Market Takes Developments in Stride

[Ben Graham]

Overview: Capital market activity is subdued. The US dollar and the dollar-bloc currencies ae mostly a little softer, while the other G10 currencies are around 0.1-0.2% firmer. Emerging market currencies are mixed with central European currencies mostly firmer, though the Russian ruble is the notable exception, off about 1%. European bond yields are slightly softer, though ahead of Sweden's Riksbank meeting tomorrow, its 10-year bonds yield is up a basis point, while the krona is the strongest of the G10 currencies, though no change is expected in the 2% policy rate. 

News of a rapprochement between India and China, one of the consequences of US foreign economic policy, helped Indian equities buck the regional down draft today. Reports suggest Beijing is lifting export restrictions on rare earths and heavy earth-moving equipment on India. Europe's Stoxx 600 is up about 0.5% and is advancing for the fifth session in the past six. US index futures are flat to slightly lower. Gold and September WTI are trading quietly inside yesterday's ranges. There seems little market reaction to the Ukraine-Russia developments, but some observers are wary of a repeat of the Sudetenland in 1938, when Czechoslovakia was forced to surrender it to Germany to avoid further war, which, of course it didn't.  Instead, the abandonment of the defended territory, like the part of Donbas that Russia has not managed to take, made a full invasion easier. The market is digesting news that the US has extended the steel/aluminum tariffs to include more than 400 consumer items. Separately, S&P affirmed the US AA+ rating, explaining that the tariffs US are collecting will offset the deterioration of the recent tax and spending bill. Lastly, the continued decline in the use of the Federal Reserve's reverse repo facility boosts the chance that next month the Fed will not only cut its target rate but may announce an exit strategy from its quantitative tightening. 

USD: Last Thursday's range remained operative through yesterday, confining the Dollar Index in a roughly 97.65-98.30. It made a marginal new high today but held below the 20-day moving average (~98.40) and this month's down trendline, found around 98.55-60 today. US reports July housing starts and permits. Both are expected to slip. Starts have fallen in two of the three months every quarter since Q2 24. In H1, starts fell by an average of 1.9% a month (compared to -1.8% average in H1 24). Tomorrow, the minutes from last month's FOMC meeting are due. The hawkish takeaway by the market confounded us, especially given the dovish dissent by two governors. If anything, subsequent events make the minutes somewhat less significant. The day following the conclusion of the FOMC meeting, the futures market almost 10 bp of cuts discounted for the Sept meeting and now it is double that.

EURO: The euro made a marginal new three-day high yesterday, slightly above $1.1715, but was sold back to almost $1.1655 in North America yesterday. Losses were extended to about $1.1640 today ahead of support seen around $1.1630, where last Thursday's low and the 20-day moving average are found. Some countries like Japan run a trade deficit and a current account surplus, but the eurozone's current account surplus is driven by the trade account. However, yesterday's news that the trade surplus narrowed to 2.8 bln euros (seasonally adjusted) from 15.6 bln in May was not reflected in today's current account report that showed the surplus widened to (seasonally adjusted) to 35.8 bln euros from 31.8 bln in May. The eurozone's current account surplus was 2.6% of GDP in 2024 and may be a little smaller this year. On an unadjusted basis, the EU's trade surplus with the US in June was almost half of the June 2024 surplus (9.6 bln euros vs. 18.5 bln) as exports fell 10.3% year-over-year and imports rose 16.4%. Exports to China are off 12.7% year-over-year, while imports are 16.7% higher.

CNY: The dollar continues to trade in a narrow range against the offshore yuan. The convergence of the five- and 20-day moving averages (~CNH7.1840) illustrate this. The dollar reached a five-day high near CNH7.1920 before being sold to almost CNH7.1830. Even as the PBOC pledges "moderately loose monetary policy," it set the dollar's reference rate at a new low for the year yesterday (CNY7.1322), though higher today (CNY7.1359). Loan prime rates are set tomorrow and look to be flat at 3.0% and 3.50% for the one- and five-year terms, respectively. After the recent batch of disappointing data, there is renewed speculation of more stimulus, perhaps in Q4.

