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Yen Selloff Slows, But Remains Vulnerable
Yen's selloff experienced a mild respite during the Asian session, bolstered by a spike in 10-year JGB yield that touched its apex since 2014. However, given the widening yield disparities with both US and European counterparts, the outlook for Yen remains bearish, at least in the foreseeable future. Interestingly, despite US benchmark yields soaring to their highest point in over fifteen years, Dollar hasn't capitalized on this momentum. A semblance of stabilization in the risk sentiment landscape further keeps both Dollar and Yen on the softer side.
In contrast, Euro and Swiss Franc currently enjoy an edge, showcasing modest gains against the Sterling. Meanwhile, the picture surrounding commodity currencies are ambiguous at best, teetering on the brink of vulnerability. Speculators are keeping a watchful eye on potential bearish news emanating from China, anticipating that any negative headlines could exacerbate the selloff in Aussie and Kiwi.
Technically, CHF/JPY's up trend resumed overnight and edged higher to 166.55. Immediate focus is now on 61.8% projection of 149.77 to 163.95 from 158.80 at 167.56. Rejection by this level, followed by break of 163.95 resistance turned support will likely turn the cross into medium term correction. However, decisive break there could prompt upside acceleration, as accompanied by an upturn in D MACD, and target 100% projection at 172.98. The developments would be a barometers in gauging the Yen's performance across other market spectrums.
In Asia, at the time of writing, Nikkei is up 0.80%. Hong Kong HSI is down -0.08%. China Shanghai SSE is down -0.39%. Singapore Strait Times is down -0.22%. Japan 10-year JGB yield is up 0.0161 at 0.671. Overnight, DOW dropped -0.11%. S&P 500 rose 0.69%. NASDAQ rose 1.56%. 10-year yield rose 0.091 to 4.342.
US 10-yr yield soars to 15-yr high, real yield breaks 2%
US 10-year Treasury yield ascended to an impressive 4.354%, marking its loftiest level since November 2007, before stabilizing at 4.342%. Notably, 10-year inflation-protected Treasury yield surpassed 2% threshold, the first such occurrence since 2009. This move highlights a significant journey from its year-to-date nadir, which hovered around 1%.
Adding to the mix, the ever-relevant two-year yield grazed 5% mark during the later hours of US session. This ascent falls just short of the highs registered earlier this year in both the previous month and March.
This rise can be attributed to indications of a more robust than anticipated growth across segments of the global economy. Such growth metrics are spurring speculations on central banks' potential inclination to maintain interest rates on current high levels for an extended duration than previously assumed.
As 10-year yield broke through 4.333 resistance, there are two questions now. Firstly, it's whether TNX could sustain above this resistance level. Secondly, it's whether there will be upside acceleration after clearing this resistance decisively. In any case, outlook will stay bullish as long as 4.094 resistance turned support holds. Next medium term target is
61.8% projection of 1.343 to 4.333 from 3.253 at 5.100.
Silver extending rebound, can it take Gold higher?
Silver's rebound from 22.21 extended higher overnight and the development should confirm short term bottoming there. A bullish scenario for Silver is that consolidation from 26.12 has completed with three waves to 22.21, after defending 61.8% retracement of 19.88 to 26.12 at 22.26 twice.
Sustained trading above 55 D EMA (now at 23.50) will bolster the bullish case for silver and bring stronger rise back to trend line resistance (now at 24.92). However, rejection by 55 D EMA will argue that current recovery is merely some short-covering profit taking, and send Silver through 22.09 support at a later stage to extend the fall from 26.12.
At the same time, Gold is still trying to defend 38.2% retracement of 1614.60 to 2062.95 at 1891.68. A stronger bounce in Silver could be accompanied by similar rebound in Gold back towards 55 D EMA (now at 1933.55). However, if the bearish case in Silver plays out, Gold would likely clear 1891.68 fibonacci support accelerate down to 100% projection of 2062.95 to 1892.76 from 1987.22 at 1817.03.
Looking ahead
Swiss trade balance, UK public sector net borrowing will be released in Euroepan session. Later in the day, US will release existing home sales.
USD/JPY Daily Outlook
Daily Pivots: (S1) 144.92; (P) 145.40; (R1) 145.87; More...
