Overview
There are three main developments. First, the market is digesting the implication of the US employment data, where the optics were strong (336k increase in nonfarm payrolls compared with 170k median forecast in Bloomberg and Dow Jones surveys) but some details were disappointing (like the third consecutive decline in full-time posts, seasonally adjusted). Second, Chinese mainland market re-opened after a six-day holiday. Chinese stocks slipped and currency strengthened. The third, and most significantly, is Hamas’s bold and brutal thrust into Israel and the Israeli response. There are three levels of analysis that seem particularly relevant. First, it does not seem coincidental, as US, Saudi Arabia and Israel were working toward a new agreement that some forces (including Iran) sought to disrupt. Second, it may be part of a larger pattern of flaring up of tensions in several places, including Nagorno-Karabakh and Kosovo and Serbia. Some have suggested that Russia is fanning the flames to sap the strength of the alliance it faces in Ukraine. Others frame it as a result of a distracted America. The third level of analysis is in the escalating tension between Israel and the Palestinians in Gaza and the West Bank. The next day to two may clarify whether Hezbollah, Iranian militias in Iraq and Syria, and Palestinians from elsewhere join the fighting. Oil prices jumped on concern of supply disruptions. November WTI settled near $84.65 and gapped higher, opening at $85.25 before rallying to about $87.25. It is now hovering around opening levels.
We had thought that the dollar was set for a setback, as the rally since mid-July looks exhausted. The price action today does not negate it, and often political developments shape but do not derail the underlying trend. The Japanese yen, where markets are closed today, Norwegian krone, and Canadian dollar are a little firmer, while the euro and sterling have been trading around 0.4% lower in late European morning turnover. Emerging market currencies are mostly lower. The Chinese yuan’s modest gains lead the complex. Asia-Pacific equities traded lower, but Europe’s STOXX 600 is slightly higher after rallying the past two sessions. US index futures are nursing small losses. European benchmark 10-year yields are mostly 2-3 bp lower. Italy is an exception, with the 10-year yield rising by a couple of basis points. Gold posted a potential key reversal before the weekend and gapped higher today in reaction to the weekend developments. It had approached $1810.50 before the weekend and settled at $1833. Gold opened slightly above $1846 and rallied to $1855.50 before stabilizing. The next target is around $1862-3.
Asia-Pacific
China’s markets re-open from the extended national holidays, while Japan, Taiwan, and South Korea’s markets were closed. Chinese equities slipped and the yuan strengthened slightly. China’s reported that the dollar value of its reserves fell by $45 billion to $3.115 trillion. Since the end of last year, China’s reserves are off by $12.6 billion. Meanwhile, China’s continues to acquire gold. Although it added 840k ounces in September, the value of the gold fell to $131.8 billion from $135.2 billion. The so-called diversification of reserves into gold should be kept in context: gold accounts for about 4% of China’s reserves.
US rates spiked higher in the immediate reaction to the jobs data before the weekend. They settled near mid-range, while the greenback closed around session highs against the yen, slightly above JPY149.30. A narrow range has prevailed today, with the local holiday of about JPY149.00-149.25. The Australian dollar posted a bullish outside day on Friday. It slipped below Thursday’s low and then recovered to settle above Thursday’s high. It stopped slightly shy of the 20-day moving average (~$0.6405). It is consolidating in a range between about $0.6345 and $0.6380. The dollar settled at CNY7.2980 when the mainland markets closed. It re-opened near CNY7.3020 and has fallen to CNY7.2870. The PBOC set the dollar’s reference rate at CNY7.1789, slightly lower than the last fix (CNY7.1798) and below the CNY7.2975 average projection in Bloomberg’s survey.
Europe
Germany is in the spotlight for two reasons. First, weekend elections in Bavaria and Hesse resulted in the center-right maintaining control. The CSU has led the Bavarian government since 1957. The party’s head (Soder) was seen a likely challenger to Chancellor Scholz in 2025, but the poor handling of a local antisemitic scandal that appears led to the CSU’s worst showing in Bavaria since 1950 has dealt him a blow. The current center-left federal government that does not enjoy strong support is being held responsible for the poor economy and the surge in immigration. In Hesse, the CDU is likely to renew its coalition with the Greens. Some fear that that the poor showing of the FDP, which appears not to have secured representation in the Bavaria local government, could be under pressure to leave the federal coalition. After these state elections, the federal government is expected to toughen its stance on immigration.
