September 2023 Monthly – Marc to Market


There is a sense of new
divergence. Most economists, including the staff at the Federal Reserve, no
longer think the US is recession-bound. Unprecedented in modern times,
inflation has fallen sharply, and unemployment has not risen, and the economy
appears to be enjoying its third consecutive quarter, and the fourth in the
past five, above what the Federal Reserve regards as the non-inflationary pace

At the same time, and despite being among the fastest
growing large economies, China’s officials continue to make one announcement
after another to support this or that sector, while the property market, which
was a key engine of growth and savings, remains broken. The eurozone is
struggling with two shocks, energy, and China. But unlike Beijing, there seems
to be little political will to offer new supportive measures, and there is risk
that the monetary tightening cycle is not over. Japan, surprised with 6%
annualized growth in Q2, but consumption contracted, and business spending
stagnated. Net exports explain the growth of the world’s third-largest economy.
Subsides for gasoline, kerosene, and fuel for fishing vessels will be extended
by three months until the end of year, and a supplemental budget is expected in

Ironically, amid the extensive discussions about
de-dollarization, the greenback is still ruling the roost. Illustrating this is
not just its performance in the foreign exchange market, but also its use on
SWIFT, which rose to a record of 46% in July. The increase in the dollar’s
share seems to come at the expense of the euro, which is in second place and
whose share slipped to a record low, slightly below 25%. The yuan’s share was a
little above 3%. 

The BRICS met last month and despite talk about a
gold-backed currency or trade settlement token, nothing really came of it. We
argue the desire to internationalize the yuan and rupee make it unlikely that
either China or India endorse a rival. Moreover, we suspect that the BRICS will
repeat the broad development of the Asian Infrastructure Investment Bank, which
is China’s Xi’s significant initiative next to the Belt-Road. Despite the US
objections, the UK joined and now so are several NATO members. The AIIB
supplements, not supplants, the other multilateral lenders. It takes
subscriptions in dollars and makes dollar loans. Reports also suggest it is
respecting the financial sanctions on Russia. 

New members will join BRICS, but it is not clear what
“it” is. It is not a free-trade agreement. It is not a military
alliance. The BRICS have a bank, the New Development Bank, which has a
medium-term goal lifting the funds raised in local currencies to 30% from less
than 20% now. Moreover, the new Chinese official maps, issued days after the
BRICS summit concluded, seemingly making territorial claims on Russia, India,

Malaysia, Brunei, and the Philippines. It illustrates the challenges that lie

The dollar rose against the all the G10 currencies in
August. The Federal Reserve’s broad trade-weighted dollar rose by about 2% in
August and peaked as Fed Chair Powell delivered his speech at Jackson Hole on
August 25. It pulled back in the last week of August, snapping a four-week advance,
hinting at what may be in store for it in September. Student loan interest
restarts ahead of resumption of payment in October, and this may cut into
September spending after strong summer for American consumption. And the US
budget drama returns as spending authorization is needed ahead of the start of
the new fiscal year on October 1. Congress has made little progress. Also,
there are numerous programs whose authorization lapses in September, including
the expanded unemployment benefits. Rather than a default that was threatened
by the debt ceiling brinkmanship, the failure to grant the spending
authorization could lead to a partial government shutdown. In addition, on
September 14, the United Auto Workers’ contract expired, and the threat of a strike

Bond yields jumped in the first half of August. It is
sometimes difficult to untangle the web of causality and many narratives can be
spun. We suggest the global move was led by the US, where the benchmark 10-year
yield rose for the fourth consecutive month. Economic activity is stronger than
expected and the anticipated supply jumped. That said, the Fitch downgrade on
August 1 seemed more embarrassing than impactful for the Treasury market. 

Some have suggested a role for the adjustment of Japan’s
Yield Curve Control at the end of July was responsible for the sell-off in
global bonds in the first part of August. However, weekly Ministry of Finance
portfolio flow report shows Japanese investors have been net buyers of foreign
bonds. In fact, they have been net buyers of foreign bonds since the 10-year
JGB yield cap was doubled to 0.50% from 0.25% last December. Japanese investor
bought around $6.5 bln in foreign bonds in August. Others suggest that
intervention in the foreign exchange market by some Asia Pacific countries
would have weighed on Treasuries. It is possible, but the Treasuries and
Agencies held in custody at the Federal Reserve for foreign central banks were
essential flat last month (up~$5 bln from July 26 through August 30).

