Dollar Edges Higher; PBOC Suggests Further Tightening Measures
After an initial dip, the dollar edged higher in the Asian session, along with the yen, though trading ranges were pretty subdued. Comments from People’s Bank of China officials suggested the central bank will adopt more measures to rein in liquidity as it combats inflation. Elsewhere in Asia, Japanese exports slowed more than expected in November, while Philippine economic growth disappointed in the third quarter. EUR/USD touched as high as $1.3360 in the Asian morning before settling into a $1.3310-30 range. The AUD lost a little ground even after strong business investment numbers, falling below A$0.98. EM currencies were mixed, with KRW leading gains after consumer confidence rebounded from a 16-month low. TWD and INR also gained, while declines came for RUB, ISK, PLN and ZAR.
Asian stocks were still buoyed by US jobs and consumer confidence data from yesterday, with the MSCI Asia Pacific index up 0.4%. Still, moves across the region were muted. Japan’s Nikkei added 0.5%, Hong Kong’s Hang Seng was 1% higher, while none of the major benchmarks in the region gained more than 1%. European markets are being called higher for now, but US futures are trading lower.
Bonds were mixed. In Japan, 10-year JGB yields added 3 basis points to 1.145%. Treasuries were little changed, with the 2-year yield down 1bp to 0.52%, the 10-year at 2.91% while the 30-year yield added 1bp to 4.29%. German’s 10-year was steady, yielding 2.71%, while Irish 10-year yields dipped 3bps to 8.62%.
There were a few less-than-stellar developments overnight in Asia, which may lean on confidence about the outlook for Asian growth. Comments from both a People’s Bank of China deputy governor and a central bank adviser suggested further tightening measures from the central bank to control inflation. The PBOC’s Hu Xiaolian said yesterday in a statement that the central bank will use quantitative and price measures to manage liquidity, while PBOC adviser Xia Bin said earlier today that higher interest rates and bank reserve ratios could be used to stem liquidity while also suggesting a Tobin-style tax on currency trading to ease capital inflows. Japanese exports slowed more than expected in October. Exports rose 7.8% from a year ago, down from 14.3% growth in September, and well below the expected 10.7% rise. Given that industrial production tends to follow exports pretty closely, and then GDP tends to follow industrial production, these numbers will spark concerns about the strength of the economy in the fourth quarter. Philippine economic growth slowed in the third quarter, albeit from a three-year high, dampened by weaker agriculture and government spending. GDP rose 6.5% from a year earlier, compared with a revised 8.2% gain in the previous quarter. That’s slower than the 7.3% growth forecast and is the weakest pace this year. There were some positive figures from Australia and South Korea however – Australia business investment rose twice as fast as expected in the third quarter, up 6.2% from Q2. South Korean consumer confidence rose in November, with the sentiment index rising from a 16-month low to 110 from 108.
The euro remains under pressure amid skepticism about Ireland’s budget plan and continued concerns about contagion in the European periphery. We are wary of the rosy growth assumptions in Ireland’s plan given the extent of fiscal tightening that’s planned. That’s really the case not just in Ireland but for the rest of peripheral euro zone as well. We believe slow growth will end up dooming most of the austerity measures planned by the periphery. The best thing for improving debt dynamics is stronger growth, but that will be almost impossible to achieve. At least with an EM debt crisis, many of those EM countries can count on a weaker currency and a return to EM-type growth rates in excess of 5-6%. For a mature developed economy, that is highly unlikely and even less so given that the euro zone prevents any sort of competitive devaluation for countries like Greece and Ireland. Therefore our base case remains for debt restructurings in Greece, Ireland, and Portugal. We have been on the fence regarding Spain, but like all the EM crises we have seen over the years, we remain resigned to the fact that contagion remains a force to be reckoned with and that it will likely claim more victims in the euro zone before the crisis is over. The euro continues to trade with a weak bias. Despite the current bounce back to 1.34 today after sinking below 1.33 earlier, further losses remain likely. Yesterday’s break of the 1.3450-60 area (50% retracement level of the big September-November rise) set up today’s test of the 62% level around 1.3270. While that level held for now, eventual break is seen which would target the September lows around 1.2640. Bond markets are voting with their feet, as the 10-year yield for Ireland is up 32 bp today. Spain is next worst performing bond market with 10-year yield up 14 bp on the day, followed by Greece (up 11 bp).
Brazilian president-elect Dilma Rousseff appointed central bank director Alexandre Tombini to replace current central bank President Meirelles when Rousseff takes office January 1. Mereilles yesterday declared that ‘this is the right moment to end the mission.’ Tombini has a doctorate in economics from the University of Illinois and is currently serving as the director of financial regulation at the central bank. While his credentials are strong, markets remain nervous that Rousseff will try to exert more control over monetary policy. And it comes at a tough time, as mid-November IPCA inflation rose a higher than expected 0.85% m/m, bringing the y/y rate to 5.5%. This is the highest rate since April 2009 and given the strong momentum still being seen in the economy, inflation could move close to 6% in the coming months. Since the bank has a 4.5% inflation target (but with a tolerance band of 2.5-6.5%), that would imply tightening ahead. Market is now looking for an end-2011 policy rate of 12.0% but we think that the rate could go as high as 12.75% next year from 10.75% currently. A more aggressive tightening path is likely to lead to more adjustments in the IOF tax, as the market appears to be in a sort of near-term “equilibrium” right now with policy rate at 10.75% and IOF tax at 6%. Next COPOM meeting is December 7/8 and no move is expected and so for now, USD/BRL remains range-bound in the 1.70-1.75 area. We continue to believe that other FX measures will be rolled out on any significant break towards 1.65. As a result, we think that the year’s low around 1.6440 is unlikely to be tested anytime soon given what we see as increased Brazil risks. We note that the real is firmer today and so markets for now seem to be comfortable with the central bank news.
Upcoming Economic Releases
Asia Pacific: Hong Kong exports, trade. Europe: Swiss employment, Spain producer prices, Sweden consumer confidence, lending PPI, Hungary retail trade, Poland retail sales. Americas: Mexico current account, GDP, unemployment. Events: Bank of England’s Sentance speaks in Belfast.