China Increases Depo Rate Stoking a Return to Dollars

Highlights

The US dollar has been put back in the driver seat as the Central Bank of China raised its one-year lending and deposit rate by 25 bps.  In effect, the move by the Chinese has drawn capital out of risk and reaffirmed the recent long dollar trend, leading to a pronounced sell-off in high-beta currencies, like the AUD, CAD and NZD.  AUD, for example, collapsed after the news, falling by nearly 1%.  Therefore, the dollar is up across the board as equities and commodities retrace.  Furthermore, the better-than-rumored German ZEW survey saw the euro and Swiss franc turn better bid for a little.  The Bank of Canada meets today but is nearly universally expected to stand pat. 

Asian stocks were mixed but mostly positive after a choppy overnight session.  Prices fluctuated as technology stocks dropped after Apple’s profit forecast missed estimates and IBM reported demand in new contracts. The MSCI Asia Pacific index slipped 0.05%.  Losers in the region included benchmarks in Korea and Taiwan which were dragged down by consumer services.  On the other hand, Chinese stocks surged as the Shanghai and Shenzhen increased by 1.5% and 2.9%, respectively.  Japan’s Nikkei added 0.4% led by a gain in utilities.  In Europe, technology stocks fluctuated as well on the negative Apple news.  The benchmark Stoxx Europe 600 Index rose by 0.08% by London’s mid afternoon session. 

The fixed income news was largely dominated by BRICS as Brazilian Finance Ministry’s once again hiked the IOF tax for fixed income investments to 6% from 4% and reaffirmed that if necessary more action may be taken.  In addition, Minister Mantega announced that the IOF tax on BM&F margins will be hiked to 6% from 0.38%.  Meanwhile, China’s central bank raised its on-year lending and deposit rate by 25bps.  In Europe Italy are selling seven-year notes in the country’s first bond issuance in over a month.  The price of the notes may range from 83 bps to 87 bps, according to the bankers involved with the auction.  Moreover, Spain sold €6.4 bln of Treasury bills at an auction and its borrowings costs declined.  German 10-year yields were up 4 bps while similar dated US yields were up 1 bps.

Currency Markets

Since the second half of last week, the strong trends in the foreign exchange market since early September seem to have broken down.  Market sentiment is largely dollar negative. It is fueled by the prospects of QEII, which some pundits have called the “mother of all interventions”, and the perceptions that the euro zone is well ahead of the US in the business cycle and in being able to exit from the extraordinary policy.  Against this many participants are cognizant the extreme sentiment readings and the risk that the QEII has largely been discounted.     The backing up in US bond yields (10-year note yield is up 8 bp over the past five sessions) while during this period, the dollar is up against all the G10 currencies, but the yen and Australian dollar.   Sterling, which frequently leads the euro, is breaking down.  Recall that most recently the sterling bottomed on Sept 7.  The euro bottomed a could days later.   Sterling is moving below its 20-day moving average today (~$1.5840), for the first time since September 14.  While there may be some support intermittent support, the downside risk extends toward $1.55 near-term.   The euro’s 20-day moving average comes in near $1.3765 and this area represents a reasonable near-term target as well.     The dollar put in a low against the Swiss franc on Oct 14.   The CHF0.9650 offers immediate resistance and the 20-day moving average is just below CHF0.9700.  It may take a move above CHF0.9750 to give boost confidence that a more sustainable low may be in place.   

German ZEW investor confidence dropped to -7.2 from -4.3 in the previous month, reaching a 21-month low. This was weaker than the market consensus, which expected the survey to decline by -7.0. Ongoing concern about the global economy and the recent discussion about a global currency war are likely to have dampened investor confidence as the euro has strengthened from the anti-dollar sentiment.  In fact, according to the BoE’s nominal trade-weighted euro index the euro has increased by nearly 6% vis-à-vis its trading partners. On the other hand, current conditions in Germany remain very robust, and the current conditions indicator jumped stronger than expected to 72.6 from 59.9. Clearly the question is if Germany can sustain the current pace of recovery in the light of global concerns, especially with a large share of export growth derived from European trade. This may explain why Bund futures actually extended losses after the result and shows that uncertainty remains high. The problem is that market pessimism can become a self fulfilling prophecy if it officials fail to address it.

The Reserve Bank of Australia (RBA) released the minutes from its last policy meeting on October 5.  The minutes highlighted the decision to keep borrowing costs unchanged was based on the outlook that the world economy would grow at trend (if not soften) in the coming months.  The RBA felt that increasing the lending rate would “effectively be tightening financial conditions at the margin” since it would constrain credit growth and most likely lead to further currency appreciation.  Overall, the bank’s statement was balanced indicating that over the short-term indicators of current growth in demand, for households and business, remained moderate.  Meanwhile, with the probability of a rate hike six months from now around 50%, the OIS market still maintains a tightening bias.  In price action the AUD initially benefited from the RBA minutes but subsequently got caught in the larger dollar moves which dominated Asian trading.  That said, the AUD/USD traded up to 0.9960 after the minutes revealed that the arguments for a further hike were finely balanced. However, it was unable to sustain these levels due to the weight of dollar buying and headed back towards 0.9882, where it remained into the afternoon session in Europe. 

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US reports the September housing starts figures.  Consensus is for a drop of nearly 20k from August, while building permits are expected to decline by 0.7 m/m.  At 17:00 EST / 21:00 GMT the US reports ABC consumer confidence.  In Canada, the Bank of Canada (BoC) announces its rate decision at 09:00 EST / 13:00 GMT.  The market expects the BoC to remain on the sidelines.   The Fed’s Bernanke, Dudley, Lockhart, Kocherlakota, and Fisher are all slated to speak this morning, which may provide some insight into the Fed’s outlook for QEII.