Dollar Firm but Sterling Stellar

Highlights
The US dollar was just about evenly split across the board versus the G10 with large gains versus yen, but largely down versus sterling and CAD.  Meanwhile, the EUR whipsawed between $1.37 and $1.38, and as London came in was at the upper end of that range. The yen similarly jumped around, though pushed higher later in the session to hit JPY82.36.  This was a continuation from yesterday’s weak bond auction where the yield spread favored long dollars over yen. Sterling was broadly higher after the BoE inflation report, lifting it nearly 0.5%. China’s trade surplus in October rose more than expected to $27.1bln in October, reinforcing how currency tensions may play a part of the G20 this weekend. EM FX mostly advanced vs the greenback, with leaders including PLN, HUF, ZAR, KRW and PHP.

Asian stocks were mixed to lower as fears about Chinese attempts to tighten monetary conditions and a weak trade report weighed on sentiment. The MSCI Asia Pacific index lost 0.4%. And despite the weak Chinese data, Japan’s Nikkei gained, rising 1.5%, led by a 2.6% gain in consumer services with oil and gas a laggard. European stocks are down as well as mining companies earnings slid with the Euro Stoxx 600 down 0.2% led by a 1.4% loss in basic materials.   Meanwhile, the Dax and FTSE were both down 0.3% led by a 1.3% loss in basic material, though utilities were a big outperformer up 3.5%.

After the UK inflation report gilts yields increased sharply, underscoring the potential for short-term inflation and dampening the outlook for further QE.  The impact was most felt on the short-end as the MPC highlighted that higher inflation may overshoot in the short-run.  10-year gilts popped by 11bp, following the announcement, while the 30-year was less elastic but jumped by 7bp.  The euro zone periphery was under duress again as the Portuguese auction showed a sharp rise in refinancing costs.  In addition, the Irish 10-year was up nearly 20bp on news that the government is extending bank guarantees covering deposits and new senior bonds with maturities up to five years.  Meanwhile, 10-year German yields are up 5bp with the 2-year US Treasury flat and the 10-year down 1bp.   

Currency Markets

On the eve of the G20 meeting, Taiwan has announced measures that limit foreign ownership of domestic debt (government bonds and money market) to 30% of the portfolio.  This may have weighed on Taiwanese bonds a bit (10-year yield up 2 bp, 5-year up 4 bp), but more important, it may continue to encourage foreign funds mangers to buy Taiwanese shares and may not help moderate the upward pressure on the currency.  Foreign investors have poured roughly $2.4 bln into Taiwanese shares already this month, which is a full third of this year’s entire equity inflow.  Even though the central bank is believed to intervene almost daily, the Taiwanese dollar’s 1.4% gain this month makes it the strongest in Asia. 

China announced intentions yesterday that will force banks to hold on to more foreign currencies and this is another species of deterring capital inflows.  Today’s move to hike reserve requirements 50 bp is a different kettle of fish.    It is a continuation of the existing policy trajectory and follows the recent increase in the benchmark 1 year rates.  Many are also reading it as a tell ahead of tomorrow’s CPI which is expected to rise to 4% or a little higher from 3.6% in Sept.  While some will complain that the Fed’s QEII and unilateral measures taken by other countries reflects a breakdown in cooperation, in fact, international relations has always been an arena in which national self-interest is pursued.  The G20 offers a larger forum for this competition.  No country would have it any other way, even as they insist on other countries taking their interests into account. China’s NSA October trade surplus jumped to $27 bln from $16.9 bln with y/y exports narrowing to +22.9% from September’s +25.1% and imports to +25.3% from +24.1%.  On a seasonally adjusted basis, though, China’s m/m exports rose 2.9% in October 2010 from September, while imports rose 5.6%, according to the customs data. The export figure was slightly worse-than-expected as the Chinese economy continues to trend sideways in the recent months after the strong recovery through mid-year that had taken shipment to pre-crisis highs.  The import figure was a bit below forecasts but the fact that m/m and y/y imports growth continues to outpace export growth is a sign that the Chinese economy is rebalancing, albeit at a much slower pace than many would like.  The continued strength of import growth with be heavily reliant on a mix of currency, flow and interest policy where, we suspect, that Chinese policy makers will allow faster yuan appreciation to stem domestic inflation, which according to some estimates may much higher than expected. 

The BoE sees CPI around 1.7% in two years time according to its November Inflation Report if rates are held unchanged throughout the forecasts period, up from a forecast of around 1.5% in the August Report.  This places more inflation pressures on the short-end of the gilts curve while the backend will wait on the economic data releases to confirm the likely trend.  But the BoE is still keeping the door open to looser monetary policy down the road, perhaps mid next year.  Based on market rate expectations, it sees CPI at around 1.6% in two years time, slightly higher than in the August Report but still well below the 2% target. The BoE noted that was a wider than usual range of views within the MPCregarding the CPI and GDP outlook, and reiterated that the central bank stood ready to act in either direction. Meanwhile, as expected, the BoE sees GDP around 3% in two years time, same as in the August report. Overall, the November Report was less dovish than we had expected, and drove the sterling to fresh high reaching $1.61.  Therefore, expect sterling to stay above the $1.608 range with stops building above the around the 20d moving average, 1.594.

Upcoming Economic Releases

At 8:30 EST / 12:30 GMT the US reports the trade balance which is expected to narrow to -45 bln from -46 bln in August.  In addition, m/m import prices are expected to increase to +1.2% from -0.3% in September.  Initial jobless claims are expected to fall by 7k while continuing claims are expected to fall 37k.  At the same time Canada reports September int’l merchandise trade which is expected to drop by 300 mln.  Events: US Treasury to sell $16 bln 30-year bonds at 1pm / 17:00 GMT followed by the October Treasury Budget.  The budget is expected to widen to -152bln.