Greek Tragedy

January 30th, 2017 8:56 am

I received this article from a fully paid up subscriber who noted that 10 Year Greece bonds were wider by 34 basis points today. He did not note if that was against Bunds or Treasuries.

Via Bloomberg:

Greek Bonds’ ECB Fantasy Faces Cold Reality of IMF Report: Gadfly
2017-01-30 13:21:20.573 GMT

By Marcus Ashworth
(Bloomberg Gadfly) — It was never going to last. Greek
government bonds have given back about a sixth of their
surprising gains late last year, having reacted badly to a
leaked International Monetary Fund draft report describing the
country’s debt and financing needs as approaching “explosive”
territory. Creditor woes look depressingly familiar, and there’s
probably a lot more bond pain to come.

Greece’s recent fixed-income popularity reflected signs
that government budget proposals would meet with approval from
the European Commission, European Central Bank and IMF, and at
long last Greek officials and the troika would have the
appearance of getting along. Some improving economic data also
helped. These ignited hopes of Greece being accepted finally
into the European Central Bank’s Public Sector Purchasing
Program, and sparked a run of gains that made the government’s
securities the best performer in Europe last year.
Greece was never eligible for the ECB’s QE as its bonds are
deeply non-investment-grade, and it’s mired in its third
bailout. The idea that it would soon shake off either of these
conditions, let alone both, never made sense. Inflation at a
four year high is just the latest scare, as it threatens to make
farcical the whole pretense that its debt is remotely
sustainable — it has at least 7 billion euros ($7.4 billion) of
bonds due to mature before August.
While the country seeks a fresh round of funding, the IMF
board will meet on Feb. 6 to discuss its debt-servicing
capacity. A return to the bad old days of bickering between the
Greek government and its main creditors beckons. Germany is
diametrically opposed to any debt forgiveness, and the IMF draft
report says this is unavoidable.
Those contradictions aside, the one thing they can agree on
is that Greece honors its commitment to get to a 3.5 percent
budget surplus to GDP by 2018. The IMF says Greece is some full
2 percentage points shy of hitting that target, so it must cut
state pensions and the tax-free allowance on personal incomes to
5,000 euros. Both Prime Minister Alexis Tsipras and Finance
Minister Euclid Tsakalotos have in the past week made comments
this would be “unacceptable” and not a “single euro” more of
austerity measures will be approved.
A European Commission spokeswoman said Monday there’s no
reason for  an “alarmist assessment” of Greece — adopting an
amazingly passive stance. The IMF view offers no such pretense.
And bond investors, who cannot afford such a chilled view, will
vote with their feet accordingly. Hopes for entry into the inner
ECB club will have to be put on the backburner, and consequently
Greek debt should return from whence it came.
This column does not necessarily reflect the opinion of
Bloomberg LP and its owners.

JPM on Treasury Supply

January 30th, 2017 8:53 am

Via Bloomberg:

Treasury Coupon Auction Sizes to Grow This Year, JPM Says
2017-01-30 13:31:13.753 GMT

By Elizabeth Stanton
(Bloomberg) — Two factors will cause U.S. financing needs
“to rise significantly” — bigger federal budget deficits,
assuming $250b of fiscal stimulus through end of 2018, and Fed
tapering reinvestments beginning in mid-2018, JPMorgan
strategists led by Jay Barry say in Jan. 27 note.

* “As a result, we expect that Treasury will likely increase
coupon auction sizes later this year,” beginning by
reversing last year’s cuts at the November refunding; 5Y-30Y
sizes would increase by $1b, TIPS by $2b
* Earliest timing for announcement on longer-maturity debt is
probably August
* JPMorgan remains tactically bullish on Treasuries; while
improving economic data and risk appetite “are certainly
bearish,” there is “downside risk around fiscal and trade
policies, and positions remain stretched to the short side”

FX

January 30th, 2017 6:23 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

  • Three major central banks meet in the week ahead
  • There are several important reports that will give investors more insight into how the economies have begun the New Year
  • Although the Lunar New Year holiday runs through the week, China will report the manufacturing and the non-manufacturing PMI, and Caixin will report its manufacturing PMI
  • EM FX was mixed last week and that continues into this week, though some markets remain closed today

The dollar is mixed against the majors.  The yen and the Scandies are outperforming, while the euro and sterling are underperforming.  EM currencies are mixed too.  TRY, SGD, and MXN are outperforming, while ZAR, BRL, and RUB are underperforming.  MSCI Asia Pacific was down 0.3%, with the Nikkei falling 0.5%.  MSCI EM is down 0.4%, with China markets closed until February 6 for the Lunar New Year holiday.  Euro Stoxx 600 is down 0.8% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is flat at 2.48%.  Commodity prices are mixed, with WTI oil up 0.3%, copper down 0.1%, and gold flat.