After a light August for G10 central banks, most meet in
September. The central banks of Sweden and Norway has already signaled
intentions to rise rates at least one more time. The Norges Bank has signaled a
September move. Outside of Scandinavia, the Bank of England is recognized as
the most likely to hike. Doubts about a move had crept in early last month, but
the strength of labor earnings growth and little meaningful decline in the core
CPI helped to persuade the market that not only will the Bank of England hike.
The swaps market briefly flirted with the possibility of a half point move, but
by the end of August, returned to status quo ante, with a 25 bp hike not quite
fully discounted. The eurozone economy is stagnant for all practical purposes
and price pressures are easing but apparently too slowly for many members. The
swaps market downgraded the chances of an ECB hike to about 20% at the end of
August from better than 50% in the middle of the month. At the September
meeting, the ECB will update its macroeconomic forecasts. The risk is that this
year’s subdued growth forecast (0.9%) is shaved while weaker growth may spur a
downward revision to next year’s CPI projection (3.0%).

The Federal Reserve will update its Summary of Economic
Projections at when the FOMC meeting concludes on September 21. The median
forecast for growth is bound to be lifted as the June’s 1.0% forecast has
already been surpassed. The 4.1% median unemployment rate projected seems too
high, though it unexpectedly rose to 3.8% in August (from 3.5% in July) as the
participation rate increased to 62.8% (from 62.6%), the highest since before
the pandemic. Inflation has fallen faster than Fed officials thought. The
headline deflator, which the Fed targets, stood at 3.3% in July. The median Fed
forecast is for its to be at 3.2% at the end of the year. This seems also be a
candidate for a small downward revision. 

Hampered by the
wildfires and dockworkers industrial action, and some disappointing data, the
Canadian economy is underperforming. The economy contracted by 0.2%
(annualized) in Q2 and Q1 growth was revised to 2.6% from 3.1%. The swaps
market never saw a hike at the September 6 meeting as particularly likely. It
has fallen from a little more than 30% at the end of July to practically no
chance after the disappointing GDP figures. 

Two risks seem to be rising. The first is that the war in
Ukraine widens and escalates. The counter-offensive fell short of objectives,
and this was recognized by US officials. Shortly, thereafter permission was
granted to Denmark and the Netherlands to transfer F-16 fighter jets to
Ukraine. This represents an escalation in terms of weaponry, and Kyiv’s ability
to strike deeper into Russia’s homeland. It is estimated to take 4-6 months to
train Ukrainian pilots to fly the F-16. 

The second risk emanates from US regional banks, where
the stress flared in March. Commercial real estate to which they are particularly
exposed, continues to suffer, and it is little consolation to know that China’s
(residential) property market is also distressed. Earlier this year, rising
rates and falling deposits was painful for many banks. Deposits have stabilized
and are about $50 bln above where they were at the end of March. However,
interest rates have continued to rise. The 10-year Treasury yield has risen by
around 90 bp since the end of March. The KBW bank index, which tracks money
center banks and large regional banks fell for three consecutive weeks before
stabilizing in the last week of August.

Bannockburn’s World Currency Index (BWCI), a GDP-weighted basket
of the currencies of the largest dozen economies, fell 1.5% in August after
rising by about 0.70% in June and July combined. It reflected the decline of
nearly all the currencies in the index against the dollar. The Mexican peso had
outperformed most of the month but sold-off after announcing officials
unannounced the winding down of its currency hedging program. The Indian
rupee’s 0.65% decline made it the best performing currency against the dollar
in the basket. The Brazilian real’s 4.6% decline was the worst performer
followed by the Russian ruble’s 4.1% fall. The yuan fell by about 1.6%, the
third best performer in the index in August. 

Among the G10 components, the euro and sterling recovered
from what appears to be a false downside break and trimmed their losses to
1.25%-1.40% against the dollar. The Australian and Canadian dollars were tagged
for about 3.5% and 2.4% respectively, and, arguably, were punished for their
central banks seemingly getting do with their monetary tightening cycle before
the US and Europe. 

BWCI has been trending irregularly lower since peaking in
early February, reflecting the end of the currencies recovery from extremes see
September-October 2022. Given the extent of the apparent divergence favoring the US, a new low the BWCI (broadly higher US dollar) looks likely.  Last year, a bottom took 5-6 weeks to form
around 92.80-93.00. The low in late August was near 94.00. That said, we do look for it bottom, and the dollar to weaken, when evidence accumulates that calls into question the idea that somehow the business cycle has been repealed rather than just elongated. 