USD/JPY is still bounded in range below 146.55 and intraday bias remains neutral at this point. On the upside, sustained break of 61.8% projection of 129.62 to 145.06 from 137.22 at 146.76 will pave the way to retest 151.93 high. However, considering bearish divergence condition in 4H MACD, firm break of 44.92 support will be a sign of reversal, and turn bias back to the downside for 55 D EMA (now at 141.95).
In the bigger picture, overall price actions from 151.93 (2022 high) are views as a corrective pattern. Rise from 127.20 is seen as the second leg of the pattern and could still be in progress. But even in case of extended rise, strong resistance should be seen from 151.93 to limit upside. Meanwhile, break of 137.22 support should confirm the start of the third leg to 127.20 (2023 low) and below.
Economic Indicators Update
| GMT | Ccy | Events | Actual | Forecast | Previous | Revised |
|---|---|---|---|---|---|---|
| 06:00 | CHF | Trade Balance (CHF) Jul | 4.50B | 4.82B | ||
| 06:00 | GBP | Public Sector Net Borrowing (GBP) Jul | 3.4B | 17.7B | ||
| 08:00 | EUR | Eurozone Current Account (EUR) Jun | 10.2B | 9.1B | ||
| 14:00 | USD | Existing Home Sales Jul | 4.15M | 4.16M |
Bundesbank Inflation Worries Despite Declining Producer Prices
Market movers today
On the data side, we get July existing home sales data for the US today. The housing market has largely defied rising interest rates, so data will be interesting to follow.
Focus is on the August flash PMIs due on Wednesday; note that the Japanese PMI will be out overnight European time. The Japanese economy has held up relatively well in recent months with record-high service PMI prints and manufacturing PMI only just below the 50 threshold, supported by a weak yen.
In the Nordics, focus will be on Norwegian GDP, see more below.
The 60 second overview
German inflation: German producer prices (PPI) declined 1.1% mom in July inducing a 6% annual decline, driven largely by energy. This is the first annual decline since end November 2020. Excluding energy, annual PPI stands at 2%. This indicates further deflationary forces on goods. That said, consumer inflation remains largely service-driven. The Bundesbank also expressed concern yesterday that inflation will remain above 2% for a long time to come due to high wage growth. They expect GDP growth around zero in Q3 and the labour market to remain robust in the coming months, with unemployment climbing slowly higher. For more, see Bundesbank.
New China forecast: Yesterday we revised down our China GDP forecast to 4.8% in 2023 (previous 5.2%) and 4.2% for 2024 (previous 4.8%), see Research China: Downside risks on the rise - scenarios for Chinese growth, 21 August. Rising financial stress and weaker economic performance over the summer has lowered growth expectations. We see a rising risk (25% probability) of a deeper financial and economic crisis but still believe that China has the tools to avert such an outcome and will use them to the extent needed. We have revised higher our USD/CNH forecast to 7.70 in 12M from 7.40 in response to the weaker outlook and rising risks. Today we host a webinar elaborating further on the China outlook, see invitation with link to the webinar here.
Equities: Global equities higher yesterday, driven by a renewed appetite for US tech stocks. It was a relative narrow window with appetite and the majority of S&P500 members were lower despite the index rising 0.65%. Large cap outperforming small cap, cyclicals outperforming defensives and VIX ticking lower. The sudden tech optimism came without major news, though it would not be surprising if some gold diggers are hoping another blowout result from Nvidia as they are set to report after the close on Wednesday. In US yesterday, Dow -0.1%, S&P 500 +0.7%, Nasdaq +1.7%, Russell 2000 -0.2%. The tech optimism is continuing in Asia this morning coupled with less bad news and a strong FX fixing out of China. For the first time in a while, we see a broad lift to indices across Asia. Please note, the MSCI Asia excl. Japan has lost almost 10% in August and one day of relief does not change a trend. Futures in Europe are positive this morning while US futures are flat.
FI: Global bond yields rebounded after the decline on Friday. 10Y US treasuries continued the upward trend that has been dominating since May when the 10Y yield bottomed at 3.4%. It now stands at 4.35%.