Three major central banks meet in the week ahead, and there are several important reports due out that will give investors more insight into how the economies have begun the New Year.  However, the uncertainty surrounding these events and data pale in comparison to known and unknown impulses from the new US Administration.  

On one hand, there is little thus far that should be surprising.  The executive orders, like freezing new regulations, are what other presidents have done, including Obama.  Further, Trump is simply doing the things that he supported during the campaign, like withdrawing from TPP, supporting pipelines, the wall on the Mexican border, not funding international activity the support abortions, and limiting immigration by Muslims.  

On the other hand, it is not so straight forward.  There are no indications that the rhetoric about prosecuting Clinton over her emails is going forward, and in fact, press reports suggest that officials in the new Administration may also be continuing to use private networks and unsecured communication.   China has not been cited as a currency manipulator, as Trump had pledged as a Day 1 priority.  

That the immigration freeze included people with green cards and those in transit struck many as particularly severe, and a judge sought to limit the impact on some new arrivals.  Many airports were scenes of large spontaneous protests over the weekend.  A study by the libertarian Cato Institute found that between 1975 and 2015, immigrants from the seven countries from where immigrants are frozen have not committed any fatal terrorist attacks on US soil.  Also, Muslim Americans with family backgrounds in those seven countries have killed no Americans in the past 15 years.  

When Trump signed the order to officially end the TPP negotiations, he noted that Clinton also opposed the deal, though during the campaign he accused her of being duplicitous and really supporting the final agreement.  Trump also expressed interest going forward in bilateral agreements rather than multilateral arrangements.  Couldn’t TPP form the basis of a bilateral US-Japan free-trade agreement?  

Investors are also continuing to wrestle with the conflicting views represented by different Administration officials.  The President seemed to endorse actions that are defined as torture, but then said he would defer to Defense Secretary General Mattis, who is opposed.  What does it mean to say that NATO is obsolete but important?  Some members of the cabinet are more pro-trade than others, and it is not clear who will be the “deciders.”  

The rubber meets the road in the middle of March.  The debt ceiling is expected to be reached.  This is the authorization to pay for what has already largely been spent.  It is the bill that comes after the meal.  The debt ceiling has been lifted nearly 75 times since the early 1960s.  It is part of the US political ritual where Congress uses the debt ceiling as leverage to try to get concessions from the President.  

The point man for the White House is the Office of Management and Budget (OMB) Director Mulaney, who is a deficit hawk.  He has gone beyond what Trump said in the campaign and suggested that cutting Social Security and Medicare may be necessary.  Other campaign promises and other cabinet members are committed to various fiscal actions, including tax cuts and infrastructure, that will likely boost the US deficit (and therefore debt), even if reasonable people differ on the magnitude and duration of the impact.

The Mexican peso was the strongest currency in the world last week, despite the escalation of tensions.  The Mexican peso bottomed on January 11 and retested the low on January 19.   It rose 3.3% last week, closed firm, and is posting further gains today.  Since it trended higher consistently last week, it is difficult to know the true impact of reports that the two Presidents talked after a scheduled meeting was canceled when Mexico refused to pay for the wall that Trump insists upon the building.  

Some suggest that the peso’s recovery was the realization that things could not get worse, though after the peso bottomed, things have in our view have indeed gotten worse.  This took the form of a suggestion that among the things that the US could do to get Mexico to pay for the wall was a 20% tariff on Mexico’s exports to the US.  While this seems far-fetched, as we have noted, the US President can impose a 15% temporary tariff under conditions of a balance payments emergency.

Given the complicated continental trade where a part could cross the border several times, the law of unintended consequences risks significant economic dislocations in the US.  Others suggest it is the Negotiator-in-Chief posturing.  Consider this:  before last week’s peso gains and since the beginning of 2016, the peso had depreciated by more than a fifth, partly driven seemingly by Trump’s comments, which if sustained would seem to offset some of the sting of a tariff.  

This is Trump’s first tangle and one that he prioritized.  It is important that he wins it from a political point of view.  The wall is of great symbolic value.  It is a campaign promise that many of his supporters appear to have taken literally.  

The Federal Reserve, the Bank of England, and the Bank of Japan hold policy meetings in the week ahead.  None of the central banks are likely to take fresh action.  Each may be somewhat more upbeat than previous statements.

The US economy moderated more than expected in Q4 16 after a 3.5% annualized clip in Q3 16.  However, the best measure for underlying economic signal excludes inventories and net exports.  This measure of final domestic sales accelerated to 2.5% from 2.1%.  The Fed’s statement will also likely recognize that increased inflation expectations.  The five-year breakeven is above 2% for the first time in a couple of years, and the three-year breakeven looks set to cross that threshold in the days ahead.  The uncertainty surrounding the fiscal initiatives of the new US Administration has not been lifted.  It seems unreasonable to expect anything about the balance sheet to be including in the statement.  This may be addressed at the mid-March meeting (around the time of the debt ceiling), if not directly than at the press conference.  