U.S. Dollar: The
relative strength of the US economy and the resulting increase in US rates
helped the dollar extended the advance that began in the middle of July.
However, the move seemed to stall at the end of the month. The two-yield
approached the high for the year (above 5.10%) but tumbled more than 25 bp in
the last three-days of August. The market has all but given up on the possibility
of a September hike and, after the August jobs report, had about a 37% chance
of a hike in the cycle at the next meeting that concludes on November 1.
September’s developments may be less supportive of the dollar. The Dollar Index
has risen in September for the past four years, but we caution against reading
much into the results of such a small sample. Over the past 20-years, the
Dollar Index has risen in 11 Septembers and declined in 9, which is well within
expectations of a random process. The weaker jobs growth (150k average in three
months through August, the least since the pandemic) and slower auto sales sets
the stage of softer economic impulses. After the August rally that carried the
dollar to new highs for the year against the Japanese yen, Chinese yuan,
Australian and New Zealand dollars, and Swedish krona, corrective forces were
already evident as August drew to a close. A challenge to the somewhat less
constructive outlook for the dollar maybe the August CPI due on September 13, a
week before the FOMC meeting. The month-over-month increase may be among the
largest since June 2022 (~0.6%) and the year-over-year rate is poised to
increase for the second consecutive month (~3.6% vs. 3.2%). Many Americans were
critical of Fitch’s downgrade of the US rating on August 1, but a new fiscal
drama is unfolding over next year’s spending, and this could result in a
partial government shutdown starting in early October.

Euro: The
euro’s retreat from the year’s high set in mid-July near $1.1275 accelerated in
August hitting a low near $1.0765 on August 25, shortly after Federal Reserve
Chair Powell finished his Jackson Hole Speech. The driver was the economic
divergence. It was expressed in the two-year interest rate differential between
the US and Germany. In mid-July it had dipped to about 150 bp in the US favor.
It peaked on August 24 near 207 bp. It came off sharply as the euro recovered
on the back a disappointing US jobs opening report (JOLTS) and finished the
month near 190 bp. It does seem like it is the US economy as the key here. The
eurozone economy is barely growing and when the ECB meets the 0.9% growth it
forecast this year could be revised lower. But there is little scope for
stimulative fiscal or monetary policy. Still, the base effect suggests that in
September and October, the eurozone’s CPI will fall sharply, perhaps below
3.5%. Still, even after the higher-than-expected preliminary estimate of August
CPI (5.3%) the market downgraded the chances of a quarter-point hike at the
September 14 ECB meeting to around 22% chance from a near coin-toss. In
addition, fiscal forbearance is ending. The Stability and Growth Pact has been
suspended since 2020, first to help cope with pandemic and that cushion to blow
from Russia’s invasion of Ukraine. The budget rules are re-instated next year
and that means they will be reflected in the 2024 budget submissions to the EU.
There was an attempt to devise new fiscal rules that were more tailored to
individual countries, but it has been bogged down in disagreements. A break of
August lows could target the $1.0600-50.

(As of September 1,
indicative closing prices, previous in parentheses)

Spot: $1.0780 ($1.1015) Median
Bloomberg One-month f8orecast: $1.0840
 ($1.1000) One-month
forward: $1.0800 
($1.0925)   One-month
implied vol: 6.8% (


Japanese Yen:  The Bank of
Japan doubled the upper-end of the 10-year JGB band to 1.0% in late July. The
BOJ bought bonds in the first week of August in unscheduled operations, though
the high yield was reached on August 23 near 0.68% in an apparent attempt to
smooth the adjustment. The divergence of policy and economic performance saw
the dollar climb slightly above JPY147.35 in late August, the high for the
year, and above the levels that prompted officials to intervene in September
2022 when they sold about $19.5 bln as the dollar had approached JPY146.00.
There is no reason to expect another change in Yield-Curve Control when the BOJ
meets on September 22. However, there are other element of policy that could be
adjusted, like the easing bias and negative overnight policy rate. Fiscal
policy will come back into focus, as well. There are two key elements. First,
the subsides for several types of energy, including gasoline, kerosene, and
electricity, as well as agriculture products and fertilize expire at the end of
September. Prime Minister Kishida has already indicated that the energy
subsides will be extended and possibly expanded. Estimate suggest that the
energy subsides have lowered headline CPI by as much as half of a percentage
point. The second fiscal issue is new spending initiatives. Given the
contraction in consumption and investment in Q2, and the weak support ratings
for the prime minister, there are political and economic arguments for a supplemental
budget. The government will likely offer new support for the fishing industry
in light of several countries (including but not limited to China) adverse
reaction to the decision to release Fukushima water back into the ocean. Part
of the spending can be financed with unspent funds in the current budget (~JPY4
trillion or ~$28 bln). New borrowing will be expensive as bond yields are near
nine-year highs. Moreover, demand at recent auctions has been soft and more
supply could aggravate the pressure on the BOJ.