FX: Despite US yields continuing higher, EUR/USD traded mostly sideways around 1.09 during yesterday's session. However, the greenback strengthened further against the Yen on the back of the rising US yields. Scandies were offered a breather yesterday as risk sentiment recovered somewhat, and both EUR/SEK and EUR/NOK closed the day more or less unchanged.
Credit: Despite the improvement in risk sentiment, the EUR credit market remained somewhat soft yesterday where iTraxx Xover widened 1.6bp (closing at its widest level since late May) and Main 0.4bp. Financial issuers were the main drivers of primary market activity, but Volvo re-opened the corporate EUR market with a EUR700m 3y bond priced at MS+40 and attracting a solid order book.
Nordic macro
Based on the monthly output figures, we expect that the Norwegian mainland GDP was unchanged in Q2. If proven right, growth (including revisions) will be very close to the projections presented by Norges Bank in its June monetary policy report.
Technical Outlook and Review
DXY:
The DXY chart currently displays a bearish momentum, suggesting a prevailing downward trend. Given this momentum, there is a potential scenario where the price could undergo a bearish breakout from the 1st support level at 103.20, potentially leading to a decline towards the 2nd support at 102.79.
The 1st support at 103.20 is identified as an overlap support that aligns with the 23.60% Fibonacci retracement level. Similarly, the 2nd support at 102.79 is also identified as an overlap support that aligns with the 50.00% Fibonacci retracement level.
To the upside, the 1st resistance level at 103.57 is identified as an overlap resistance. Additionally, the 2nd resistance at 103.87 is also identified as another overlap resistance.
EUR/USD:
The EUR/USD chart is currently exhibiting a bullish momentum, there is a potential scenario where the price might experience a bullish continuation towards the 1st resistance at 1.0918.
This 1st resistance at 1.0918 is identified as an overlap resistance. Furthermore, the 2nd resistance at 1.0956 is also identified as an overlap resistance that aligns with the 50.00% Fibonacci retracement level.
To the downside, the intermediate support at 1.0855 is identified as a swing-low support while the 1st support at 1.0835 gains importance due to its identification as a multiple swing-low support.
EUR/JPY:
The EUR/JPY chart indicates a bullish overall momentum, and this momentum is further supported by the fact that the price is currently above the bullish Ichimoku cloud.
There is a potential scenario where the price might continue in a bullish direction towards the 1st resistance level.
The 1st support is positioned at 158.44 and is considered advantageous due to its overlap support characteristics. Additionally, the 2nd support at 157.70 is valuable as it represents a pullback support.
On the resistance side, the 1st resistance level at 159.79 is noteworthy and is associated with a 127.20% Fibonacci Extension. Furthermore, the 2nd resistance at 160.34 is significant due to its 161.80% Fibonacci Extension attribute. Additionally, there is an intermediate support at 159.20, which further adds to the potential bullish scenario.
EUR/GBP:
The EUR/GBP chart indicates a bearish overall momentum. There is a potential scenario where the price might rise towards the 1st resistance level in the short term, but then reverse off it and drop towards the 1st support.
The 1st support is located at 0.8505 and is considered advantageous due to its swing low support characteristics. Additionally, the 2nd support at 0.8450 is valuable as it is associated with a 127.20% Fibonacci Extension.
On the resistance side, the 1st resistance level at 0.8555 is noteworthy as it represents a pullback resistance, along with a 23.60% Fibonacci Retracement. Furthermore, the 2nd resistance at 0.8594 is significant due to its pullback resistance attributes and its association with the 50% Fibonacci Retracement.
GBP/USD:
The GBP/USD chart currently displays a bullish momentum, indicating a prevalent upward trend. There is a potential scenario where price could experience a bullish continuation towards the 1st resistance at 1.2790.
This 1st resistance at 1.2790 is identified as an overlap resistance that aligns with the 61.80% Fibonacci projection level. In addition, the 2nd resistance at 1.2873 is identified as a pullback resistance that aligns with the 100.00% Fibonacci projection level.
To the downside, the 1st support at 1.2709 is identified as a multiple swing-low support that aligns with the 50.00% Fibonacci retracement level. Additionally, the 2nd support at 1.2610 is identified as an overlap support.