After rallying into the last FOMC meeting, the dollar has pulled back in recent weeks.  The euro’s five-week, roughly 4.4% gain was snapped last week with a 0.05% loss.  Since the last FOMC meeting, the only one of the major trading partners that the dollar has appreciated against is the peso (2.65%).  It has fallen against the euro (2.8%), Canadian dollar (1.4%), and Chinese yuan (1.0%).  The Federal Reserve is unlikely to feel compelled to discuss the dollar.  

The Bank of Japan meets.  The rise in global interest rates is pulling up Japanese rates, requiring the central bank to defend its +/- 10 bp target range.  The BOJ may upgrade its economic assessment after stronger than expected exports and industrial output.  It may be too early to expect the BOJ to upgrade its inflation outlook, but even many private sector economists suspect the worst of deflation is passed.  

The Bank of England meets.  Although some talk about the central bank’s neutral stance, it is still engaged in buying Gilts and corporate bonds.  It has been fairly successful in purchasing corporate bonds and may achieve its objective earlier than had been anticipated.  There could be some update of operational issues.

It is true that the risk of a BOE rate cut has slackened considerably since last summer, and that the next move is likely to be an increase.  The decision to keep rates on hold will likely have unanimous support.  The risk is that the BOE turns more upbeat at exactly the wrong time.  The official forecasts for this year and next are above the median forecast (1.4% vs. 1.2% and 1.5% vs. 1.3%, official vs. median for 2017 and 2018, respectively).  

While the potential to impact the market is strong, the January US jobs report has little policy implication.  What the Fed decides to do in March will have practically nothing to do with the number of jobs or wage growth seen in January.  It will not change the general perception that while job growth is slowing as full employment is reached, it is sufficiently strong to continue to absorb some slack.  The US economy created an average of 180k jobs a month last year after 229k a month in 2015. In Q4 16 average job growth slowed to 165k.  The median forecast is for around 175k increase.  

Average hourly wages will be watched especially closely following the increase in minimum wage in many states and cities at the start of the year.  A 0.3% increase after 0.4% in December would be solid.  The three, six, and 12-month average is 0.2%.  However, because of the base effect (0.5% increase last January), the year-over-year rate will likely ease from 2.9%.  The year-over-year comparison is more likely to improve this month.  Last February earnings were flat.

Separately, note that US auto sales are expected to slow from a cyclical high 18.39 mln annual pace in December.  A 17.5 mln unit pace in January would still be solid and a little above last year’s monthly average even if sequentially it is softer.  

Headline eurozone inflation is rising.  It rose 1.1% year-over-year in December after a 0.6% pace in November.  The first estimate for January is expected to be 1.4%-15%.  The ECB target is near but below 2%, but Draghi has been emphasizing the core rate, which is expected to remain unchanged at a subdued 0.9% pace.  It bottomed at 0.6%.  He is opposed to reconsidering the decision made last month to extend the asset purchases through the end of this year but at a 60 bln euro a month pace rather than the current 80 bln that runs through March, based on the recovery in oil prices.

German state CPI reports have been trickling out today.  Most are showing acceleration from December, which points to upside risks to the national reading.  That will be reported today at  8 AM ET, with consensus at 2.0% y/y vs. 1.7% in December.  

We have made the point before, and it is worth making again:  In lieu of offsetting stimulus policies by Germany, or the structural reforms that Draghi repeatedly demands, German inflation running a bit above the periphery is helpful in boosting the competitiveness of the periphery.  That said, ideas that an Italian election could be held in June, now that the Court ruling leaves both chambers with a proportional representation system, suggests Italian bonds will continue to underperform.  

We suspect that the economies and prices will evolve to allow the ECB to consider tapering further in late Q3 or early Q4.  The eurozone also reports its first estimate of Q4 GDP.  The data suggests growth of 0.4%-0.5%, which would keep the four quarter pace steady in the 1.8%-1.9% range that has been sustained since the middle of 2015.  Growth is not spectacular, but it is solid and above what economists estimate to be the trend pace.  The PMIs suggest the momentum has been sustained into early 2017. Unemployment is stubbornly easing in Greece, Italy, and Spain, but in the aggregate the unemployment area in EMU is expected to have remained at 9.8% in December for the third consecutive month.  

Although the Lunar New Year holiday runs through the week, China will report the manufacturing and the non-manufacturing PMI, and Caixin will report its manufacturing PMI.  The manufacturing surveys are expected to soften slightly (0.1-0.2 points) with little significance.  Both are expanding, with readings between 51-52.  The non-manufacturing PMI rose 54.5 in December, which was the second best reading (after November 54.7) in a couple of years.  Officials in Beijing are likely watching the new US Administration closely, perhaps through the prism of the Chinese saying about killing a chicken to scare the monkeys.  