Second, Germany reported August industrial output fell by 0.2%. It was the fourth consecutive decline, though the July contraction was revised to -0.6% from -0.8%. Recall that before the weekend, Germany reported August factory orders rose 3.9%, more than twice the 1.5% median forecast in Bloomberg’s survey. Domestic orders rose by 4.0% and foreign orders rose by 3.9%. German industrial output had fallen in the May through August period at nearly a 7% annualized pace. The aggregate report for the eurozone is due Thursday. France reported a 0.3% decline, slightly better than expected, but July’s gain was revised to 0.5% from 0.8%. Spain reported a 0.8% contraction in August industrial production. A 0.3% decline was expected. July’s gain was shaved to 0.1% from 0.2%. Italy’s August industrial output figures are due Thursday. It is expected to have fallen by 0.3% after the 0.7% decline in July. Note that in terms of manufacturing output, last year’s Germany’s output (~1.3 trillion euros) was roughly the size of France (714 billion euros) and Italy (630 billion euros) combined.
The euro recorded a bullish outside up day ahead of the weekend. It recovered from slightly below $1.0485 to $1.0600. There are 1.8 billion euros in options struck at $1.06 that expire today. The euro fell $1.0520 in late Asia/early European turnover. Some pressure may have been spurred when it fell below $1.0550, where options for 1.2 billion euros expire today. Nearby resistance is seen near $1.0560 and $1.0575. Sterling also posted a bullish outside up day, rallying from almost $1.2105 to $1.2260. It too stopped short of the 20-day moving average (~$1.2280). It was sold to about $1.2165 today and approached $1.2200 in the European morning. The session high is about $1.2225, and a move above there would be constructive. Separately, we note that the UK’s Metro Bank appears to have secured funding, as its largest shareholder boosted its stake six-fold and holders of tier 2 notes took a substantial haircut (40%).
America
The US has sold about $1.8 trillion of debt so far this year, the second highest behind 2020. There is a flood of supply in this holiday-shortened week (the bond market is closed today even though the stock market is open). There are $101 billion in coupons being sold starting tomorrow ($46 billion three-year notes, followed by $35 billion 10-year notes on Wednesday and $20 billion 30-year bonds on Thursday). The US Treasury also will auction $209 billion in bills between the three- and six-month bills and a cash management bill. On top of that, four-month bills and four- and eight-week bills will also be sold. We argue that the rise in US yields can be accounted for by Fed policy (and the expectations for overnight rates, higher for longer), supply (Treasury and corporate), and the unexpected strength of the US economy. There is still a penchant among some American observers to blame Japan (though MOF and US data show they have been net buyers of foreign bonds and Treasuries this year) or China (where a closer look suggests Beijing has been more engaged in a shift from Treasuries to Agencies).
The other point that is worth noting is that the auctions are well-oversubscribed. There is no capital strike against the US like there was against the UK last year. Sterling sank to a record low. Reasonable people may differ about the outlook for the dollar, but the greenback’s strength amid rising rates has been a differentiator. One place to look for stress on the US banking system is the use of the Fed’s emergency facilities. Borrowing from the discount window eased to about $2.8 billion from $3.2 billion, and the use of the Fed’s Bank Term Funding Program is stable around $108 billion.
Canada’s jobs data also beat expectations, growing almost 64k jobs, more than three times the median forecast in Bloomberg’s survey. Year-to-date, Canada has filled almost 388k jobs, of which almost 300k are full-time posts. The strength of the data, including the unexpected uptick in wage growth, saw the swaps market boost the chances of a Bank of Canada rate hike. The odds of hike this month rose to about 42% from 29% a week ago, and the odds of a hike by the end of the year has increased to almost 68% from 58%.
The Canadian dollar rose by about a third of a percentage point, the most in nearly four weeks, at the end of last week on a combination of the strength of its jobs report and the broader US dollar pullback. It marks the end of the greenback’s surge that took it from about CAD1.3415 at the end of September to almost CAD1.3800 last week. In fact, the two-day decline has seen it retrace (38.2%) of that rally. The US dollar briefly traded marginally through the pre-weekend low to CAD1.3640. The next retracement (50%) is near CAD1.3600. There are options for about $556 million at CAD1.3615 that expire today and ~$610 million at CAD1.3655 expire tomorrow. The US dollar initially extended its recovery against the Mexican peso, reaching about MXN18.4860, its best level since March. It reversed lower and fell slightly below MXN18.1050. The risk-off drive that starts this week saw the greenback rise back to almost MXN18.3815. It has since stabilized around MXN18.25. Mexico reports September CPI today. The issue is not the direction of prices; pressures are still easing, but the magnitude. And in any case, the central bank is on an extended plateau. Ultimately, the US dollar’s broader direction and risk appetite may be more important.
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