GBP/JPY:
The GBP/JPY chart indicates a bullish overall momentum. There is a potential scenario where the price might continue in a bullish direction towards the 1st resistance level.
The 1st support is positioned at 185.85 and is considered advantageous due to its overlap support characteristics. Additionally, the 2nd support at 184.71 is valuable as it represents a pullback support.
On the resistance side, the 1st resistance level at 187.14 is noteworthy and is associated with a 127.20% Fibonacci Extension. Furthermore, the 2nd resistance at 188.34 is significant due to its swing high resistance attributes and its association with the 61.80% Fibonacci Projection.
USD/CHF:
The USD/CHF chart’s overall momentum reflects a bearish trend, which is supported by the fact that price has broken below an ascending support line, signaling a potential for further downward movement. There is a possibility that price could continue its bearish movement towards the 1st support at 0.8759.
This 1st support at 0.8759 is identified as a multiple swing-low support. Additionally, the 2nd support at 0.8697 is identified as an overlap support.
To the upside, the 1st resistance at 0.8826 and the 2nd resistance at 0.8911 are both identified as overlap resistances, which could potentially act as barriers to upward price movement.
USD/JPY:
The current chart momentum indicates a neutral trend in the market, with neither strong bullish nor bearish indications. There is a potential scenario for price to fluctuate between the 1st resistance and the 1st support levels.
The 1st support at 144.94 is identified as an overlap support that aligns with the 100.00% Fibonacci projection level. Similarly, the 2nd support at 143.73 is also identified as an overlap support.
To the upside, the 1st resistance at 146.47 is identified as a multiple swing-high resistance while the 2nd resistance at 147.27 is identified as a resistance level that aligns with the 127.20% Fibonacci extension level.
USD/CAD:
The USD/CAD chart currently shows a weak bullish momentum with low confidence, indicating a potential upward trend. The momentum is based on the factor that the price is positioned above the bullish Ichimoku cloud, suggesting a potential for upward movement.
There is a possibility that the price could continue its bullish trajectory towards the 1st resistance level at 1.3568. This level is recognized as an overlap resistance that aligns close to the 61.80% Fibonacci projection level. Furthermore, the 2nd resistance at 1.3650 is a multiple swing-high that aligns with the 78.60% Fibonacci projection level
The 1st support at 1.3502 is identified as an overlap support that aligns with the 38.20% Fibonacci retracement level. Additionally, the 2nd support at 1.3445 is also identified as an overlap support that aligns with the 61.80% Fibonacci retracement level.
AUD/USD:
The AUD/USD chart is currently displaying a bearish momentum, indicating a potential downward trend as price is positioned below the bearish Ichimoku cloud, indicating a likelihood of continued downward movement. However, there is a potential for a bearish reaction off the 1st resistance level.
The 1st resistance level at 0.6458 is identified as a pullback resistance that aligns with the 38.20% Fibonacci retracement level. There is also an intermediate resistance at 0.6419 that is identified as a pullback resistance. Furthermore, the 2nd resistance at 0.6508 is identified as an overlap resistance that aligns with the 61.80% Fibonacci retracement level.
To the downside, the 1st support level at 0.6364 is identified as a swing-low support. Furthermore, the 2nd support at 0.6296 is identified as a support level that aligns with the 61.80% Fibonacci projection level.
NZD/USD
The NZD/USD chart currently displays a bearish momentum, indicating a prevailing downward trend as price is positioned below the bearish Ichimoku cloud, indicating a likelihood of continued downward movement. However, there is a potential for a bearish reaction off the 1st resistance level.
The 1st resistance level at 0.5954 is identified as a pullback resistance that aligns with the 23.60% Fibonacci retracement level. Furthermore, the 2nd resistance at 0.5993 is identified as an overlap resistance that aligns with the 38.20% Fibonacci retracement level.
The 1st support at 0.5896 is identified as a swing-low support. Additionally, the 2nd support at 0.5840 is identified as a pullback support that aligns close to the 161.80% Fibonacci extension level.
DJ30:
The DJ30 chart indicates a bullish overall momentum. There is a potential for a bullish continuation towards the 1st resistance level.
