Deflation Continues to Grip China

[Ben Graham]

Overview: The US dollar is trading quietly today, ahead of the August PPI, though with a weaker bias against most of the G10 currencies. The yen and Canadian dollar are the laggards. Two news developments are among the talking points. First, a federal judge temporarily blocked President Trump's attempt to remove Federal Reserve Governor Cook. Barring a new ruling, she will vote at next week's FOMC meeting. Most likely, so will Miran, as he will likely be confirmed shortly. The Fed funds futures are discounting about a 1-in-8 chance of a 50 bp cut. It was around a 1-in-12 chance after the employment data before the weekend. Second, tensions are elevated after Poland shot down Russian drones that had entered its air space. Poland's stocks, bonds, and zloty have been sold in response. All of the central European currencies are weaker, as are most emerging market currencies. 

News that the US is encouraging Europe to levy 100% tariffs on India and China, and if they do the US would match it, is seen as a feint. The impact seems marginal at best. Asia Pacific equities have rallied, including India and China and both currencies have also edged up against the dollar. Europe's Stoxx 600 is firmer for the third consecutive session. US index futures are also a little higher after the S&P 500 and Nasdaq set record highs yesterday. Benchmark 10-year yields are mostly little changed today, and the 10-year Treasury yield is practically flat, a little above 4.08%. Gold recovered from yesterday's pullback but is holding below the record high set then near $3674. October WTI is firm near $63, but within yesterday's range. 

USD: The Dollar Index was sold to six-week lows yesterday near 97.25. It held above the low from late July (~97.10). DXY recovered to around 97.80 yesterday. It edged up to nearly 97.95 today, but is closer to 97.75 now.  A move above the pre-weekend high (~98.25) would be important from a technical perspective. Yesterday's sharp downward revision to US job growth in the year ending in March will allow the market's attention to turn toward US price pressures. Today, is August PPI and tomorrow CPI. July PPI rose 0.9% and is expected to rise another 0.3% at the headline and core levels today. Still, due to the base effect, the year-over-year headline rate is seen steady at 3.3% and the core can slip to 3.5% from 3.7%. Tomorrow's headline CPI is expected to rise to 2.9% from 2.7%. If accurate, it would be the highest print since February. Also, below the surface, money market pressures are building. SOFRA is at its highest level since early July. Reverse repo usage is trending lower. Treasury auctions also drain reserves. September 15 is a corporate and personal tax date, which also drains liquidity. 

EURO: The euro reached $1.1780 yesterday, a new high since last July, in Asia Pacific turnover. The session low was recorded in North America after Europe closed near $1.1700. It slipped to a new low for the week today, slightly below $1.1685. It recovered in the European morning to almost $1.1720 where it looked to be stalling. With the upside momentum stalling, late longs may move to the sidelines. It approached support seen near $1.1675. A break of the pre-US jobs data low near $1.1650, where options for almost 825 mln euros expire today, would likely force out more longs. The ECB meets tomorrow and there is little chance of a change in policy. The staff will update its economic projections. French President Macron named the only person who has been a minister throughout his presidency, the current defense minister Lecornu. It is not yet clear if he will survive a vote of confidence. The French 10-year premium over Germany is a little wider. Remember Fitch is set to announce the results of its review of France's AA- credit rating that is on negative watch.

CNY: China reported the August CPI fell back into deflationary levels (-0.4% year-over-year). It is the first negative print since May and the most since February's 0.7% decline. The main culprit seems to be food prices, which fell 4.3% year-over-year. Clothing prices rose 1.8%, and the prices of other goods and services jumped 8.6%, while transportation and communication prices fell 2.4%. Core prices, excluding food and energy rose by 0.8%, the most in 18 months. Deflation among producer prices diminished to -2.9% from -3.6%. It is the least factory-gate deflation since April. Some attribute the reduced deflation at the producer-level due to Beijing's campaign against over-investment (involution). Imagine if China were to reduce its investment as a percentage of GDP, the consumption component would rise. Through its lower dollar fix, the PBOC has encouraged the appreciation of the offshore yuan, which set a new high for the year yesterday (~CNH7.1135) before rebounding to almost CNH7.1250. It reached almost CNH7.1290 today where sellers emerged and set the dollar back to nearly CNH7.1135 before Europe entered the fray. It is consolidating mostly between CNH7.1170-CNH7.1200 in Europe. The dollar's reference rate was set at CNY7.1062 (CNY7.1008 yesterday). It is not clear what it means when Bloomberg's survey showed a range of estimates for the fix is well-off the market. Today's range of estimates was CNY7.1333-CNY7.1405. The fix has not been set in that range since August 20. 

