Overview: The US dollar is paring this week's gains, retreating against most of the major and emerging market currencies today amid a risk-on mood. Inconclusive talks between Biden and Xi, the first direct communication in more than six months, and Beijing's clarification that it will slow but not freeze new game approvals were cited as drivers. The dollar-bloc currencies and the Norweigan krone are leading today's move, but the Australian and Canadian dollars remain the poorest performers on the week. The JP Morgan Emerging Market Currency Index is posting small gains for the second day but is off about 0.6% for the week ahead of the Latam open. Japan and Hong Kong equity markets gained more than 1% to lead the MSCI Asia Pacific Index higher. It managed a small gain on the week after more than 3.3% advances in each of the past two weeks. Europe's Dow Jones Stoxx 600 is edging higher to snap a three-day 1.6% fall. US futures are recouping yesterday's slide. European and US benchmark 10-year yields are 1-2 bp higher, leaving the US Treasury yield at 1.32%, virtually unchanged on the week. The UK's 10-year Gilt yield is flat today after disappointing July data, but its 4.5 bp rise this week is the most of the major markets. Gold is trading at its best level in three days, trying to re-establish a foothold above $1800. Oil is winding down a choppy week on an up note. October crude oil lost nearly 1.7% yesterday and has recouped it in full today. For the week, it is also flat for all practical purposes. China's iron ore futures contract slipped today to record a 5.5% loss for the week after dropping 6.6% last week. On the other hand, copper is up about 1.5% today after a 1.2% gain yesterday, which is enough to turn it higher for the week (~0.5%). The CRB Index is off by about 0.75% for the week coming into today.

Asia Pacific

There are three Chinese developments to note: Beijing tapping its strategic oil reserves, bilateral talk with the US, and the latest lending figures. First, China has already auctioned some of its strategic industrial metal holdings to end-users. Yesterday, it announced it would provide oil from its holdings in "batches" to domestic companies, apparently focusing on petrochemical producers. Recall that earlier yesterday, China reported a new jump in producer prices. The US media talked about this as evidence of China's statist approach, but that might not be a particularly useful framing. The US, after all, does the same thing. Just yesterday, it was announced that the US would lend oil from its strategic reserves to Exxon to help compensate for lost production in the Gulf. The US fiscal plans also call for some liquidation of the strategic oil reserves, as if it were a piggy bank used to facilitate budget compromises. The US has done the same thing in the past for some grains. More recently, the Biden administration lobbied (though the historian Tooze called it "bullying") OPEC to produce more oil but refrained from addressing the issue itself by releasing its strategic oil holdings to dampen the price.

At President Biden's initiative, there was a call with China's Xi. It was reportedly the first direct communication since February. According to reports, the essence of the conversation was that Biden sought to secure Beijing's cooperation on the environment, and Xi sees such cooperation as an integral part of the larger relationship. The US wants to de-link issues, and China sees them more holistically. The Sino-American relationship is in disrepair, and today's call does not seem to change this. The US appears to list actions it wants China to take, while China's demands seem minimalist. Quit demonizing it and respect its red lines. Yet its red lines strike at the very heart of the international order, such as its claims on most of the South China Sea and its aggressive provocative actions in the region.

China's lending rose sharply in August as the financial purse strings opened and the economy lost more momentum. New yuan loans, which are bank loans, rose by CNY1.22 trillion, above the CNY1.08 trillion in July, though not as much as the CNY1.4 trillion expected. This was made up for by non-bank activity (shadow banking). It jumped by CNY1.74 trillion after falling slightly in July. This lifted the aggregate financing to CNY2.96 trillion, which was a bit more than expected, after a CNY1.06 trillion in July. The takeaway here is that Beijing has become somewhat more accommodative but is reluctant to unveil a large program or blunt the instrument of interest rates, apparently preferring more modest measures and perhaps more targeted measures.

The US dollar tested the lower end of its recent range against the yen yesterday near JPY109.60, and it has firmed to almost JPY110.00 today. Today, a firm US PPI report could see the greenback test the JPY110.10-JPY110.25, where nearly $1.5 bln in expiring options have been struck. They may prove a sufficient cap ahead of the weekend. The Australian dollar is trading above $0.7400 for the first time in three days. There is an option there for A$810 that expires today. The $0.7410 and $0.7425 area are retracement targets of the drop since last Friday's test on the $0.7480 area. The dollar is trading below the CNY6.45-level, which it has not closed below since mid-June. It approached last week's spike low (September 3 ~CNY6.4335), but last week, it recovered in late dealing and settled near CNY6.4550. Meanwhile, the PBOC dollar fix was tight to expectations (CNY6.4566 vs. CNY6.4568). 

