Stronger USD continues to rebound after China fiscal policy announcement

CNY: China fiscal policy announcement lacked details

The US dollar has continued to strengthen at the start of this week with the dollar index  attempting to break above the 103.00-level. The US dollar has had strong upward momentum in the first half of this month as evident by the run of ten consecutive days of higher daily closes for the dollar index. The US dollar’s upward momentum was supported at the end of last week by the release of the PPI report for September which has reinforced expectations for stronger core PCE deflator reading for September. After rising by just 0.1%M/M in August, the core PCE deflator is expected to pick-up by +0.3%M/M in September. While it is not a game changer for the Fed, it has reinforced market expectations that the Fed will slow down the pace of easing by delivering smaller 25bps rate cuts in November and December. A view that it is well priced into the US rate market now which helps to explain why US yields have lost upward momentum especially at the short end of the curve over the past week. The 2-year US Treasury yield has been struggling to sustain levels above 4.0% which was evident again on Friday when it hit an intra-day high of 4.09% but has since fallen back  below 4.00% at the start of this week.

The US dollar has also derived support from the mixed market reaction to the fiscal policy announcement from China over the weekend. The Chinese equity market has staged modest rebound (+1.5% for the Shanghai Composite) at the start of this week while the Chinese renminbi and G10 commodity currencies of the Australian and New Zealand dollar have weakened modestly (+0.16% for USD/CNY and -0.16% for AUD/USD).  At the press conference on Saturday, China’s Ministry of Finance Ministry provided reassuring signals on support for the economy without unveiling fresh stimulus. However, it did provide a strong signal that it will focus in the coming months on addressing local government debt problems and weakness in the housing market which have been the biggest drags on growth. 

The immediate focus of the government will be to make efficient use of the unspent budget for this year to help meet the growth target for this year of around 5%. According to Bloomberg’s estimate, the government still had around CNY18.4 trillion of unspent budget funds available in August. Looking ahead to next year, Finance Minister Lan Fo’An stressed that the central government has “relatively large room” to increase its debt and deficits without disclosing any figures, and the MoF has indicated that some new policy tools are under consideration. More specifically on addressing local government debt problems, the MoF stated that the government would raise government debt limits on a large scale to allow local governments to replace existing hidden debt. The central government will also closely monitor the funds that local governments have available to maintain basic operation suggesting further support for local governments if needed. The MoF added that it will allow local governments to use funds raised form special bonds and affordable housing project subsidies to finance purchases of homes. It adds to measures announced recently by the government to help absorb inventories of unsold homes party through state purchases as they seek to stabilize the housing market. Overall, the fiscal policy announcement has disappointed market expectations that were looking for the government to outline a bigger package of fresh stimulus measures over the weekend. A development that should help to keep the US dollar on a stronger footing in the near-term until further details of stimulus are released.    

USD REBOUND HELPING TO LIFT USD/CNY

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Faster BoE rate cuts & Budget unease pose downside risks   

The GBP has corrected modestly lower so far this month following strong gains recorded over the summer. It has resulted in cable falling back towards support at the 1.3000-level after hitting a year to date high of 1.3434 on 26th September. Similarly, EUR/GBP has risen back up towards the 0.8400-level after hitting a year to date low of 0.8310 on 1st October. Despite the recent setback the GBP remains by far the best performing G10 currency this year having strengthened by 2.7% against the USD and 3.7% against the EUR.                    

The recent correction lower for the GBP has been driven by a combination of external and domestic fundamentals drivers. The significant escalation of tensions in the Middle East with market participants still waiting to see how Israel retaliates to the missile attacks from Iran could be encouraging a lightening of long GBP positions. The attractiveness of long GBP carry positions would be undermined by higher financial market volatility and the UK economy would be hurt again if there was another  negative energy price shock. At the same time, carry attractiveness was challenged recently by dovish comments from BoE Governor Bailey who indicated that he was open to a faster pace of rate cuts if there is further positive progress in slowing inflation back towards their 2.0% target. The comments are supportive of our forecasts for the BoE to deliver back-to-back rate cuts in November and December. They will need to be backed up by further evidence of slowing inflation and wage growth in the week ahead. Recent comments form Chief Economist Pill indicated that the dovish sentiment expressed by Govern Bailey may not be shared yet by a majority of MPC members. He continued to express caution over cutting rates “too far or too fast”. The UK rate market remains confident that the BoE will cut rate again by 25bps in November but is not yet convinced that a back-to-back cuts in December are the most likely scenario.

The upcoming release of the Labour government’s first Budget on 30th October is beginning to attract more market attention as the Chancellor and her team test public sentiment to see which policies current under discussion will make the final cut. The government has been the laying the ground to announce a package of tax raising measures to help fill a projected GBP22billion overspend in this year’s budget. Just over the past week policy measures such as raising the capital gains tax as high as 40% and introducing a national insurance charge to be paid by employers on pension contributions have been floated in the media. Adding to the uncertainty amongst gilt market participants are reports that the government could adjust the fiscal rules to allow more leeway to borrow more to invest. Please see our latest FX Weekly report (click here) to see how the GBP could be impacted by the upcoming budget announcement in more detail.                

KEY RELEASES AND EVENTS

Country	BST	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	09:30	BoE MPC Member Dhingra Speaks	--	--	--	!
US	12:00	OPEC Monthly Report	--	--	--	!!
US	14:00	FOMC Member Kashkari Speaks	--	--	--	!!
US	16:00	Consumer Inflation Expectations	Sep	--	3.0%	!
US	20:00	Fed Waller Speaks	--	--	--	!!
US	22:00	FOMC Member Kashkari Speaks	--	--	--	!!

Source: Bloomberg