JPY: The dollar firmed to a marginal new four-day high today, and pushed a little aboveJPY148, the (38.2%) retracement of this month's decline. Selling pressure emerged and the US dollar was knocked back to JPY146.55. Support is seen in the JPY147.15-35 area. Japan reports the July trade figures first thing tomorrow. On an unadjusted basis, it is expected to report a surplus of almost JPY200 bln. Without seasonal adjustments, a deficit is projected. In the first half, Japan recorded an average monthly deficit of JPY370 bln (unadjusted). In H1 24, the average monthly deficit was almost JPY561 bln and an average deficit of nearly JPY1.12 trillion. Despite last week's call from the US Treasury Secretary for the BOJ to hike rates and the stronger than expected Q2 GDP, and the contraction in Q1 GDP revised away, the swaps market still see little chance of a hike next month. It has about 2.5 bp discounted compared with 1.5 bp a week ago.

GBP: Sterling reached almost $1.3600 last Thursday after the stronger than expected Q2 GDP figures but was greeted by sellers and finished lower on the session. Sterling was sold to a three-day low slightly above $1.35 yesterday. Follow-through selling took it slightly below $1.3490 today before finding bids. A break of the $1.3480 area could signal a move toward the (38.2%) retracement of this month's rally and the 20-day moving average around $1.3420. Tomorrow, the UK reports July CPI. The median forecast in Bloomberg's survey is for a flat reading, which given the base effect, would allow the year-over-year rate to tick up to 3.7% (from 3.6%), while core and services prices remain elevated. The BOE warned that the headline rate may rise to 3.8% and sees a peak of 4.0% next month. It projected service price inflation to rise to 4.9% (from 4.7%). The swaps market is pricing in about 13 bp of cuts before the end of the year (~52% chance of a quarter-point cut), down from fully pricing in a cut before the last BOE meeting earlier this month.

CAD: The US dollar rose to about CAD1.3830 yesterday, its best level since August 1. The upside momentum was not sustained and the greenback eased to around CAD1.3800. That more or less has held today, and the US dollar is back near CAD1.3820 late in the European morning. The next near-term target is around CAD1.3840 and then the August 1 high around CAD1.3880. The Canadian dollar's initial decline losses came despite favorable economic news but amid a broadly firmer greenback. Yesterday, Canada reported the fourth consecutive increase in housing starts, and the 294.1k annual rate was the strongest since September 2022. Separately, Canada reported that foreign investors were net buyers of Canadian stocks in bonds in July for the first time since January, but it was minor (C$701 mln). Today, Canada reports July CPI. Given the base effect, the 0.3% increase expected will allow the year-over-year rate to slip to 1.8% from 1.9%. However, the underlying core rates look firm (may average 3.1% in July from 3.05% in June) and this will likely keep the Bank of Canada on hold next month. 

AUD: The Australian dollar rallied from about $0.6420 on August 1 to nearly $0.6570 on last Thursday. It slipped marginally through the pre-weekend low yesterday (slightly above $0.6480). The $0.6475, which the Aussie has held above today, corresponds to the (61.8%) retracement of this month's rally. A break could signal a move to $0.6450 initially. Despite the Aussie sometimes being seen as a G10 proxy for China, it has not worked so well recently. The correlation between changes in the exchange rate and China's CSI 300 is less than 0.15 over the past 30 sessions, which is the lowest in about six weeks. The high for the year was set in early May a little above 0.75. The Reserve Bank of New Zealand is expected to cut its target rate a quarter-point tomorrow to 3.0%. The swaps market sees the terminal rate near 2.75%.

MXN: The greenback remains in its trough against the Mexican peso. It was volatile in the first part of the year as the market tried assessing the implications of Trump's second term. In the first four months of the year, three-month implied volatility average 13.2%. Since the end of April, the average is closer to 10.3%. The dollar has been trading roughly between MXN18.50 and MXN19.00 since late June. Given the carry, one is paid to be long peso even in the sideways market. Speculators (non-commercials) have among the largest net long peso positions in the futures market in about a year. The greenback reached almost MXN18.87 yesterday but slipped back to nearly unchanged levels in late turnover. The dollar remains firm today in a roughly MXN18.7470-MXN18.8120 range. 

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