to potential reversal patterns.
The US also reports several
economic reports, but what has emerged as a consensus among economists is
unlikely to be changed by the data. Specifically, a
recent Wall Street Journal survey found nearly 75% of economists expect the Fed
to announce its balance sheet operations in September and a December rate hike.
The FOMC minutes, among the week’s highlights, may reinforce such
expectations by showing concerns about the slowing of inflation, while also
finding the willingness to decouple the
balance sheet strategy from the more
direct monetary policy.
economic reports, but what has emerged as a consensus among economists is
unlikely to be changed by the data. Specifically, a
recent Wall Street Journal survey found nearly 75% of economists expect the Fed
to announce its balance sheet operations in September and a December rate hike.
The FOMC minutes, among the week’s highlights, may reinforce such
expectations by showing concerns about the slowing of inflation, while also
finding the willingness to decouple the
balance sheet strategy from the more
direct monetary policy.
Retail sales, at both the
headline and GDP-component levels, likely snapped a two-month decline. The expected 0.4% would offset
those declines. Industrial output and manufacturing production appear to be weathering the slower impulses
from the auto sector. Small increases are
expected. Early readings for August from the Empire and Philly Fed
surveys are unlikely to signal a material
change in the trajectory of the US economy, which appears to be uninspiring but
near trend.
headline and GDP-component levels, likely snapped a two-month decline. The expected 0.4% would offset
those declines. Industrial output and manufacturing production appear to be weathering the slower impulses
from the auto sector. Small increases are
expected. Early readings for August from the Empire and Philly Fed
surveys are unlikely to signal a material
change in the trajectory of the US economy, which appears to be uninspiring but
near trend.
China’s official economic
metrics have held up better than many had expected so far this year, and surely
the yuan’s 4.2% appreciation against the dollar is even more surprising. Still, it appears that perhaps
like the eurozone, the Chinese economy
has lost some momentum at the start of Q3. Both retail sales and
industrial output is expected to slow slightly from the pace reported in June.
Aggregate financing is expected to have slowed considerably in July, but
caution is advised. Lending
typically (without fail since 2002) slows in July from June. Many suspect that efforts are being made to avoid
turbulence ahead of the Party Congress in two months.
metrics have held up better than many had expected so far this year, and surely
the yuan’s 4.2% appreciation against the dollar is even more surprising. Still, it appears that perhaps
like the eurozone, the Chinese economy
has lost some momentum at the start of Q3. Both retail sales and
industrial output is expected to slow slightly from the pace reported in June.
Aggregate financing is expected to have slowed considerably in July, but
caution is advised. Lending
typically (without fail since 2002) slows in July from June. Many suspect that efforts are being made to avoid
turbulence ahead of the Party Congress in two months.
In conclusion, the
macroeconomic data on tap are unlikely to sway views on the state of the economies or the trajectory of
monetary policy. Without
renewed widening of the interest rate differentials, the dollar may struggle to
sustain traction, even against sterling.
The price action of the Swiss franc may suggest that participants are
beginning to see the rhetorical barbs as part of the US declaratory policy,
while the operational policy is a
different thing. It has held back from its most strident stances (citing
China as a currency manipulator, pulling out of NAFTA, NATO as obsolete, steel
tariffs on national security grounds, etc.).
Still, the US has reportedly signaled new measures directed toward China
(intellectual property rights seems to have superseded steel and aluminum as
the focus) will be announced as early as
August 14.
macroeconomic data on tap are unlikely to sway views on the state of the economies or the trajectory of
monetary policy. Without
renewed widening of the interest rate differentials, the dollar may struggle to
sustain traction, even against sterling.
The price action of the Swiss franc may suggest that participants are
beginning to see the rhetorical barbs as part of the US declaratory policy,
while the operational policy is a
different thing. It has held back from its most strident stances (citing
China as a currency manipulator, pulling out of NAFTA, NATO as obsolete, steel
tariffs on national security grounds, etc.).
Still, the US has reportedly signaled new measures directed toward China
(intellectual property rights seems to have superseded steel and aluminum as
the focus) will be announced as early as
August 14.
On the other, the hand, the too frequent use of
threats and innuendos will dilute their purchasing power. In the middle of heightened tensions
on the Korean peninsula, the US President’s explicitly threat of military force
in Venezuela seemed to many to be more
bluster and distraction. However, despite China’s previous support for
the Maduro government, it is Russia that is making the most strategic inroads,
and through Rosneft controls an estimated 13% of Venezuela’s oil exports.
At the same time the heated criticisms of the Republican leadership in
the Senate, and indications that at least a couple of Republican Senators who
have been critical of the President will face sponsored primary challenges
makes many unsure that the debt ceiling
and spending authorization will be addressed
in a timely manner.
threats and innuendos will dilute their purchasing power. In the middle of heightened tensions
on the Korean peninsula, the US President’s explicitly threat of military force
in Venezuela seemed to many to be more
bluster and distraction. However, despite China’s previous support for
the Maduro government, it is Russia that is making the most strategic inroads,
and through Rosneft controls an estimated 13% of Venezuela’s oil exports.
At the same time the heated criticisms of the Republican leadership in
the Senate, and indications that at least a couple of Republican Senators who
have been critical of the President will face sponsored primary challenges
makes many unsure that the debt ceiling
and spending authorization will be addressed
in a timely manner.
The S&P 500 is up nearly
9.5% this year, and that is after last
week’s 1.4% drop, the largest in six months. The Dow Jones Industrials gained for
10 consecutive sessions before falling
for three sessions starting August 8. Both managed to recover early
losses to post minor gains ahead of the weekend. We are watching a gap
(from the higher opening on July 12) that is
found roughly between 2429 and 2435. If that area does not hold, a
more important test on 2400 looms.
9.5% this year, and that is after last
week’s 1.4% drop, the largest in six months. The Dow Jones Industrials gained for
10 consecutive sessions before falling
for three sessions starting August 8. Both managed to recover early
losses to post minor gains ahead of the weekend. We are watching a gap
(from the higher opening on July 12) that is
found roughly between 2429 and 2435. If that area does not hold, a
more important test on 2400 looms.
Synthetic FX View–Macro and Prices
Reviewed by Marc Chandler
on
August 12, 2017
Rating: