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Don’t Make a Fetish Out of What may be a Minor Change in the Pace of ECB Bond Buying

Summary:
Overview: Yesterday's retreat in US indices was part of and helped further this bout of profit-taking.  The MSCI Asia Pacific Index ended an eight-day advance yesterday and fell further today.  Japanese indices, which had set multiyear highs, fell for the first time in nine sessions.  Hong Kong led the regional slide with a 2.3% decline as China's crackdown on the gaming industry continued.  Some companies in this space were reportedly to enforce the limits on minors, remove "obscene and violent content" and other unhealthy tendencies, including the "worship of money" and "effeminacy."  The Dow Jones Stoxx 600 is off for the third consecutive session, which would be the longest downdraft in a couple of months.  US futures are also trading heavily.  The US 10-year yield peaked on Tuesday

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Don't Make a Fetish Out of What may be a Minor Change in the Pace of ECB Bond Buying

Overview: Yesterday's retreat in US indices was part of and helped further this bout of profit-taking.  The MSCI Asia Pacific Index ended an eight-day advance yesterday and fell further today.  Japanese indices, which had set multiyear highs, fell for the first time in nine sessions.  Hong Kong led the regional slide with a 2.3% decline as China's crackdown on the gaming industry continued.  Some companies in this space were reportedly to enforce the limits on minors, remove "obscene and violent content" and other unhealthy tendencies, including the "worship of money" and "effeminacy."  The Dow Jones Stoxx 600 is off for the third consecutive session, which would be the longest downdraft in a couple of months.  US futures are also trading heavily.  The US 10-year yield peaked on Tuesday slightly above 1.38%, and today is around 1.33%.  European yields are also softer, with the UK's two basis point rise being an exception. The dollar is heavy, falling against all the major currencies, with sterling, the Swiss franc and Japanese yen leading the way.  Emerging market currencies, especially most of the freely accessible ones, are trading with a higher bias.  The JP Morgan Emerging Markets Currency Index is firmer for the first time in four sessions.  Gold is consolidating inside yesterday's range, meeting resistance in front of $1800.  October WTI remains in the range seen last Thursday (~$67.85-$70.60) and has been mostly confined to a $69.00-$69.50 range today.  China's iron ore contract snapped a six-day decline yesterday and rose about 0.55%.  Today it gave it back and more, shedding 2.1% to make a marginal new low.  On the other hand, copper and other base metals are trading higher today.  

Asia Pacific

China's August CPI was softer than expected, while the PPI was higher than anticipated.  China's CPI stands 0.8% above year-ago levels.  It has been held in check by falling food prices, which declined 4.1% year-over-year after a 3.7% decline in July.  Pork is the obvious culprit.  Prices fell by 44.9% from a year ago (-43.5% in July).  Non-food prices eased to 1.9% from 2.1%, the first decline since January. Core CPI (excluding food and energy) rose 1.2%, slightly slower than the 1.3% in July.   Producer prices are a different story.  They are 9.5% above year-ago levels, up from 9.0% in July.  The drivers remain the same.  Metals and materials rose.  The gap between producer and consumer price increases is seen by many observers as "pent-up" inflation. Still, we are less convinced and recognize it as a phenomenon not unique to China.  For most goods, the pipeline inflation hypothesis does not appear to hold.  

Investing in China has become increasingly controversial.  George Soros has penned essays in the leading financial press warning about investing in China.  At the recent panel discussion at the US-China Economic and Security Review Commission, it was suggested that American investors are unaware of the risk.  But this does not seem to be a fair assessment.  Several US regulatory agencies have underscored the political risks and lack of transparency.  Still, Blackrock has launched new funds for Chinese investors and its Investor Institute has advocated a higher allocation to Chinese stocks.  Bridgewater's Dalio argues that China is too big to ignore, and the crackdown is not necessarily "anti-capitalist."  If the "fear of missing out" can explain chasing valuations to historically rich levels, it seems a more robust explanation for investment in Chinese shares.  

The dollar peaked yesterday near JPY110.45. Slipping yields and falling stocks pushed the greenback to almost JPY109.85 today.  The trendline drawn off the early and mid-August lows, and catching the early September lows, comes in near JPY109.70 today.  Below there, congestion in the JPY109.40-JPY109.50 area may be sufficient to hold back steeper losses.  The Australian dollar is trading within yesterday's range  (~$0.7345-$0.7405).  Near midday in Europe, it is hovering near $0.7375, where a A$980 mln option is set to expire later today.  Another set of expiring options for around A$700 mln are stacked in the $0.7330-$0.7350 area.  The Chinese yuan edged higher for the second day, but the move was small (less than 0.1%).  The dollar has been in a CNY6.45-CNY6.50 range, with only a few exceptions for the better part of three months.  For the second week, it has been confined to the lower half.  The PBOC set the dollar's reference rate at CNY6.4615, close to the median projection in Bloomberg's survey for CNY6.4610.   

Europe

The Financial Times says that today the ECB "needs to explain clearly and credibly" how it will wind down the Pandemic Emergency Purchase Program.  With all due respect, poppycock.  Why must it be done today?  It seems that the only thing that has to be decided is the current pace, as the June decision was to continue the acceleration agreed in March.  The FT editorial is misguided.  It is more prudent to make the bigger decision when it has to be made, and that is not until at least December.  More information, including the evolution of the virus itself, will be available.  

