Yen surges after new LDP leader picked, while the greenback consolidates

Overview:  Japan's LDP leadership selection has not been the dragged-out affair that many thought likely with a record nine candidate vying for the post. It turns out that the economy may have been less important than foreign affairs and the threat posed by China. Shigeru Ishiba is strong nationalist, who reports indicate own shares in Nippon Steel, whose bid for US steel has faced domestic opposition in the US on seemingly nationalist, rather than economic grounds. The yen reversed its initial weakness and reached a new high for the week. More broadly, the dollar is trading firmer against the G10 currencies, but the yen and Swiss franc. Emerging market currencies are mixed. The Chinese yuan is up about 0.5% this week. Here in Q3, the yuan has risen in all but three weeks. It has only fallen in one week since the end of July. The Mexican peso and Taiwanese dollar lead the emerging market currencies today, while central European currencies are laggards. 

China's CSI 300 continued to rally. Its 4.5% gain today bring the weekly advance to 15.7%. Japanese shares also rallied. The Nikkei gained 2.3% for a 7.2% gain on the week. Europe's Stoxx 600 is about marginally and has risen by almost 2.5% this week. US index futures are trading a little softer. The S&P 500 is up about 0.75% this week and the NASDAQ is up about 1.35%. European 10-year yields are off 3-5 bp today and the peripheral premium, including France, are narrower. The 10-year US Treasury yield is off a little more than a basis point near 3.78%, which is about three basis points higher than a week ago. Gold is softer but consolidating after reaching a new record yesterday. November WTI is also consolidating. It is holding above $67 but was sold when it poked above $68.  

Asia Pacific

Japan will have a new prime minister after the LDP picked a new leader, Shigeru Ishiba. It was surprising as many expected Takaichi to win and had sold yen ahead today's selection process on ideas she opposes the rate hikes. Ishiba's victory may speak to rising tension with China. His selection saw the yen recover and JGBs retreat. One issue is whether Ishiba will seek a popular mandate by calling for snap elections. We suspect the decision may wait util after the US election. Separately, the modest decline in Tokyo's September CPI reinforces the sense that the Bank of Japan will not raise rates at its next meeting at the end of next month. There never was a compelling case for it but the swaps market is also less confident of another hike until early next year. The timing of the government's energy subsidy seemed to be the main drag on Tokyo's CPI, which eased to 2.2% from 2.6%. The core rate returned to the 2% target from 2.4% in July. The measure that excludes fresh food and energy as unchanged at 1.6%. This week will also be remembered Beijing's numerous measures (and more being "considered") may not satisfy China's many critics, but it has changed the investment environment for several asset classes, including equities and commodities, and arguably emerging markets. Of course, large Fed rate cut and more anticipated this in Q4 pushes in the same direction. 

The dollar rose to about JPY146.20 in the local session today, its highest level since September 3, before reversing sharply lower. It spiraled down to JPY142.80, a new low. the week. In one fell swoop, it retraced half of its gains since the low was set on September 16 (~JPY139.60). Look for a consolidative North American session ahead of the weekend. The Australian dollar fully recovered from Wednesday's sell-off, which we, like others attributed to profit-taking as opposed to a fundamental development. The Australian dollar is sometimes seen as a China play, given the trade ties. After slipping through $0.6820, the Aussie rallied back through $0.6900yesterday. It stopped a few hundredths of a cent from Wednesday's high and has held below it today. It is in a narrow range of roughly $0.6870-$0.6900 so far today. Options for about A$500 mln at $0.6925 expire today. The dollar extended its decline below CNH7.00 yesterday, falling to almost CNH7.97, which is holding today. It is not the same magnitude as the unwinding of the yen carry trade, but Beijing has caught the market leaning the wrong way and this looks like a powerful short squeeze, even if one finds fault with the seemingly large measures announced in recent days. It seems a question of positioning, which is opaque. A break of CNH6.95 could spur a move toward CNH6.84, but of course, officials could seek to slow place or limit the yuan's appreciation. The PBOC set the dollar's reference rate at CNY7.0101 today (CNY7.0354 yesterday and CNY7.0644 a week ago).

Europe

Outside of some non-market-moving confidence surveys, the week ends with a quiet European economic diary. The highlight this week were the rate cuts by the Sweden's Riksbank, which confirmed market suspicions that a 50 bp cut after three quarter-point cuts is likely in Q4, and the Swiss National Bank's three quarter-point cut. Next week's highlight is the eurozone's preliminary September CPI. A 0.2% increase translates to 1.2% three-month annualized rate, and given the base effect, would see the year-over-year rate slip to 2.1% from 2.2%. The swaps market has gradually increased the likelihood of another ECB rate cut next month. Now, it is discounting around an 80% chance, up from about 25% a week ago.

The euro rebounded to almost $1.1190 yesterday from around $1.1125. It set a new high for the year on Wednesday (~$1.1215) before the retreat. Today, it remains mired in the well-worn range of about $1.1125-$1.1180. We remain cautious. The odds of a 50 bp cut from the Fed in November has been shaved, while the probability of the ECB cutting in October has increased. The US 2-year premium over Germany has risen by a little more than 15 bp this week, which should translate into support for the dollar. Sterling's key downside reversal on Wednesday proved for naught. It fully recovered and reached a new high since March 2022 (~$1.3435). Sterling still looks stretched. There has been no follow-through buying today and sterling is trading mostly between $1.3360 and $1.3415 today. A break of this week's low near $1.3315 boost ideas that a near-term top was being carved. 

America

August personal income and consumption will help economists fine-tune estimates for Q3 GDP, which appears to be tracking near 3%. The deflators draw the interest, but CPI steels its thunder. Fed Chair Powell and Governor Waller both cited the August CPI, which was released during the quiet period ahead of the FOMC meeting, as the key data point that spurred the 50 bp cut. Yes, the headline PCE is the targeted measure, but the signal is given by the CPI (and PPI). Next week's employment report may have more impact on rate expectations. Estimates are centering around 140k, in line with the job growth in August. Powell indicated that he is doing what market participants have done, which is to discount the jobs growth given the persistent and substantial downward revisions. The average downward revision this year is around 60k. The unemployment rate is expected to be steady at 4.2%. Canada reports July monthly GDP. It is expected to have risen by 0.1% after a flat June. In terms of market impact, it will likely be overshadowed by the US data. Banxico delivered a 25 bp rate cut yesterday, bringing the overnight target to 10.25%. The swaps market has about 100 bp of cuts discounted over the next six months. Today, Mexico reports August trade figures. Through July, the trade deficit is running about 20% below the first seven months of 2023. The highlight next week is President-elect Sheinbaum’s inauguration October 1, a national holiday. 

The Canadian dollar edged slightly higher yesterday, but this reflected the greenback's broader weakness. The US dollar was confined to a relative narrow range yesterday, largely between CAD1.3460 and CAD1.3490. Today, the greenback reached CAD1.3495, a new three-day high. Nearby resistance may be encountered in the CAD1.3510-30 area. The pricing in the swaps market suggests there is slightly greater chance that the Bank of Canada delivers 75 bp in cuts in Q4 than the Federal Reserve. The peso was little changed yesterday, and the market did not react much initially to Banxico’ s rate cut. The dollar's pullback below MXN19.50 was bought and it set a new two-week high near MXN19.75 before settling below MXN19.65. The greenback is trading heavier today, pulling back to about MXN19.53. With the dollar's momentum stalling and the still high carry, late peso shorts are being covered. Corrective pressures could see MXN19.40. Meanwhile, the dollar found support ahead of support near BRL5.40. It has been frayed on an intraday basis a few times, but it has not closed below it since June.