Spot: JPY146.20 (JPY141.15Median
Bloomberg One-month forecast: JPY144.10 
(JPY139.55) One-month
forward: JPY144.50 
(JPY140.50) One-month
implied vol: 9.0% 


British Pound: Strong
wage growth and sticky core inflation fanned ideas that when the Bank of
England meets on September 21, it could hike by half-of-a-point. However,
weaker than expected July retail sales (-1.2%) and the large slump in the
composite PMI (preliminary estimate of 47.9 from 50.8) discouraged such
expectations. Expectations have swung around in recent weeks, `but as of the
end of August, the market no longer had a quarter-point hike fully discounted
after having flirted with the idea of a 50 bp move. That said, before the BOE
meets, the July/August employment data (September 12) and August CPI (September
20) will be reported. Sterling had traded most of August in a two-cent range
between $1.26 and $1.28. In late August, it fell through $1.26, and lingered for
a few days. However, the broad pullback of the dollar helped sterling
recover toward the upper end the range that had prevailed. Meanwhile, the
political jostling continues ahead of the election expected late next year.
Labour continues to push toward the middle, with its latest shift being to rule
a wealth tax (top tax rate is now 45%), while the Conservatives shift to the
right. Reports suggest that with this in mind, Prime Minister Sunak will not
attend the UN General Assembly (September 18-19) that is scheduled to include a
review of progress on 17 “sustainable development goals” and
preparation for the COP28 summit in the UAE in late November. 

Spot: $1.2850 ($1.2590) Median Bloomberg One-month forecast:
($1.2775) One-month forward:  $1.2590 ($1.2855) One-month
implied vol: 7.6%


Canadian Dollar: The US
dollar trended higher against the Canadian dollar in August as it recovered
from the 10-month low recorded in mid-July slightly below CAD1.3100. A six-week
rally took the greenback above CAD1.3600 and took out the April/May highs in
the CAD1.3650-70 area after the disappointing 0.2% contraction in Q2 GDP was
reported on September 1. The Canadian economy is diverging from the US. Its
contractions contrasts to the US, which still appears to be growing above trend.
At the same time, price pressures are proving stubborn. Through July, headline
CPI rose at an annualized rate of nearly 5.5%. After slowing below 3.0% in
June, on a year-over-year basis, Canada’s CPI rose to 3.3% (in July (from 2.8%
in June) and likely increased again in August. The swaps market has about
nearly completely unwound even modest expectations of a hike at the September 6
Bank of Canada meeting. There are three market-sensitive economic reports in
September. The August employment report is released two days after the Bank of
Canada meeting concludes (September 8), the August CPI (September 19), and the
July GDP (September 29).

Spot: CAD1.3590 

(CAD 1.3235) Median Bloomberg One-month
forecast: CAD1.3510 
(CAD1.3220) One-month forward:
(CAD1.3230) One-month implied: vol 5.5% (5.9%) 