The onshore yuan has appreciated by almost 1.0% this month, and the onshore yuan has risen by 1.5%.  Since the squeeze that appears to have been engineered by the PBOC at the start of January, the offshore yuan is trading at a premium to the onshore yuan, suggesting speculative pull has been neutralized, at least for the time being. The evolution of the relationship in a stronger US dollar environment may be an important test.

EM FX was mixed last week and that continues into this week, though some markets remain closed today for the Lunar New Year holiday.  MXN, BRL, and ZAR were the best performers last week, while TRY, HUF, and RON were the worst.  MXN continues to gain despite signs that Trump will maintain a bellicose stance towards Mexico, but we think the peso remains vulnerable to further selling.  

Several EM countries were either downgraded or had their outlooks cut last week, including Turkey, Nigeria, and Chile.  S&P affirmed China’s AA- rating but maintained a negative outlook due to rising financial risks.  Our quarterly EM and Frontier Sovereign ratings models warn of a continued bias towards downgrades this year.  

Weekend Data Preview

January 27th, 2017 1:23 pm

Via Robert Sinche at Amherst Pierpont Securities:

JAPAN: After surging by 3.0% over the 3 months ended November, the Bberg consensus expects that Retail Sales dropped 0.5% MOM in December, a small giveback given recent gains.

EURO ZONE: The set of monthly EC economic and confidence surveys are expected to hold recent gains. The Bberg consensus expects the overall Economic Confidence Index for January held at a 6-year high of 107.8 while the GDP-leading Business Climate Indicator (BCI) is expected to inch up to 0.80 from 0.79, the highest since mid-2011.

GERMANY: The Bberg consensus expects that while the EU Harmonized CPI fell back -0.6% MOM in preliminary data for January, the YOY increase would increase to 2.0%, which would be the highest reading since December 2012. But the January/February YOY readings should mark the peak as the contribution from energy price comparisons lessens.

SPAIN: The Bberg consensus expects that preliminary data for Real GDP for 4Q2016 will show another 0.7% QOQ rise, bringing YOY growth down to 3.0%, the slowest in 7 quarters but still solidly above the EZ average of just over 1.5%.

SWITZERLAND: The Bberg consensus expects the December KoF Leading Indicator to have bounced back up to 102.9 after falling back to 102.2 in November.

GREECE: After declining by more than 35% from 2008, a depression-sized decline, it appears that nominal Retail Sales may finally be stabilizing with the Nov

Durable Goods

January 27th, 2017 1:18 pm

Via Stephen Stanley at Amherst Pierpont Securities:

The headline December durable goods orders figure was disappointing, as both defense and aircraft bookings were softer than expected.  Defense orders more than reversed the 30% jump recorded in November, falling to the lowest level since June.  Aircraft bookings were projected to improve substantially, based on Boeing data, but in fact the tally only posted a tepid rebound.  As a result, overall durable goods orders slipped by 0.4%.  However, the various “core” measures were all better than I had expected.  Excluding the two noisy categories detailed above, orders advanced by 0.9% on top of November’s 1.1% gain (previously reported +0.7%).  In fact, December marks the seventh straight monthly increase for the ex-defense and aircraft measure, the longest such string since the early days of the expansion.  Similarly, the ex-transportation figure rose by 0.5% in December, a sixth straight increase.

The business investment outlook is beginning to perk up.  Core capital goods orders were up by 0.8% on top of November’s 1.5% advance (revised from 0.9%).  This gauge had fallen in 5 out of 7 months through May but has now moved higher in 6 of the most recent 7 months.  Core capital goods shipments seem to have turned the corner as well, surging by 1.0% in December on the back of November’s 0.6% rise.  The modest advance in the business equipment spending component of GDP in Q4 after four straight quarterly declines confirms the upturn.  As noted in the GDP discussion, I expect a friendlier policy environment to spur an acceleration in investment outlays in 2017, though the full unleashing of pent-up activity may not come until corporate tax reform makes its way through Congress.

Consumer Sentiment Dissected

January 27th, 2017 10:54 am

Via Stephen Stanley at Amherst Pierpont Securities:

Given the extreme optimism illustrated by the University of Michigan sentiment figures (as well as other measures of consumer confidence), I thought it might be a good time to look under the hood at what may be driving consumer attitudes.  Clearly, the election was the catalyst for the abrupt jump in optimism, but what exactly are consumers thinking?

The January University of Michigan consumer sentiment gauge was revised slightly higher to 98.5, the highest reading since January 2004.  The bulk of the 11-point gain in the headline figure has come from more upbeat expectations.  The current conditions index is up, but at 111.3 in January, was only half a point higher than in June, while the expectations index has increased 11 points since October to within a point of the 13-year high.  This makes sense, as households are responding to the prospects of what they view as better economic policies (of course, with high hopes come the possibility of disappointment if things do not pan out).