The 1st support is positioned at 34270.21 and is considered advantageous due to its multi-swing low support characteristics. Additionally, the 2nd support at 34048.51 is valuable as it represents a pullback support, along with a 78.60% Fibonacci Retracement.
On the resistance side, the 1st resistance level at 34616.41 is noteworthy as it represents an overlap resistance, along with a 23.60% Fibonacci Retracement. Furthermore, the 2nd resistance at 34913.84 is significant as it represents a pullback resistance and has a 50% Fibonacci Retracement association.
GER30:
The GER30 chart indicates a bearish overall momentum. The contributing factor to this momentum is that the price is currently below the bearish Ichimoku cloud, which suggests a bearish market trend.
There is a potential scenario where the price might rise towards the 1st resistance level in the short term, but then reverse off it and drop towards the 1st support.
The 1st support is located at 15467.25 and is considered advantageous due to its multi-swing low support characteristics. Additionally, the 2nd support at 15306.00 is valuable as it represents a pullback support.
On the resistance side, the 1st resistance level at 15717.77 is noteworthy as it represents an overlap resistance. Furthermore, the 2nd resistance at 16002.42 is significant due to its pullback resistance attributes, as well as its association with the 50% Fibonacci Retracement.
US500
The US500 chart indicates a bearish overall momentum, and this is reinforced by the fact that the price is currently below the bearish Ichimoku cloud.
There is a potential for a bearish reaction off the 1st resistance level, leading the price to drop towards the 1st support.
The 1st support is located at 4335.0 and is considered advantageous due to its multi-swing low support characteristics. Additionally, the 2nd support at 4296.6 is valuable as it represents a pullback support.
On the resistance side, the 1st resistance level at 4399.0 is noteworthy as it represents a pullback resistance, along with a 23.60% Fibonacci Retracement. Furthermore, the 2nd resistance at 4455.2 is significant due to its overlap resistance attributes, as well as its association with the 50% Fibonacci Retracement.
BTC/USD:
The BTC/USD chart indicates a bearish overall momentum. There is a potential for a bearish continuation towards the 1st support level.
The 1st support is positioned at 25841 and is considered advantageous due to its multi-swing low support characteristics. Additionally, the 2nd support at 24816 is valuable as it represents a swing low support.
On the resistance side, the 1st resistance level at 26675 is noteworthy as it represents an overlap resistance, along with a 23.60% Fibonacci Retracement. Furthermore, the 2nd resistance at 28070 is significant due to its overlap resistance attributes, as well as its association with the 50% Fibonacci Retracement.
ETH/USD:
The ETH/USD chart indicates a bearish overall momentum. There is a potential for a bearish continuation towards the 1st support level.
The 1st support is located at 1653.70 and is considered advantageous due to its multi-swing low support characteristics. Additionally, the 2nd support at 1538.14 is valuable as it represents a swing low support.
On the resistance side, the 1st resistance level at 1719.08 is noteworthy as it represents an overlap resistance, along with a 38.20% Fibonacci Retracement. Furthermore, the 2nd resistance at 1815.81 is significant as it represents a pullback resistance.
WTI/USD:
The WTI/USD chart currently exhibits a bearish momentum, indicating a prevailing downward trend that is attributed to price being positioned below the bearish Ichimoku cloud.
The 1st support level at 78.83 is identified as an overlap support that aligns with the 127.20% Fibonacci extension level. Similarly, the 2nd support at 76.90 is also identified as an overlap support that aligns with the 161.80% Fibonacci extension level.
To the upside, the 1st resistance level at 81.44 is identified as an overlap resistance that aligns with the 50.00% Fibonacci retracement level. Furthermore, the 2nd resistance at 83.15 is identified as a pullback resistance that coincides with the 78.60% Fibonacci retracement level.
XAU/USD (GOLD):
The current chart momentum suggests a neutral trend in the market, with no clear indications of strong bullish or bearish movements. There is a possibility that price could fluctuate between the 1st resistance and the 1st support levels.
The 1st support at 1885.58 is identified as a multiple swing-low support. Additionally, the 2nd support at 1867.68 is identified as a support level that aligns with the 127.20% Fibonacci extension level.