Australian Dollar: Nothing
went right for the Australian dollar for most of August. It fell by more than
5.5% against the US dollar, at its worst, to return to its lowest level since
last November (~$0.6365). The Aussie’s slump was more than the reflection of
the strong greenback. The central bank defied economists’ expectations for a
hike to start the month. Australia unexpectedly lost jobs in July, and the
nearly 15k decline was the most since September 2021. The August composite PMI
was below the 50 boom/bust level for the second consecutive month. At 47.1, it
is the lowest since January 2022. The disappointing performance of the Chinese
economy has not help, though the rolling 60-day correlation between change in
the Australian dollar and the CSI 300 has fallen from its highest since March
2022 (~0.45) in mid-July to a five-month low below 0.25 in August. At the same
time, Australia’s discount to the US for two-year borrowing fell to 120 bp in
late August, the most since April. The Reserve Bank of Australia meets on
September 5. The market sees practically no chance of a hike. It is Governor
Lowe’s last meeting and Michele Bullock, the deputy governor since April will
replace him on September 18. The swaps market sees steady policy through next
year. The Australian dollar formed a double top on the charts near $0.6900 and
took out the neckline around $0.6600 in early August. It targets $0.6300 and
the August low may have satisfied it. A push above $0.6570-$0.6600 may needed
to boost confidence a low is in place.

Spot: $0.6455 

Median Bloomberg One-month forecast: $0.6495 ($0.6675) One-month
forward $0.6465 
($0.6660)    One-month
implied vol 10.2% (10.1%) 


Mexican Peso:  After
falling for the first seven months of the year, the dollar rose by 1.75%
against the peso in August, and it all took place on the last day of the month.
The peso slumped after officials indicated that that currency hedging facility,
which has been in place for nearly seven years, was going to wind down with a
50% reduction ($7.5 bln facility) in September. Market positioning more
than a change in underlying drivers sent the greenback higher, and it now looks
poised to test the highs here set earlier in Q3 (~MXN17.39-MXN17.43). Still,
with the market expecting the Federal Reserve to stand pat in September at
5.50%, Mexico’s 11.25% policy rate indicates the attractive carry (interest
rate pick-up) will persist. Inflation continues to trend lower, and the
external account is strong. Minutes from the August central bank meeting
showed a majority still see the core rate at elevated levels and that service
inflation is still not in a clear downtrend. The central bank also boosted this
year’s GDP forecast to 3.0% from 2.3% and next year’s to 2.1% from 1.6% and
acknowledged that exports to the US help explain the economy’s resilience. The
swaps market is pushing out expectations for the first cut into next year. That
said, Chile and Brazil have already begun to cut rates, and are poised to cut
again in September. 

Spot: MXN17.0890 (MXN16.6870) Median Bloomberg One-Month forecast
(MXN16.9250) One-month forward
(MXN16.78) One-month implied vol


Chinese YuanSentiment is fickle. It
has swung from “China stands astride the world and set to eclipse the
US” to” it cannot do anything right and is collapsing.”
Previously, it was the US and Europe “turning Japanese” and now a
fashionable argument is that it is really China that is experiencing a
balance-sheet recession, sparked by the collapse of the property market bubble.
Yet, China does not appear to be de-leveraging, though one of the largest
developers appears to be on the verge of failing. New lending is being strongly
encouraged. Property sales were a key source of revenue for provincial
governments, and as this dried up, their fiscal straits intensified. After
numerous policy announcements, including a reduction in current mortgages and
lower down payments, and a push for provincial governments to meet quotas for
special bonds, with Beijing setting a September deadline to use their remaining
allocations, it may begin convincing investors. Still, many are dismayed that
Beijing is not taking out the proverbial “bazooka.”   One
explanation is that Xi is trying to get rid of the China put, whereby an
economic slowdown would be greeted with stimulus (largely on the supply-side),
just as much as Fed Chair Powell is said to want to get rid of the “Fed
put” (seen in response, the theory goes, to sharp declines in the equity
market). Moreover, Xi tends to agree with those who argue that welfare
disincentivizes hard work and contributes to laziness. The dollar made a new
high for the year against the Chinese yuan in August (~CNY7.3175) while holding
below last year’s high (CNY7.3275). The PBOC has taken numerous measures to
slow the yuan’s decline, including cutting the required reserves on foreign
currency deposits, consistently setting the dollar’s reference rate well below
survey averages, discouraging banks from selling the yuan, and tightening
offshore yuan funding. To this list, some would add ordering dollar sales
through state-owned banks, but it is hard to distinguish between their normal
activity on behalf of clients and itself. Still, many are not persuaded that
Beijing can or even desire to turn the yuan around. There is talk of
CNY7.60-CNY7.70 this year but we suspect it is exaggerated, suggesting
sentiment may be extreme.

Spot: CNY7.2665 

(CNY7.1485) Median Bloomberg One-month forecast
(CNY7.14400) One-month forward CNY7.2075 (CNY7.1170) One-month implied vol 6.4% (5.7%) 



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