A variety of expectations metrics confirm this.  44% expected an improving economy over the next year, the highest proportion since 2004.  51% have a favorable long-term economic outlook, matching the highest reading since 2004.  33% look for the unemployment rate to decline, the most optimistic reading since 1984.  The optimism extends to personal finances, as 41% of consumers anticipated improving personal finances, the best since 2005.  Specifically, the average expected income gain for the year ahead was the strongest since 2008, and over half of respondents expect home prices to rise for the first time since 2007.

There are two other notable developments in the January report.  First, inflation expectations ticked higher.  Both the 1-year and the long-term expectations medians moved to 2.6%.  For the long-term outlook, 2.6% makes the top of the range seen since early last year, though it is still toward the bottom of the range seen over a longer period (the 2.3% reading in December had been the all-time low).  Second, while the financial markets remain somewhat skeptical that the Fed has the guts to follow through on the dots, consumers are bracing for higher interest rates.  74% of respondents expect increases this year, the highest proportion since 2006 (which happens to be the last year that the Fed raised rates more than once).  As a result, 20% of households cited the prospect of higher mortgage rates as a reason that now is a good time to buy a home, the highest reading since 1995.

IP Dissected

January 18th, 2017 9:46 am

Via Stephen Stanley at Amherst Pierpont Securities:

Industrial production surged in December by 0.8%, mainly driven by a weather-induced 6.6% rebound in utility usage.  In fact, the utility category has been driving the headline figures for several months.  In contrast, manufacturing output has been on a steadier but glacial uptrend.  Factory production rose by 0.2% in December and is up on average by 0.1% per month over the past four months (and by a cumulative 0.2% over the last 12 months).  While this is far from robust, it is a little better than what we saw in 2015 and early 2016, when factory output was being dampened by the steep dollar appreciation that occurred in late 2014/early 2015.  Despite President-elect Trump’s best efforts to keep production on shore, another run-up in the dollar since the election is not going to be helpful for manufacturers.  Once tax and regulatory reform begin to kick in (presumably in the second half of this year), manufacturers may have a lot to cheer about, but, for now, the near-term outlook remains tepid at best.

CPI Dissected

January 18th, 2017 9:20 am

Via TDSecurities:

US: Inflation Breaks 2% On Energy and Core Services

 

·         December CPI accelerated to 2.1% y/y in line with expectations, boosted by gasoline prices and a solid 0.2% m/m print in the core (ex food & energy) index. The latter pushed up the core inflation rate back to 2.2% y/y.  

 

·         Most of the core strength was found in services while goods prices remained subdued as USD appreciation continued to weigh on domestic price pressures. A recovery in the latter will be key for a further acceleration in core inflation this year. Accelerating Chinese manufacturing goods inflation is a welcome development but USD appreciation may remain an offsetting factor in the near-term.

 

Headline CPI rose 0.3% m/m in December, leading the headline inflation rate higher to 2.1% y/y. Energy prices firmed further to 5.4% y/y on higher gasoline prices, while electricity prices were flat and natural gas prices declined. Food prices were flat on the month and remained below year ago levels (-0.2% y/y) though look to have bottomed in our view.  We expect food inflation to firm further this year on the back of higher producer level prices and firming global commodity indexes.

Excluding food and energy, the core CPI rose a solid 0.2% m/m (0.230% m/m). That lead the core inflation rate back to 2.2% y/y. The strength continued to be concentrated in services, with shelter prices accelerating to a new cycle high of 3.6% y/y on hotel prices. Transportation services also contributed due to a bounce in airfares. Elsewhere however, price pressures remained subdued with another soft reading for medical care services (+0.1% m/m). Core goods prices were flat on the month (-0.6% y/y) as USD appreciation continue to weigh. Continued m/m declines were seen in apparel, household furnishings and recreational goods with offsetting modest increases in education/communication categories and medical care goods.

FX

January 17th, 2017 7:13 am

Via Marc Chandler at Brown Brothers Harriman:

Trump’s Comments Send the Dollar Reeling

  • In a WSJ interview, Trump pushes against GOP border adjustment plan and warns the dollar is already too strong.  
  • Details of UK’s May Brexit speech has already been provided via advanced extracts.  Sterling recovers from yesterday’s slide
  • Global equities are heavier and bond yields lower

The US dollar is broadly lower and North American session will begin with the greenback on session lows.  The intraday technicals look stretched and North American operators were more constructive the dollar in the second half of last week than Asia or Europe.  The South African ran, Brazilian real, Russian rouble, and Mexican peso are leading the emerging market currencies higher.  Bonds are rallying, Us 10-year Treasuries off nearly 7 bp to 2.33% and European bond yields are off 4-6 bp.  Equity markets are mixed.  The MSCI Asia Pacific eked out almost 0.2% gain, most markets outside of China, Hong Kong and South Korea were lower.  MSCI Emerging market index has retraced yesterday’s 0.75% loss.  However, European markets are weak, with the Dow Jones Stoxx 60 is off 0.5% with all sectors lower, lead by materials and telecoms.  
The US dollar is broadly lower against major and emerging market currencies.  It has given up yesterday’s gains and more.  The proximate cause appears to be comments by President-elect Trump in a Wall Street Journal interview.