To the upside, the 1st resistance at 1906.61 is identified as an overlap resistance that aligns with the 23.60% Fibonacci retracement level. Similarly, the 2nd resistance at 1926.35 is also identified as an overlap resistance that aligns with a 38.20% Fibonacci retracement level.
Silver extending rebound, can it take Gold higher?
Silver's rebound from 22.21 extended higher overnight and the development should confirm short term bottoming there. A bullish scenario for Silver is that consolidation from 26.12 has completed with three waves to 22.21, after defending 61.8% retracement of 19.88 to 26.12 at 22.26 twice.
Sustained trading above 55 D EMA (now at 23.50) will bolster the bullish case for silver and bring stronger rise back to trend line resistance (now at 24.92). However, rejection by 55 D EMA will argue that current recovery is merely some short-covering profit taking, and send Silver through 22.09 support at a later stage to extend the fall from 26.12.
At the same time, Gold is still trying to defend 38.2% retracement of 1614.60 to 2062.95 at 1891.68. A stronger bounce in Silver could be accompanied by similar rebound in Gold back towards 55 D EMA (now at 1933.55). However, if the bearish case in Silver plays out, Gold would likely clear 1891.68 fibonacci support accelerate down to 100% projection of 2062.95 to 1892.76 from 1987.22 at 1817.03.
US 10-yr yield soars to 15-yr high, real yield breaks 2%
US 10-year Treasury yield ascended to an impressive 4.354%, marking its loftiest level since November 2007, before stabilizing at 4.342%. Notably, 10-year inflation-protected Treasury yield surpassed 2% threshold, the first such occurrence since 2009. This move highlights a significant journey from its year-to-date nadir, which hovered around 1%.
Adding to the mix, the ever-relevant two-year yield grazed 5% mark during the later hours of US session. This ascent falls just short of the highs registered earlier this year in both the previous month and March.
This rise can be attributed to indications of a more robust than anticipated growth across segments of the global economy. Such growth metrics are spurring speculations on central banks' potential inclination to maintain interest rates on current high levels for an extended duration than previously assumed.
As 10-year yield broke through 4.333 resistance, there are two questions now. Firstly, it's whether TNX could sustain above this resistance level. Secondly, it's whether there will be upside acceleration after clearing this resistance decisively. In any case, outlook will stay bullish as long as 4.094 resistance turned support holds. Next medium term target is 61.8% projection of 1.343 to 4.333 from 3.253 at 5.100.
GBP/USD Eyes Recovery To 1.2800 or Higher
Key Highlights
- GBP/USD is correcting losses from the 1.2620 zone.
- A major bearish trend line is forming with resistance near 1.2750 on the 4-hour chart.
- EUR/USD could struggle to recover above 1.0930.
- Gold prices are at risk of more downsides below $1,880.
GBP/USD Technical Analysis
The British Pound started a major decline from well above 1.3000 against the US Dollar. GBP/USD traded below the 1.2800 support to move into a bearish zone.
Looking at the 4-hour chart, the pair settled below the 1.2765 level, the 100 simple moving average (red, 4 hours), and the 200 simple moving average (green, 4 hours).
Finally, the bulls took a stand near 1.2620 and recently the pair started an upside correction. There was a move above the 1.2680 and 1.2700 levels. The pair climbed above the 50% Fib retracement level of the downward move from the 1.2818 swing high to the 1.2616 low.
On the upside, an initial resistance is near the 1.2750 level. There is also a major bearish trend line forming with resistance near 1.2750 on the same chart.
A close above the 1.2750 resistance could start a decent increase. In the stated case, the pair could rise toward the 1.2800 level. Any more gains could start a fresh increase toward the 1.2840 level.
If not, the pair might continue lower below the 1.2685 level. The first key support is seen near the 1.2650 level. If there is a move below 1.2650, the pair could dive toward 1.2620. Any more gains might open the doors for a test of 1.2500.
Looking at Gold, the price is showing bearish signs and there could be more losses below the $1,880 level in the near term.
Economic Releases
- US Existing Home Sales for July 2023 (MoM) - Forecast -0.2%, versus -3.3% previous.
Downside Risks on the Rise – Scenarios for Chinese Growth
- Financial stress is on the rise turning focus yet again on whether China is heading for a deeper financial and economic crisis.
