The Bull

Monday 22

October, 201812:21 AM



The Daily Fix - Inter-Market Analysis and Macro Insights

The Daily Fix - Inter-Market Analysis and Macro Insights

With US payrolls in the rear-view mirror, the focus on the floors today has been on the re-opening of the Chinese equity markets, as well as the PBoC CNY ?fixing?.

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08.10.2018 03:29 PM

With US payrolls in the rear-view mirror, the focus on the floors today has been on the re-opening of the Chinese equity markets, as well as the PBoC CNY ‘fixing’.

Playing catch-up to some punchy moves in Chinese off-shore equity markets last week, with the A50 futures, Hang Seng and H-shares falling 4.1%, 4.4% and 4.4% respectively, the market was clearly anticipating a strong gap lower. The interesting aspect here is that the moves from Chinese authorities to cut banks Reserve Ratio Requirements by a punchy 100 basis points (1ppt), allowing some RMB750b in additional liquidity to cushion to banks from future tax payments, have just not resonated as expected. The timing is obviously not a coincidence, and cleverly timed to alter sentiment, with the CSI 300 missing all of last week’s shenanigans - so the fact the index is currently 3.6% lower has us questioning how much worse things could have been.

Traders and investors have seen the moves to boost liquidity as one designed to fight a fire, and a sugar rush that doesn’t change the broader macro picture. While in FX markets, the fact we saw the PBoC ‘fix’ the CNY at 6.8957, +165 pips from the prior close was perhaps lower than expected, and despite a lower RRR historically being a negative for the CNY, it would not be out of the question to see a very stable yuan for the next two weeks. And, certainly, this should be the case ahead of the upcoming US Treasury report to Congress on ‘Macroeconomic and Foreign Exchange Policies of Major Trading Partners’.

Trump called China a currency ‘manipulator’ only in August, and this is a view shared by VP Pence only last week. That said, given the criteria for being labelled a ‘manipulator’, it feels as though China should feel rather aggrieved if they were formally recognised as such, especially since all their efforts have been to strengthen their yuan to curb capital outflows. Still, in a world with a beady eye on Sino-US relations, it wouldn’t surprise if the US Treasury did go down this murky road and subsequently further disincentives investors to add risk to portfolios.

Asia initially got off to a modestly positive start, although the bid has dried up and sellers have had an easy time pushing markets lower. S&P 500 futures have held in well though and are largely unchanged on the day. So, while the likes of tech will work inversely to moves in US Treasury yields, perhaps the new thematic is increasingly more of a bottom-up story, with Citigroup, JP Morgan and Wells Fargo reporting quarterly earnings this Friday and expectations are sky high here, with 3Q EPS expected to gain 21%yoy.

The ASX 200 is a laggard with a broad-based sell-off across the sectors, although materials are getting a working over, with the sector 2.3% lower. Perhaps we can see that play through in the European open, with BHP and RIO offering a headwind for the FTSE 100, and although the combined weighting is just 4%, the materials sector contributes 10% to the index, while energy (17% of the FTSE 100) will not like the 0.9% fall in Brent crude. Japan is closed for everyone’s favourite holiday, Health-Sports Day, and perhaps that has taken some direction out of the markets.

We will be watching USDCNH given the implications for AUD and gold, although whether the pair can convincingly push through 6.9000 could be driven to a large extent by this Thursday's US CPI print. Here, we can look at this CPI ex-energy (core) and see expectations set for a slight gain to 2.3% YoY. Headline CPI is expected to drop a touch, but it’s the core measure which should get the greater attention and puts the US fixed income market firmly on the radar once again as the centre of the financial world this week.

Naturally, the world will continue to react to moves in the US 10- and 30-year Treasury, although the more significant story has to be the limited moves in inflation expectations last week and subsequently ‘real' US 10-year Treasury yields have broken out to the highest level since March 2011. This represents a genuine tightening of US financial conditions if yields keep heading higher this week and would be a consideration for the Fed in the weeks ahead, although Chair Powell showed the Fed have a tolerance for higher yields and basically gave traders the green light to carry on selling rates and long-dated bonds last week, when he detailed neutral rates were some way off and that the fed funds rate could go beyond neutral.

(Source: Bloomberg)

Another consideration doing the rounds is the anticipation and look ahead to the October US payrolls report on 2 November. Granted, last weeks payrolls were on the weak side, however, as we look forward to the October print base effects from a weak October 2017 report should see the average hourly earnings (AHE) easily above 3% YoY. US data warrants the 82% probability of a December rate hike priced into the fed funds curve, but a 3-handle on wages will get people talking and should support the USD in the short-term.

Italy could come back onto the front pages with a focus again on the Italian BTP yield spread over German Bunds. Despite all the bravado from certain factions, the Italian government have moved to meet the market, although the real issue now is one of credibility. So, political theatre could move to one where the market just doesn’t buy their deficit projections, as they are based on some somewhat optimistic growth projections, and that is before the wider EU accepts the budget targets.

With Italy potentially driving EUR and MIB index flows, amid a backdrop of further Brexit headlines this week, EURGBP has to be on the radar given the current set-up on the daily chart. GBP is clearly reacting to the better tone expressed from both EU and UK officials, and it seems we have come a reasonable way from the clear disagreement at the Salzburg Summit to convergence and potential agreement and we should learn more this week – all the right noises are being made to avoid a ‘no Brexit’ scenario. Technically, EURGBP is breaking below level after level, with a move through the 200-day MA, as well as the 20 September low on Friday,  getting good attention.

My preference is to fade strength into the 5-day EMA at 0.8821, as this short-term average should contain the selling, given the power behind the recent sell-off. GBPAUD should also be on the radar, where aggressive traders may look to buy the pair at current spot given the weekly close through the year-to-date highs of 1.8507. More defensive traders may wait for the re-test of the breakout highs and going long on a rejection to confirm support.

(GBPAUD Daily)



Published by Chris Weston, Head of Research, Pepperstone
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