There are two parts of Trump’s comments that would have likely weighed on the dollar separately, and together they seem to be worth between 0.5% and 1.0% for the major currencies.  First, Trump pushed against the “border adjustment” plan from Republicans that would have taxed imports and exempted exports.  He said it was “too complicated.”  Recall, many economics, including Harvard’s Martin Feldstein, argued that the tax would spur an “automatic” 20-25% increase in the dollar.

Second, Trump specifically said the dollar was too strong.  The context was about China, but the remarks seemed to have broader implications.  “Our companies can’t compete with them [China] now because our currency is too strong.  And it is killing us.”  He said the yuan was “dropping like a rock” and the central bank was supported it simply “because they don’t want us to get angry.”

The investment community, like Americans themselves, is grappling with how literal to take the seemingly visceral remarks.  Some of the strident positions taken during the campaign have been softened, including the nomination of at least five men from Goldman Sachs, not pushing for criminal charges against Clinton, and citing China as a currency market manipulator on Day 1 (which, in any event, is now said to be not the day after inauguration but Monday January 23).  It is the uncertainty that is weighing on the greenback today.

In the larger picture, of the numerous factors that impact foreign exchange rates, the wish and desires of officials do not often seem to be particularly salient.  Our long-term bullish outlook for the dollar is based on the divergence of monetary policy, the relative health of the financial system, the anticipated policy mix, and the uncertainty surrounding this year’s elections in Europe.

The highlight of today was supposed to be UK Prime Minister May’s speech on Brexit. Much of what she is going to say is believed to have been largely reported with advanced extracts.  The essence of the approach is a “clean break” with the EU, including the single market.   Also, we expected the time frame for triggering Article 50 remains the same, end of Q1.  That said, recall the Supreme Court ruling on the role of Parliament and the snafu in Northern Ireland pose risks to the plans.

Sterling gapped lower yesterday in Asia, falling below $1.20 briefly after Chancellor of the Exchequer Hammond appeared to threaten sharp cuts in UK corporate tax rates if necessary to remain competitive in post-EU circumstances.  It filled the gap today, which extended a little above $1.2120.  Sterling approached $1.2190, with the help of a firmer CPI (1.6% up from 1.2% in November, and the highest since July 2014, with the core rate also firming.  A break now of $.12080 would suggest the short-squeeze may have run its course.

The ECB meeting in a couple of days is another highlight of the week.  The euro slipped to $1.0580 yesterday and rallied a cent by early European hours today.   It stopped just shy of last week’s high set on January 12 at $1.0685.  Intraday technicals, like for sterling, suggest the North American dealers may be more constructive on the dollar as it was several days last week. Initial support for the euro is seen near $1.0620-$1.6030.

The German ZEW had a little perceptible impact.  The January reading saw improvement, more in the assessment of the current situation (77.3 from 63.5 and 65.0 median guesstimates in the Bloomberg survey) than in expectations (16.6 from 13.8 and 18.4 median).   The final estimate of Germany’s December CPI will be released tomorrow.  It is expected to confirm the 1.7% preliminary estimate, and is a timely reminder ahead of the ECB meeting of the challenges of a one-zone fits all monetary policy.

The dollar’s recent losses against the yen are being extended today.  The greenback fell to almost JPY113.00, its lowest level since December 5.  In addition to the broad dollar decline today, other drivers seem to be also encouraging short-covering of previously sold yen positions.  US 10-year yields are six basis points lower at 2.33%.  The low point last week was almost 2.30%.  Recall that the yield peaked near 2.64% in the middle of December.  Also, US equities are trading lower, with the S&P are called to open around 0.5% lower.   The Nikkei itself gapped lower (gap:19043-19061) and closed off 1.5%, for its biggest loss since the US election.  It closed on its lows, which has not been seen since December 8.

The dollar lost 0.6% against the Chinese yuan.  At a little below CNY6.86, the dollar is at its weakest against the yuan since mid-November.  While this likely reflects the broadly weaker dollar, China’s overnight repo rate jumped 23 bp to 2.40%.  This does not seem to be tied to the short squeeze officials engineered early this month in the offshore yuan.  Instead, the onshore pressure comes from the tightening of conditions ahead of the Lunar New Year holidays.  The PBOC has tried to offset the shortage by injecting a relatively large amount (net CNY270 bln or ~$39 bln) the most since last January.  The Lunar New Year holiday runs from January 27 through February 2.

