Capital Markets: "Mid-Course Correction Sends Greenback Higher"

From Marc to Market:

Overview: The Federal Reserve delivered the first rate cut since the Great Financial Crisis but couched it in terms of a mid-course correction rather than the start of a larger easing cycle. By doing so, Fed chief Powell cast the cut in less dovish terms than the market expected and the reaction function of the market has been clear. The US dollar has advanced against nearly all the world's currencies. The greenback broke through key levels that had been holding capping it, like JPY109 and $1.11 for the euro. Asian equities followed the US lead lower, with Japan an exception. European equities are faring better. US shares are little changed in European turnover. Benchmark 10-year bond yields are around basis points higher, and the peripheral yields in Europe are up a little more. Gold has been knocked back toward $1400, and WTI for September delivery is snapping a five-day advance.

Asia Pacific
China's Caixin manufacturing PMI edged higher but is still below the 50 boom/bust level, but barely. It rose to 49.9 from 49.4. In the coming days, the rest of the Caixin PMI will be reported, as will reserves, trade, and inflation. The PBOC is widely expected to reduce reserve requires to ease financial conditions in the coming period.

Japan's manufacturing PMI firmed slightly to 49.4 from 49.3 from June, but disappointing given that the preliminary estimate was 49.6. It is the third consecutive month below 50. Separately, Japan reported strong auto production for May (9.3% year-over-year, double April's 4.7% pace and the strongest in two years. The BOJ left rates on hold earlier this week after both it and the government shaved growth forecasts.

South Korea reported its July manufacturing PMI slipped to 47.3 from 47.5, as its manufacturing sector remains distressed. After a bounce in March and April, it has returned to the March low (47.2). In all but one month since last October, it has been below 50. Separately, South Korea reported softer inflation (0.6% year-over-year vs. 0.7%), suggesting the central bank has more scope to ease monetary policy. The July trade figures were a little better than expected but still weak. Exports were off 11% year-over-year compared with a 13.7% decline in June. Imports fell 2.7% after a 10.9% slide in June. The challenges in the semiconductor industry continued. South Korea semiconductor exports were off 28.1% year-over-year (-25.6% in June). Exports to China were 16.3% lower than a year ago, while exports to the US were 0.7% lower. Imports from China rose 5.8%, and imports from the US rose 9.9%.

Japan's cabinet is expected to decide tomorrow whether to exclude South Korea from its "white list" of preferred export partners. Japan claims that all of the claims against it from WWII were settled in a 1965 treat the US helped negotiate. South Korean courts say otherwise, and this is the source of the current dispute. If Japan does exclude South Korea, most of Japan's exports to South Korea will be impacted and required to have individual product approvals. South Korean producers will have little choice but to find alternatives. This is seen as an opening for Chinese companies, and in particular, help the PRC develop its semiconductor fabrication capability. In turn, this would be consistent with its import-substitution strategy. The US appears to have a greater interest in the Japan-South Korea dispute than officials may have recognized.

The dollar popped above JPY109 in Asia for the first time since May and reached JPY109.30 before returning to the breakout area. A convincing break of JPY109 requires at least a close and perhaps a weekly close tomorrow. From a technical perspective, it suggests potential to JPY111.00. Below JPY109, support is seen in the JPY108.60-JPY108.80 area. There are a little more than $2 bln in JPY109.00-JPY109.10 options that expire today, and there is another option for about $825 mln at JPY109.30 that will also be cut. The Australian dollar initially saw its losses extended through $0.6830 but has found a new bid and is staging a recovery. A move above $0.6900 would lift the tone. It is trying to end an eight-day slump. The Chinese yuan softened and the dollar traded above CNY6.90 for the first time since mid-June.

Europe
The manufacturing sector in the eurozone seems so challenged that even a small upward revision to the flash PMI failed to ease concerns. The German preliminary reading of 43.1 was revised to 43.2, but it is still a cyclical low and is off from the lowly 45 reading in June. France's manufacturing PMI was revised to 49.7, matching its cyclical low, from 50 of the flash reading and 51.9 in June. Both Italy and Spain ticked up from the June readings but are both below 50 (48.5 and 48.2 respectively). For the region as a while, the manufacturing PMI stands at 46.5 from the 46.4 flash reading and 47.6 in June.

The Bank of England meets today...

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