The PEPP is intended to be completed by the end of March.  It is not helpful to make a fetish out the difference between buying 60 bln euros a month of bonds and 80 bln.  The Eurosystem was authorized to buy as much as 1.85 bln euros worth of bonds under PEPP.  It has used a little more than 70% of its "envelope." It is already clear that the ECB, like the BOJ, was buying bonds before the pandemic struck and have programs to do so after the "crisis phase" passes. The ECB's Asset Purchase Program is less flexible, and those self-imposed constraints, like issuer limits, seem to be part of the legal compromise.  

Despite some grumbling, the Tory backbenchers supported the Johnson government's 1.25% increase in the national insurance by employers and employees and on dividends.  That it violates the campaign manifesto would not be a big deal in itself. After all, the pandemic was a shock.  However, the Johnson government seems cavalier about other promises, like the "triple lock" on pensions and the commitment to inspect foodstuff from other parts of Britain to Northern Ireland.  Moreover, the national insurance tax is seen as less progressive than income tax.  

The euro peaked after the US jobs data at the end of last week, poking above $1.19 for the first time since late July.  Yesterday, it approached $1.1800.  It is in-between two retracements of its recovery from the year's low set on August 20 near $1.1665.  The first (38.2%) is around $1.1815, and the other (50%) is closer to $1.1785.  There is an expiring option for a little more than 930 mln euros at $1.1875, which seems too far out to be relevant, barring an unexpectedly hawkish signal from the ECB.   Comments by the Bank of England Governor Bailey that half of the eight MPC members (Mann has not assumed her post yet) thought the minimum but not sufficient conditions for a hike have been met is helping underpin sterling today. The implied yield of the June 2022 short-sterling futures contract has jumped 4.5 bp to 43 bp, its highest level in nearly a month.  Sterling had peaked a little below $1.3900 on the US employment miss and yesterday had dipped below $1.3730.  It is approaching $1.3830 around midday in Europe, which is near the (61.8%) retracement objective of the losses in recent days.  Above there, the $1.3860 area offers the next hurdle.  

America

The narrative of the Beige Book is straightforward.  Growth slowed in July and August to moderate, chiefly due to the virus.  Most districts, it said, were optimistic.  Supply chain disruptions were still a bane.  Inflation was steady at elevated levels, which is what next week's CPI will likely confirm.  The Beige Book supports our prior:  the Fed recognizes the modest slowing that market participants know about, and nothing here will deter the beginning of tapering toward the end of the year.  When Chair Powell says, investors and businesses will be given ample notice, acknowledging that a majority of officials see a move this year does not rise to the level that meets the "ample notice" threshold.  To begin tapering this month was never really in the cards or expected.  

The Bank of Canada delivered, not drama. No-fuss. No muss. It is content with its weekly purchases of C$2 bln a week and, despite some disappointing data, continues to see the output gap closing around the middle of next year.  Many market participants understand the closing of the output gap with the opening of the window to raise rates.  Swap rates seem to imply a rate hike in Q3 has been discounted. 

The draft of Mexico's 2022 budget contained some notable macro assumptions.  Growth is put at 4.1%, which is in line with the IMF's 4.2%  projection, which is high compared to the World Bank's 3% and the OECD's 3.2%.  The government assumes CPI will average about 3.4% next year, while the OECD and IMF are a little lower at 3.1%.  The budget assumes the dollar averages MXN20.30 in 2022.   So far this year, it has averaged about MXN20.13.  The average of the median quarterly projections in Bloomberg's survey works out to be around MXN20.20 for next year.  

While the ECB's meeting will dominate the early trading in North America, there are several data points to note.  The US weekly initial jobless claims are expected to continue to slip lower.  The US EIA's weekly inventory figures are released today, a day later than usual, due to the US holiday on Monday.  A 4.3 mln barrel drawdown is expected after a 7.2 mln barrel draw the previous week.  The bulk of the Gulf production is still not up and running after the storm.  In addition to the four and eight-week bill auctions, which could be skewed by the debt ceiling, for which Treasury Secretary Yellen anticipates to bite next month, Treasury auctions $24 bln 30-year bonds.  This week's coupon sales have seen strong indirect bidding, but the 30-year typically does not draw much international interest.  Lastly, no fewer than four Fed officials speak.  

Mexico reports August CPI.  The year-over-year pace is expected to moderate from 5.81% in July.  A slower pace will reinforce the signal that Banxico is likely to pause at this month's meeting after hiking in July and August.  Brazil's IPCA inflation is expected to accelerate to 9.50% from 8.99%.  Food and electricity prices are surging.  Politics are fluid as President Bolsonaro's approval rating is near 25%.  He lost the support of the moderates previously, and his base does not constitute a majority.  The Brazilian real is off about 2.4% this week coming into today.  The central bank meets on September 22 and is widely expected to continue to hike the Selic Rate.  

The US dollar spiked from CAD1.2520 on Monday to CAD1.2760 yesterday.  It is consolidating today at little changed levels.  It has been mostly confined to a 20-pip range on either side of CAD1.2700 today.  The Canadian dollar appears particularly sensitive to the US stock market (a proxy for risk appetites).  The latest polls show support for Trudeau's Liberals has stabilized.  As long as the CAD1.2650 area holds, the bias is toward a higher greenback.  The US dollar appears to be going nowhere quickly against the Mexican peso.  It remains within the range set last Friday (~MXN19.85-MXN19.9850).  The intraday technicals for both exchange rates seem to favor the US dollar, at least at the start of the North American session.  


Disclaimer 


Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.

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