FX

January 16th, 2017 7:12 am

Via Marc Chandler at Brown Brothers Harriman;

Drivers for the Week Ahead

  • May’s Brexit speech on January 17
  • ECB meeting on January 19
  • Trump’s inauguration as 45th US President on January 20
  • Bank of Canada meets
  • China’s President Xi to address Davos

Sterling’s drop through $1.20 in Asia in response to additional confirmation that the UK government will accept that it no longer will retain access to the single market in exchange for immigration control and not being subject to the European Court of Justice.  This is what investors regard as a hard exit and negative for sterling.  The anxiety that is leading to sterling sales also seemed to weigh on the usually currency sensitive FTSE 100 , which is poised to snap a record 14-day advance.  Sterling’s drop may have helped drag down most of the other major currencies, with the Japanese yen bucking the trend.  The yen found a bid seemingly from the falling equities and benchmark yields in Europe.  Chinese stocks tumbled amid reports suggesting that initial public offerings may be accelerated.  The Shanghai Composite closed fractionally lower after losing more than 2%, while the Shenzhen’s 3.6% decline represents almost half of the loss at its worst today.  Most Asian and European bourses are lower.  European bond yields are lower led by the UK gilts.  Brent oil is firmer, but consolidating within last Thursday’s ranges.  Iron ore prices continue to rally strongly, tacking on another 7.5% to bring the year-to-day rise to almost 20%.  The euro has been sold to $!.0580, roughly a cent down from the pre-weekend high.  Sterling is a drag, but also comments from US President-elect Trump that NATO is obsolete and that more countries will likely follow the UK out of the EU, which is a German project.  Trump also extended his attack auto companies using Mexico as an export platform and specifically mentioned BMW.  Italian assets are underperforming after the DBRS downgrade before the weekend.  After a two day rally on tightening liquidity, the Turkish lira is back on the defensive as is the South African rand.  The Russian rouble is the best performing emerging market currency, following a suggestion by Trump that sanction can be lifted in exchange for a nuclear weapons agreement.  

Like many, we recognize that political factors may overshadow macroeconomic drivers in shaping the investment climate in the period ahead.  We suspect this will be very much the case in the coming days  It is not that the economic data doesn’t matter, but for many investors, the imprecision and quirky nature of the high frequency economic data pale in comparison to the risks emanating from politics and policy.  

Before providing a thumbnail sketch of the five events, we think may shape the investment climate in the week ahead, allow us to briefly preview the economic highlights.  The US and Japan round out the large countries industrial output reports. Europe accelerated.  Japan is will likely confirm the strongest monthly increase since March 2014.  US industrial output is expected to have snapped back from a weak November.  The soft patch the dragged it lower for three of the past four months through November may have ended.  

The US, UK, and Canada report inflation measures.  UK inflation is expected to have stabilized at higher levels, though PPI may continue to trend higher.  US headline CPI is expected to continue to converge with the core rate, as is repeatedly done for the past fifty years.  It is expected to push through 2.0% for the first time since July 2014.  The core rate is expected to tick up to 2.2% from 2.1%.   Canada’s CPI has averaged 1.4% this year and 1.1% in 2015.  It is expected to rebound from 1.2% in November to 1.7% last month.

Investors will get an update the UK labor market, which has lost some momentum in recent months, and average weekly earnings that appear to have steadied.  Australia reports December employment figures.  It created almost 25k jobs a month in 2015 and less than a third of that in 2016. It reported an outsized 39.1k  job growth in November. These were all full-time jobs.  Economists expect a 10k increase in December, which seems optimistic.  Canada reports November retail sales. The 1.1% jump in October (1.4% excluding autos) is obviously unsustainable. The risk seems to be on the downside of the Bloomberg median forecast of 0.5%.   

Now, let’s turn to the five key events:  

5.  Bank of Canada meeting and updated economic assessment:  The overnight rate will remain unchanged at 0.5%, and the anticipation of closing the output gap in mid-2018 also won’t be altered. However, we flag this because we expect a more upbeat tone to the central bank’s neutrality.  Also, we suspect that in the US dollar appreciation that we expect to resume shortly, investors will also look for alternatives to the greenback and the Canadian dollar is a potential candidate.  The Canadian dollar was the strongest of the major currencies against the US dollar in 2016, gaining almost 3%. The US dollar has been sold from CAD1.36 on December 30 to nearly CAD1.30 on January 12.   The US two-year premium has fallen from nearly 48 bp to 39 bp at the end of last week. It is approaching the lower end of a range  (~35 bp) that has been sustained since the middle of November.    The US premium had risen steadily from below six bp last-July.    The US 10-year premium more than doubled from last April’s 32 bp to 81 bp peak in late-November.  It has subsequently pulled back and has not been above 70 bp since January 4.  

4:  China’s President Xi goes to Davos: This will be the first time a Chinese President attends Davos.  It is part of an important and ironic juxtaposition that appears to be unfolding.  It will be Chinese “core” leader that will defend globalization from the populism and protectionism that appears to be on the rise in the United States and Europe.  The shoe has been on the other foot for years.  Chinese nationalism was worrisome for many.  It was China’s reluctance to free-trade rules embodied in the WTO agreements that was the cause of much trade friction.  Meanwhile, the price of stabilizing the economy has been a continued increase in credit extension.  At the same time, capital controls have been tightened stem the outflows.  The painful squeeze inflicted in the offshore yuan market continues to deter speculation as CNH is trading at its largest premium (rather than the more usual discount) for the longest period under this dual currency regime.  

