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Overview: The softer-than-expected US inflation figures unleashed a significant market adjustment that continues to ripple through the capital markets. The modification of some of China’s Covid stance may have also fanned some optimism, but we suggest that measures are modest tweaks, and the surge in infections will prevent the end of disruptive restrictions. Although we have been arguing that a significant dollar top was being forged, the move is stretched from a technical perspective and immediate caution is advised. The strong rally seen in equities yesterday is continuing today. Hong Kong led the rally in the Asia Pacific region with a 7.75% surge. China’s equities advanced but were laggards among the large regional markets. The Stoxx 600 is adding another 0.3% to yesterday’s 2.75% rally. US futures are also trading with a firmer bias. US and Canadian bond markets are closed today, and European bonds are paring yesterday’s huge rally. Benchmark 10-year yields are up mostly 4-8 bp. While the greenback is softer across the board, the yen’s rise is the most impressive. It is up 1.25% as the dollar punched through JPY140 and short-yen funding positions were squeezed out. Gold has soared on the back of the weaker dollar and on rate-peak ideas. It finished last week slightly below $1682 and is now trading above $1760. December WTI has recovered smartly from yesterday’s low near $85 to approach $90 today. US natgas recovered 6.4% yesterday after sliding 16% over the previous two sessions. It is firm today. Europe’s natgas benchmark is off for the third consecutive session. The 3.85% drop brings the three-day decline to more than 10%. Iron ore jumped 5.6% to bring this week’s advance to nearly 6.6% after last week’s 8.25% rally. December copper is up nearly 3%. It is the fourth consecutive advance and the longest streak since July. It is up about 4.85% this week on top of last week’s 7.5% surge. December wheat is snapping a four-day slide and is up nearly 1%. 
 

Asia Pacific

The Bank of Japan has defied the odds. Its intervention in September and October was not very surprising after several warnings. It was unilateral. It did not signal an underlying change in policy. What it did do was buy time. for around $63 bln (size of intervention in September and October). If the US 10-year yield did not peak on October 21 slightly below 4.35%, it likely came awfully close. It fell to about 3.82% yesterday. It will not trade today as the US bond market is closed for Veterans Day. The US two-year yield may have peaked last week around 4.80%. It was 50 bp lower yesterday. When the BOJ intervened on September 22 the greenback was approaching JPY146.00. It settled that day near JPY142.40. Yesterday it moved there for the first time as the US dollar fell to JPY140.20. The drop in US yields will also take the pressure off the 0.25% Yield Curve Control cap which is also part of the BOJ's monetary policy stance. It had been bumping against for several weeks. It will likely have more breathing space now.

China announced some adjustments to its quarantine policy that had been anticipated last week. It reduced the time inbound travelers and those that have come into close contact with the Covid infection need to be quarantined. Inbound travelers now will be required to spend five days in a government quarantine facility and three days at home, instead of ten days in the past. Also, Beijing has reiterated that it wants more targeted approaches to social restrictions. This appears to already be in the process of being implemented. Some are calling this a significant change. It might not be. Meanwhile, note that the number of Covid cases is above 10k for the first time since April. Optimists may point to the rally in Chinese shares, where the Shanghai and Shenzhen markets rallied about 1.7% and 1.3% respectively, but most other bourses rallied more including Japan, Taiwan, South Korea, and Australia. 

The dollar is trading heavily against the Japanese yen, and trading below yesterday's low (~JPY140.20) in the European morning to trade below JPY140 for the first time in two months. Stops appear to have been triggered and the dollar quickly dropped to nearly JPY139.10, as the dam broke. The intraday momentum indicators are stretched, and the greenback is trading below its lower Bollinger Band (two standard deviations below the 20-day moving average). Indeed, it briefly was three standard deviations below the 20-day moving average. We caution against chasing it and suspect if the near-term low is not in place, it has been approached. The high set in the Asia Pacific session was near JPY142.50. The Australian dollar is building on its outside-up day recorded yesterday. It pushed to almost $0.6680. The next key chart point is around $0.6740. The high was recorded in the European morning and the intraday momentum indicators have turned down. The Aussie is also above its upper Bollinger Band, seen near $0.6620 today. A rising tide lifts all boats, and the Chinese yuan has risen for a second consecutive session for the first time since the end of September. The yuan's gains over the two sessions are almost equal to the surge last Friday amid rumors of the imminent end of the zero-Covid policy (~1.6%). At one point, the greenback traded below CNY7.0750, for the first time since September 22. It has recovered to almost CNY7.13. In an unusual move, the PBOC set the dollar's reference rate stronger than expected (CNY7.1907 vs. CNY7.1756). Given the 2% band around the fix, it allowed for a CNY7.0469-CNY7.3345 range today.
 