Europe

The ECB unanimously resolved to a "moderately lower" pace of bond purchases in Q4 from the roughly 80 bln euros a month in Q2 and Q3. Although the ECB did not specify the precise amount of bonds it would buy, a Reuters report cited unnamed officials suggesting that it would be between 60 and 70 bln euros. Remember, like the Bank of Japan, the ECB had a bond-buying program before the pandemic struck, and this program (APP) is at about a 20 bln euro a month pace. It will continue after the PEPP "envelope" expires at the end of March. It is the size and flexibility of the APP effort that seems to be the new contested terrain. Many expect a new envelope for it will be approved. The flexibility, such as how much it has to track the capital key or issuer limits, appears to be part of the discussion. In terms of its forecasts, the ECB staff pushed up this year's growth forecast to 5.0% from 4.6% and shaved next year to 4.6% from 4.7%. Its 2023 forecast was unchanged at 2.1%. Inflation is a different story. It boosted this year's forecast above 2%. Although it tweaked next year's forecast higher (1.7%) and 2023 (1.5%), the fact is that both remain below 2%, and this is where the thin edge of the dovish thrust is evident. As long as inflation is expected to undershoot the new symmetrical target, policy needs to be accommodative.

Although the Bank of England's Bailey revealed that half of the MPC believes that the minimum condition for a rate hike exists, which has helped underpin sterling and UK rates, today's data disappointed. Economists had expected July GDP to rise by 0.5%. Instead, 0.1% growth was reported. The weakness did not stem from industrial production, which grew by 1.2%, rather than the 0.4% economists anticipated. The weakness was in construction (-1.6% vs. 0.5% expectations), and more importantly, in services (0.0 vs. 0.6% forecasts). Trade was also a notable drag. The deficit widened to GBP3.1 bln from GBP2.5 bln. The median forecast in Bloomberg's survey was for a GBP1.6 bln shortfall. Next week, the UK reports on the labor market (slow improvement), prices (sharp jump in CPI), and retail sales (a modest recovery after an unexpectedly large 2.5% decline in July). 

In the middle of the week, the euro set a high, slightly above $1.1850, and tested it again in the European morning. It is proving sticky, and there are options for nearly 1.5 bln euros struck there that expire today. Another set for around 965 mln at $1.1875 also expires today. The euro settled last week close to $1.1880 to complete a six-day advance. It fell in the first three sessions this week. Support is seen ahead of $1.1800. The disappointing data have prevented sterling from rising to a new high for the week near $1.3885. Last week's high was a touch higher, though it has not traded above $1.3900 in a month. The upper Bollinger Band (two standard deviations above the 20-day moving average) comes in just above $1.3900. After trying in vain for a couple of weeks to close above GBP0.8600, players looked to have given up, and the cross fell to GBP0.8525 yesterday, its lowest in nearly three weeks. It is consolidating today.

America

The US PPI typically does not draw the same attention as the CPI, which will be reported next Tuesday. Yet, some contacts report keen interest in today's report. It could be because there is little else to focus on ahead of the weekend. It cannot really be surprising that US producer prices remain elevated. Everyone seems to recognize it and China's PPI figures earlier this week provided more confirmation. There are good reasons why central banks do not target PPI. When it comes to headline and core inflation, it has been well-established that headline convergences to core historically in the US, not the other way around. The relationship between producer prices and consumer prices is a different story.

Canada reports August employment data today. Recall that Canada lost full-time jobs in May and June before bouncing back in July (83k). Canada appears to have emerged from the soft patch that produced an unexpected 1.1% contraction in Q2. Although the central bank's preliminary projection showed the economy contracted again in July after expanding in June, the high-frequency data, including the July employment report, suggested a more upbeat outlook. The median forecast in Bloomberg's survey calls for net job growth of 67.5k (94.0k in July), a small increase in the participation rate (65.3% vs. 65.2%), and a decline in the unemployment rate (7.3% vs.7.5%). The Bank of Canada will update its forecasts and could announce more tapering at its next meeting on October 27.

Mexico's August CPI was in line with expectations, with the headline slipping to 5.59% from 5.81%. The core rate moderated but was still slightly firmer than expected. Nevertheless, the comment from the central bank governor seemed to reinforce the sense that after hiking rates in July and August, Banxico will pause when it meets later this month. Today, July industrial production is on tap, and a small gain after June's 0.5% decline is expected. On the other hand, Brazil's August CPI rose more than expected (9.68% vs. 8.99% in July). The central bank meets on September 22 and is expected to continue to hike rates. July retail sales will be reported today, and broad measures may have declined for the second consecutive month. Lastly, as expected, Peru's central bank doubled its reference rate yesterday to 1.0%.

The US dollar is unwinding the gains scored earlier this week against the Canadian dollar. The greenback poked above CAD1.2760 in the middle of the week, its highest level in nearly three weeks. It mostly consolidated yesterday and is moving lower today to test the CAD1.2600 area. A convincing break would see a push toward CAD1.2550. The nearly $900 mln of expiring options set in the CAD1.2510-CAD1.2515 area seems too far away to impact today. The US dollar has traded quietly against the peso this week. It has held below MXN20.00 and above MXN19.87. Note that since August 26, the US dollar has settled only once higher (Sept 7). It has fallen in 9 of the past 10 sessions coming into today, and it is nursing a loss of about 0.2% in Europe.