We had argued that just like Bush and Obama backed off their campaign pledges to cite China as a currency manipulator when they assumed office.  Our forecast that Trump would also back off his pledge to cite China on day one was also bluster is coming to pass.  In an interview in the Wall Street Journal, the President-elect says it won’t be day one.  He will talk to them first.  Revealing either his reluctance to take language seriously or a subtle slight to China, Trump referred to President Xi as chairman.  It would be like calling a US president Commander.  It is a title they have but not this purpose. Alternatively, it could be a jab that Xi is not elected.   More antagonistic to the Chinese, Trump said he is not committed to the US traditional one-China policy.  He claimed it was up for negotiations.  

3.  May’s Brexit strategy: When May became Prime Minister there was a small window of opportunity to change the trajectory.  She could have said she was not bound by Cameron’s pledge to adhere to the results of the referendum.  May’s government has not been bound by other policies of the previous Tory government. She could have said that the referendum was non-binding and why pretend otherwise.  It won with the slightest of majorities, which was not to make such an important decision as changing a treaty.  With Labour having inflicted on itself serious injury, she could have won an election if she lost a vote of confidence.  Instead, she went with the “Brexit is Brexit”  slogan that may still prove tantamount to cutting one’s nose to spite one’s face.  

A week ago, May confirmed that she was willing to sacrifice access to the single market in exchange for greater control over immigration and not being subject to the European Court of Justice. Sterling fell in response through the $1.22 area that had served as a base since October and fell to two-month lows against the euro.  She is expected to outline more of her approach in a speech on January 17.  A new wrinkle has emerged, and it may blunt or neutralize the negativity of the hard exit that May appears to be leading the UK.  The Northern Ireland government collapsed at the start of last week. If the UK Supreme Court grants, it is expected to do shortly, a role for the parliament that sits in Westminster, the Parliament in Northern Ireland has joined the suit.  Without a sitting parliament in Northern Ireland, May’s intention on triggering Article 50 at the end of Q1 would likely be frustrated.   

2.  ECB meeting: After having adjustment policy last month, there seems to be practically no chance that the ECB introduces new initiatives.  Draghi’s presentation may be ho-hum. The eurozone economy has evolved in line with the ECB’s expectations.  Investors will be most interested learning Draghi and the ECB’s take on the stronger than expected rise in CPI.  Recall headline CPI jumped to 1.1% in the preliminary estimate in December from 0.6% in November. It is expected to be confirmed the day before the ECB meets. Draghi can be expected to resist ideas such as those suggested by German Finance Minister Schaeuble that it is time to reconsider the thrust of monetary policy.   If it were up to officials like Schaeuble, the policy would not have been implemented in the first place.  

The first inkling that policy is indeed working is not the time to pullback, Draghi may say.  In addition to cautioning against jumping to conclusions based on one month’s data, he may note that the rise in headline measures is primarily the result of energy prices.  The core rate increased to 0.9% in the preliminary estimate for December.  The cyclical low was 0.6%.  Pressure is likely to mount until the updated staff forecasts in March.  Note that the base effect warns of additional gains in CPI. Last January’s 1.4% decline (month-over-month)  will drop out of the year-over-year comparison.  Despite the increase in price pressures, inflation expectations remain deflated.  The German 10-year breakeven is a little below 1.3%.  

1:  Trump’s inauguration:   Donald J Trump will become the 45th President of the United States on January 20.  There is great uncertainty surrounding the policies his administration will pursue, and its priorities.  The only thing we can be confident of is there will be changes in both style and substance. It has already become clear in the confirmation process that many of new cabinet officials disagree with important elements Trump’s campaign rhetoric, and disagree with each other.  Presidents have their own decision-making style, and it is not clear where power will truly lie.  Only infrequently is an org chart particularly helpful.  

Amid the uncertainty, there are a few important constants.  First, the economic team is very pro-growth.  The usual reasons for not pursuing policies that lead to stronger growth, as the effect on the trade deficit, the dollar, or inflation are not acceptable to many in the new economic team.  Second, Trump does not feel bound by American tradition, including resisting sphere of influence claims (including formally recognizing Russia’s annexation of Crimea), opposing nuclear proliferation, defender of free-trade, and the acceptance that Taiwan is part of China (even while opposing a military solution).  Third, the communication style, including the extensive use of Twitter and citing names of specific companies and people, create new uncertainties for investors.  In situations like that, people often find ways to look like they are complying in hopes of deflecting negative attention while pursuing their own agenda.  Fourth, the style and policy substance is likely to lend itself to a heavy volume of misunderstanding, clarifications, and in one word, controversies, that make it all the more important that investors distinguish between noise and signal and focus on the latter.