Europe

The US CPI figures saw the US 2-year yield fell by more than 25 bp and helped push down European rates too. US rates fell further and the US premium over Germany fell nearly 10 bp, which pushed it well below the 200-day moving average (~2.35%). As we noted earlier this week, the US premium has not broken this moving average since June 2021. The US premium over Germany typically peaks before the dollar does and the peak was likely recorded in early August near 2.77%. The next key level is around 2.20%.

The UK reported that the economy contracted by 0.6% in September, a larger contraction than what was expected. Still, the contraction in Q3 as a whole was not as bad as expected as the July and August figures were revised. The 0.2% fall in output in Q3 (rather than the 0.5% expected) is seen as the start of a several-quarter recession. Consumption and business investment fell by 0.5% each, while government spending jumped 1.3%, and trade improved. Nevertheless, the output is about 0.4% below pre-Covid levels. Separately, the Bank of England announced that starting November 29, it plans to begin to sell the GBP19 bln (~$22 bln) of long-dated and inflation-linked bonds it bought during the market turmoil in late September/early October. More operational details will be announced in the week of November 21.

The euro recorded a big outside-up day yesterday and closed above $1.02. Follow-through buying lifted it to $1.0280 today. It closed above its upper Bollinger Band yesterday, which comes in today near $1.0210. We suspect the near-term high is in place, and some of the buying today may have been related to the 2.24 bln of options struck at $1.0240 that expire today. We peg initial support in the $1.0200-20 area. Sterling, which we have seen as our high conviction of the first to G10 to bottom against the dollar, extended yesterday's gains to nearly $1.1775 today. Our next target is $1.20, but not immediately. It too is stretched. The upper Bollinger Band is nearly $1.1765. Initial support may be seen in the $1.1700-20 band.
 

America

The softer-than-expected US October CPI has dramatically shifted market expectations for Fed policy in several ways. First, it has reinforced ideas that the Fed is done with 75 bp moves and that it will hike 50 bp next month. Second, the terminal rate expectation has been brought back to 4.75%-5.00% from 5.00%-5.25%. Third, the market sees the peak likely in Q1 23 rather than Q2. Fourth, the market is the most confident it has been that the Fed cuts rates in Q4 23. Of course, this is simply a snapshot of market expectations, and the market we have seen can be quite fickle. The day before the next FOMC meeting concludes (December 14), this month's CPI will be reported.

Any inflation report can be noisy, so it does not make sense to annualize it. However, quarterly figures may be more meaningful, and as we have noted the annualized pace of Q1, and Q2 CPI was a little above 10%. It dropped to 2% in Q3. That may overstate the improvement, but the direction is clearer, barring new shocks. The core rate is a somewhat different story. First, contrary to what has been often repeated, the reason food and energy are excluded is not that they are volatile, or because they are mostly driven by supply considerations. They are excluded because, over time, it provides the signal, which is to say that headline inflation converges to core inflation, and not the other way around. At an annualized rate core inflation rose a bit faster than 5.6% in Q1 and 7.6% in Q2 before slipping back to 6.0% in Q3. 

The US dollar fell to its lowest level since March 2020 against the Mexican peso shortly after the softer-than-expected US CPI figures. The dollar's low was near MXN19.3380. A bounce near midday took it to slightly above MXN19.47 ahead of Banxico's decision. As expected, it delivered a 75 bp increase, lifting the overnight target rate to 10%, and the dollar made a low near MXN19.3350. Brazil moved in the opposite direction. The Brazilian real slumped by nearly 3%, the biggest single-day loss since April. Mexico's Bolsa advanced 1.8% while the Bovespa sank 3.25%. Newly elected Brazilian Lula's fiscal plans spooked investors and Moody's seemed to warn that it could pose a risk to Brazil's credit rating. Moody's sees Brazil as a Ba2 credit (=BB), while Fitch and S&P are one notch lower. To fulfill his campaign promises, it may cost Brazil BRL160-BRL200 bln (~$30-$37 bln). There reportedly has been some discussion of exempting social aid expenditures from the spending cap rules. The budget bill for next year, which was drafted before the election, anticipated a primary deficit (excludes debt servicing) or 0.6% of GDP. Lula's extra spending could lift it to closer to 1%. Lastly, Peru hiked 25 bp yesterday, lifting its target rate to 7.25%. It is the 16th consecutive hike. Like Brazil and Chile, Peru may have finished its tightening cycle.

The US dollar recorded a big outside down day against the Canadian dollar yesterday and follow-through selling pushed the greenback below CAD1.3300. It has not been here since late September. The objective of the head and shoulders pattern that broke last week is CAD1.30. The lower Bollinger Band is around CAD1.3325. Canadian markets are closed today for Remembrance Day. The greenback's intraday momentum has stalled near CAD1.3285. Initial resistance is seen near CAD1.3350. At first, the US dollar continued to fall against the Mexican peso today, reaching MXN19.2655, its lowest level since March 2020. The unwinding of some long peso carry trades (e.g., vs Japan) was unwound, and the dollar jumped to almost MXN19.38. Nearby resistance is seen in the MXN19.40-45 band.

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