- While we do see a rising risk of this happening (25% probability), our baseline scenario remains that China has the tools to avert such an outcome and will use them to the extend needed. Yet, due to the recent weak data and rise in financial stress we have revised down our forecast to 4.8% growth this year and 4.2% in 2024.
- We have lifted our forecast for both USD/CNH and EUR/CNH taking the new weaker growth outlook as well as rising risks into account. We now project USD/CNH to hit 7.60 in 12M up from 7.40 previously.
Headwinds on the rise again – lower GDP growth
As we wrote about in China holiday wrap-up – part three: risks of a financial crisis resurface, 14 August, financial stress has increased lately with another major developer, Country Garden, at brink of default and contagion to the shadow banking system increasingly visible. On top of this economic data has disappointed across the board with both consumer spending, home sales and exports undershooting expectations. Taking these developments into account we revise down growth to 4.8% this and 4.2% next year.
In this baseline scenario we assume policy makers to step up stimulus as broadly signalled following the Politburo meeting in late July and to take more measures to improve financing channels for developers, lift home sales. We also expect them to provide the necessary lifelines to local governments and facilitate a restructuring of major shadow banking entities in distress, such as Zhongzi Enterprise Group. Our assumption is that they will still strive to reach the 5% target and do what is necessary to at least put a floor under growth so it does not fall below 4-4½%.
So which tools does the Chinese government have at its disposal to fight this crisis? First, it can follow through on the "forceful stimulus" it already vowed to do in late July in order to lift demand for private consumption, housing and infrastructure investments, see China holiday wrap-up – part 2: Stimulus and private sector plan lift Chinese markets, 28 July. Second, it can increase funding channels for developers. On Friday, PBOC and financial regulators met with bank executives telling them to direct more lending to support an economic recovery. It suggests policy makers are increasingly concerned about the recent financial stress and as the big lenders are state-owned they have some control over the amount of lending. Third, they can cut Reserve Requirement Ratios (RRR) for banks to free up more liquidity to buy credit bonds and increase lending. The RRR for small and medium sized banks is 7.75% while it is 10.75% for large banks. Fourth, like in developed economies China could opt for quantitative easing (QE) with PBOC buying bonds directly in the market. This would serve as a strong signal that they step in as lender of last resort. Why are they not doing it yet? Probably because the other tools have not been exhausted yet and they would rather cut RRR and let state banks do the buying.
Why are policy makers not already doing more?
That is a question often asked these days and it is also what causes concern to us. There are several options.
First, we do not know yet if they actually are preparing to do bigger stimulus but are just slow in implementation as the slowdown during spring came as a surprise. The policy signal from the Politburo in July did suggest a more forceful response. But the action has been underwhelming so far with only moderate rate cuts of 10-15bp. Still, it could be that they are brewing on other tools instead as they are concerned about cutting rates too much as it could add to the downward pressure on the yuan, which they are currently defending via stronger fixings and state banks selling dollars in the market. The jury is still out on how much stimulus is actually planned.
Second, it seems clear that Chinese policy makers have learned from the past mistakes of providing too much stimulus in a fairly uncontrolled manner as was the case in 2008-09. It led to a severe hangover with rising debt levels and wasteful investments. The risk is, though, that the pendulum has swung too much in the other direction and they don't do enough to get ahead of the curve and turn the economy around.
Third, Chinese leaders seem very keen on weaning the Chinese economy off the 'addiction' to a strong housing market, which has made many sectors over-reliant on continued growth in this sector. Households have 60% of their wealth in the sector. Developers have been riding the market with rising leverage for years and absorbed capital that would have been put to better use in the 'real economy'. Local governments depend on land sales for a large chunk of their revenues. And ordinary businesses have sometimes bought property just to use it as collateral for loans and for investment. This is not sustainable and policy makers may see the situation as a necessary pain to adjust to a new world where capital is allocated to more efficient sectors, not least high-tech manufacturing and tech. The risk is, though, that the whole economy crashes if Chinese leaders let the adjustment happen too fast. Also, it undermines their attempt to restore consumer confidence and make consumers a key driver of overall demand. So they will likely step in with more support but they will probably not do more than is absolutely necessary.