JPY: Yesterday's the dollar spent little time above Monday's settlement (~JPY147.50) and was sold almost JPY146.30 in the European morning. The greenback recovered in North American almost back to session highs, above JPY147.40. It is trading in a narrow range around JPY147.25-JPY147.60 so far today. Speculation that the changes in the LDP, leading to a new Japanese prime minister, will not deter the BOJ from hiking rates should be kept in context. At the end of August, the swaps market had almost 17 bp of tightening discounted for the remainder of the year. The political machinations and uncertainty saw it fall to nearly 11 bp on Monday. It rebounded to 16 yesterday but is a little softer today. 

GBP: Sterling approached the $1.36-nemesis in Europe yesterday and spent the North American session trending lower toward $1.3520. Options for about GBP375 mln expired at $1.36 yesterday and another set for almost GBP610 mln expires there tomorrow. Separately, GBP390 mln options at $1.3475 expire today. The near-term path of least resistance seems lower. It eased to slightly below $1.3515 today but is chopping around $1.3520-45 in the European morning. There may be potential toward $1.3460-90. The data highlight of the week still lay ahead. On Friday, the UK reports July GDP and details. The median forecast is for unchanged after a 0.4% growth was seen in June. 

CAD: The greenback traded in a wide range last Friday after both the US and Canada reported disappointing August employment data. The US dollar has been confined to that range, roughly CAD1.3760 to CAD1.3855. Yesterday, it traded within Monday's range, which was about CAD1.3790-CAD1.3850. It briefly traded to almost CAD1.3865 today, its highest level since August 26. It is near the middle of today's narrow range (~CAD1.3840-65) in late European morning turnover. A firmer US dollar environment that we anticipate will not prevent the Canadian dollar from weakening further, but rather the Loonie tends to do better on the crosses when the greenback is bid. The market feels more comfortable with a Bank of Canada rate cut next week. Another cut is nearly fully discounted for Q1 26. The poor string of Canadian data has seen the swaps market adjust the terminal rate to near 2.25% from 2.50% previously. The overnight rate now is 2.75%.

AUD: In price action vaguely reminiscent of the July 24, the Australian dollar pushed above $0.6600 yesterday and the momentum stalled and settled below $0.6590. On July 24, the intraday high of the year was recorded near $0.6625. Yesterday, perhaps with the help of option-related demand, the Aussie reached $0.6620 in Europe and fell to almost $0.6580 in North America. On July 24, it settled at $0.6590. The market has not given up on $0.6600. After retesting the $0.6580 area, it has recovered and is back above $0.6600 near midday in Europe. 

MXN: The US dollar approached last Friday's low yesterday, shortly before the North American session began. It reached about MXN18.5860 compared with the pre-weekend low closer to MXN18.5820. Apparently in response to the firmer than expected Mexican CPI, the dollar recovered to around MXN18.6550. It has been mostly confined to a MXN18.6075-MXN18.6520 range today. Both the headline and core CPI rose slightly more than the median forecast in Bloomberg's survey projected. It is important, though, to keep it in perspective. The headline pace increased from 3.51% to 3.57%. Core CPI was unchanged at 4.23%. It was the first increase in the headline rate since it peaked in May at 4.42%. This does not appear to stand in the way of a rate cut at Banxico’s meeting on September 25.

 

Disclaimer