Another turbulent week across asset markets saw 10-year US Treasuries (UST) test the 2% level, falling to year-lows of 2.014% intra-day on Friday. The risk-off run followed a number of headwinds including: heightened geopolitical tensions, relatively dovish notes from the Fed, and the relentless devastation resulting from the hurricanes. The yield on the benchmark 10-year fell 12bps closing the week at 2.05%, testing the 2% level. Meanwhile, the dollar had a torrid week, falling a further 1.58%.
The Chinese renminbi was the talk of the town last week after it witnessed a one-way rally against the dollar heading beyond the 6.5 level; the offshore renminbi gained 1.03% against the greenback last week and is up 7.42% so far this year. The recent gains have wiped out the falls against the greenback witnessed last year (2016); when markets speculated that policymakers were losing their grip on the currency and in fact allowing it to depreciate to increase export competitiveness. It appeared the relentless dollar weakness is forcing Chinese corporates (who aren't fully hedged) to sell their dollar holding to buy the renminbi. We maintain our view that the currency is undervalued and continue to expect long-term, steady appreciation of the renminbi. We say steady appreciation as we heard at the end of the week that the PBoC announced the removal of the 20% reserve requirement on fx forward trading; the reserve requirement was introduced back in October 2015 to prevent market players from taking further speculative bets on the renminbi's depreciation. This move, effective today, goes to show that policymakers are less keen on intervening directly (e.g. using fx reserves as a tool), rather allowing the renminbi to be more market-driven.
On the data front, the Caixin composite and services PMI readings for China remained robust in August; services expanded by the most in three months. According to official statistics, the services sector accounted for over a half of H1’17 growth. FX reserves also grew in August, to USD 3,091.5bn. Exports grew less than expected in August, at 5.5% yoy, while imports increased 13.3% yoy; the trade balance was released at USD 41.99bn. CPI (1.8% yoy versus expectations for 1.4%) and PPI rebounded in August, driven by stronger domestic demand. The uptick in growth momentum over the past few months will no doubt bode well for the Communist Party Congress (Oct18); where deleveraging and financial risk management will be high on the agenda. This week will see retail sales, Industrial production and fixed asset releases for August all expected relatively unchanged from July’s levels.
Elsewhere, in terms of the Fed, which remains very clearly split, known dove Governor Brainard highlighted her concerns over inflation sticking below the central bank’s target; thus a cautious approach to tightening rates further. Kashkari said it’s possible that ‘rate hikes over the past 18 months are leading to slower job growth, leaving more people on the sidelines, leading to lower wage growth, and leading to lower inflation and inflation expectations’. On the flipside, Cleveland's hawkish Mester said she is ‘comfortable’ with raising rates further this year, while New York's’ Fed president, Dudley expects the US economy to perform well, adding ‘we will continue to gradually remove monetary policy accommodation’. The futures market is pricing in a 26.9% chance of a further rate hike this year (down from 34.5% on Sept,1). More importantly, however, further updates on the timing of the balance sheet unwind will grab market attention.
Staying with the Fed, known hawk Stanley Fischer announced his early resignation from his Vice Chair position; effective mid-October. This announcement added more uncertainty to the central bank’s future leadership, especially as Fed Chair Yellen's term expires in February, and there is no firm successor; this assumes she is not re-appointed. With the central bank in its current vulnerable position, with only three out of seven board positions currently occupied, this could make way for Trump to reshape the Fed.
It appears Mr Trump has a number of huge decisions on his hands. One of the most important being the looming debt ceiling debate, where last week he managed to agree to a three-month delay with the Democrats (shunning the Republicans). According to sources, the US president said there are ‘a lot of good reasons’ to scrap the debt ceiling altogether. Senate also approved a USD 15.25bn hurricane aid package which will raise the federal borrowing limit and passed the debt ceiling extension into December. Interestingly of the 80-17 votes of approval, none came from Republicans. Tax reform, like the repeal of Obamacare, is also too complicated to get done anytime soon, so the budget could be in limbo for the rest of the year. Or Congress would have to pass a package that did not incorporate tax reform. The problem is that the Republicans, despite having control of Congress for many years, currently have no viable plans either for health care or tax reform.
Data wise it was a relatively quiet but broadly weaker week in the US. Factory orders slumped -3.3% in July (in-line with expectations) after a particularly strong June; resulting from the Paris Air Show orders. Durable goods orders missed expectations, tumbling -6.8% in July. Market service and composite PMIs dipped in August. The Beige book was relatively unexciting: modest economic expansion, tight labour markets - where employment has slowed somewhat on balance- and ‘modest to moderate wage growth.’ This week will see the JOLTS job opening reading on Tuesday, followed by PPI and CPI data on Wednesday and Thursday, respectively; where the market expects core CPI for August to be released at 1.6% yoy. Empire manufacturing and retail sales should be of interest on Friday; as the bulk of the readings are expected to have moderated from July’s levels.
Meanwhile, the final reading for Q2’17 EU GDP came in at 0.6%qoq (unchanged and in-line with market expectations) and upwardly surprised at 2.3% yoy. As was widely expected, the ECB maintained policy on Thursday, however, hinted at increasing ‘our asset purchase programme in terms of size and/or duration’ if the economic outlook turns less favourable. The euro witnessed a volatile session following Draghi’s comments on the relative strength of the currency (resulting from improving economic fundamentals), and the subsequent knock-on effects on eurozone inflation and growth. It appears that the strong euro (up 1.48% so far this month and +14.44% this year) is currently preventing the ECB from making any concrete announcements on future policy decisions. Markets witnessed a broader rally across European benchmark bond yields through last week; periphery bonds outperformed. By close on Friday reports suggested that ECB officials discussed the possibility of reducing asset purchases to ‘EUR 40bn or 20bn’ a month (from EUR 60bn a month). We expect more colour on QE at the central bank meeting on October, 26. Before that, this week will see the eurozone's employment numbers released on Wednesday, followed by industrial production numbers, which the markets expect will have picked up in Q217. Also, CPI releases across Europe will be of interest.
Later today the House of Commons will vote on the EU withdrawal Bill; the bill was presented on Thursday. It appears a contentious bit of legislation and there are concerns that labour will attempt to block it. Brexit Secretary David Davis warned that ‘A vote against the bill is a vote for a chaotic exit from the European Union’. We expect sterling to come under pressure ahead of the vote. Later in the week, we will hear from the BoE, this could be an interesting meeting on Thursday, especially as upward inflation concerns remain. Looking back to the previous meeting, the committee agreed that if economic growth remains in-line with the central bank’s forecasts, ‘monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the path implied’.