Risk scenarios – financial stress escalates triggering deeper crisis
With the fine balancing act of on the one hand finally getting rid of moral hazard and the economy's 'housing addiction' and on the other hand not triggering a deeper crisis, there is a risk that policy makers miscalculate and fall too far behind the curve so that the financial snowball that is rolling now gets too big to stop.
One way this could happen, would for example be if financial confidence in Wealth Management Products (WMP's) erodes sharply and causes a 'bank run' on these savings products. WMP's are basically a kind of deposits held in shadow banks that yield a higher rate than in ordinary banks, but also has much higher risk. Any losses are transferred directly to the depositor (buyer of the WMP) rather than the 'bank', but often times buyers of the products are not alert to this feature. If money is pulled out of the system rapidly, the financial stress could become so high that the government is unable to stop it – at least initially. The shadow banking system is already showing cracks and a few more bad stories could risk triggering a run on the system. One problem in these products is a classic maturity mismatch as they can be exited with short notice (3 months for example) but they finance loans with longer maturities – and with some of them being loans to developers. If the money is pulled out, it would not only hurt developers but also other companies that get funding through these products. It could thus trigger defaults more broadly as it cascades through the economy. On a positive side, shadow banking does not play as big a role as 6-7 years ago as the government realized the risks and started a crackdown. But it is still close to 25% of GDP. And in combination with other risks, such as those from local government debt (around 50% of GDP), and a possible deeper housing slump, the situation warrants close monitoring.
In a financial crisis scenario, growth could drop much further in the short term, but policy makers would likely step in as 'lender of last resort' via PBOC and state banks to avoid a continued significant credit crunch. Stimulus would also be scaled up markedly. Nevertheless short term pain would likely be felt across the economy before the government's rescue action would have its' impact. A bit like the European debt crisis where the ECB refused to step in as lender of last resort until it threatened the whole euro system, and they stated they 'would do whatever it takes'. From there on the crises was more or less over. Why did the ECB wait so long? Same reason as in China. Moral hazard issues suggesting that you should only come to the rescue when there is no other option. Investors need to bear pain along the way to avoid too much risk taking again in the future.
It is hard to put numbers on these things as it could unravel in many ways but to give a sense of what we think of, we see both a 'mild crisis scenario' being possible where growth drops down to 3% for 6-9 months before the rescue action turns things around and a 'hard crisis scenario' that leads to outright negative growth for around 6-9 months. Currently we put the probability of a 'mild crisis scenario' at 15% and a 'hard crisis scenario' at 10% with a total risk of some crisis scenario summing up to 25%.
USD/CNH to continue higher
Based on the downward revision to our baseline growth scenario, we now also see USD/CNH moving even higher than in our current forecast as monetary policy divergence continues and downside risks weigh on the CNH. We now look for the cross to reach 7.70 in 12M (previously 7.40). For EUR/CNH, it implies a broadly flat level around 7.95 for the next 6-12 months based on our projection of a further decline in EUR/USD. The risk is skewed to the upside, though, as we see a higher probability of Chinese activity surprising to the downside still adding more downside on the CNH.
AUDJPY Wave Analysis
- AUDJPY reversed from support level 93.00
- Likely to rise to resistance level 94.35
AUDJPY currency pair recently reversed up from the support level 93.00 (which has been reversing the price from the end of July), coinciding with the lower daily Bollinger Band and the 38.2% Fibonacci correction of the sharp upward impulse from March.
The upward reversal from the support level 93.00 is likely to form the daily Japanese candlesticks reversal pattern Morning Star.
Given the strong yen sales, AUDJPY currency pair can be expected to rise further toward the next resistance level 94.35.
AUDCAD Wave Analysis
- AUDCAD reversed from support level 0.8630
- Likely to rise to resistance level 0.8745
AUDCAD currency pair recently reversed up from the major long-term support level 0.8630 (former strong support from October and November), coinciding with the lower daily Bollinger Band.
The upward reversal from the support level 0.8630 created the daily Japanese candlesticks reversal pattern Hammer.
Given the strength of the support level 0.8630 and the oversold daily Stochastic, AUDCAD currency pair can be expected to rise further toward the next resistance level 0.8745.
