Across the Curve

FX

March 16th, 2017 6:42 am

Via Marc Chandler at Brown Brothers Harriman:

Greenback Consolidates Losses as Yields Stabilize

• The Fed hike and Dutch election were not very surprising; the surprise of the day was China
• The BOJ, SNB, and Norges Bank stood pat; the focus shifts to the BOE
• AUD and NZD are under some pressure after both reported poor data
• Turkey is expected to tighten policy with a 75 bp hike in the late liquidity window rate; Chile is expected to cut rates 25 bp to 3.0%

The dollar is mostly firmer against the majors, recouping some of its post-FOMC losses.  The Swiss franc and the Loonie are outperforming, while Nokkie and Kiwi are underperforming.  EM currencies are mixed.  KRW and RUB are outperforming, while the CEE currencies and TRY are underperforming.  MSCI Asia Pacific was up 1.5%, with the Nikkei rising 0.1%.  MSCI EM is up 2%, with China shares rising 0.5%.  Euro Stoxx 600 is up 0.6% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 3 bp at 2.53%.  Commodity prices are mostly higher, with oil up 1.2%, copper up 1.1%, and gold up 0.4%.

The US dollar remained under pressure in Asia following the disappointment that the FOMC did not signal a more aggressive stance, even though it delivered the nearly universally expected 25 bp rate hike.  News that the populist-nationalist Freedom Party did worse than expected in the Dutch elections also helped underpin the euro, which rose to nearly $1.0750 from a low close to $1.06 yesterday.  European activity has seen the dollar recover a little, but the tone still seems fragile, even though US interest rates have stabilized and the 10-year Treasury yield is back above the 2.50% level.

The US premium over Germany on two-year money peaked a week ago near 2.23.  After the US yield had fallen in response to the Fed’s move, the spread finished near 2.12%, from which it has not moved far.  Initial euro support has been found a little above $1.07.  The first retracement target of the run-up is a little below there at $1.0690.  The other retracement targets are seen near $1.0675 and $1.0655.

Few expected Wilders in the Netherlands to have a say in the next Dutch government.  He drew about 13% of the vote and will hold about 20 seats, which is five more than currently.  Prime Minister Rutte’s party appears to have received the most votes and won 33 seats, down from 41.  The other coalition partners did worse.  In particular, the disastrous showing of Labor means that Dijsselbloem, the current finance minister and head of the Eurogroup of finance ministers, is unlikely to hold his post.  Labor may have less than 10 seats in the new parliament, down from 38.  The other coalition partner, Liberals, lost eight seats.

The new parliament will sit in a week and negotiations for a new government will begin.  It will take some time.  The last election (2012) took 54 days to sort out, while in 1977 it took more than 200 days to form a new government.

The Fed hike and Dutch election were not very surprising; the surprise of the day was China.  The PBOC announced a 10 bp increase in its medium lending facility loans and open market operation reports.  Its statement did try to temper the surprise by noting that these increases were not the same as an increase in the benchmark rates.  This seems to suggest that the increase in rates is unlikely to be passed on to households or business.

Three other central banks have met today, and as expected, did not change policy.  The Bank of Japan, the Swiss National Bank, and Norway’s Norges Bank stood pat.  The focus shifts to the Bank of England.  It too is widely expected to maintain its neutral stance.

The Australian and New Zealand dollars are under some pressure independent of the US dollar.  Both reported poor data.  Australia reported a 6.4k drop in employment.  The Bloomberg survey’s median forecast was for a 16k increase after 13.5k in January.  The unemployment rate ticked up to 5.9% from 5.7%, while the participation rate was unchanged at 64.6%.  One positive aspect of the report was the mix of full and part-time jobs.  Full-time positions increased by 27.1k after a 44.1k decline previously, while there were 33.5k less part-time jobs after a 57.5k surge in January.

New Zealand reported Q4 GDP expanded by 0.4%, not the 0.7% expected.  Q3 growth was revised to 0.8% from 1.1%.  This puts the year-over-year rate at 2.7% down from a revised 3.3% (was 3.5%) in Q3.

The Australian dollar pushed back from the nearly $0.7720 high seen in the US to a little below $0.7680 in Asia.  However, it has been better supported in the European morning, perhaps helped by the reports of a large foreign acquisition in the energy space.

The drop in US yields weighed on the dollar against the yen.  It fell from the upper end of its two-month range toward the middle of it.  It was near JPY114.50 before the Fed announcement and was pushed a little through JPY113 in early European activity.  It managed to recover to around JPY113.50 before stalling, seemingly awaiting fresh cues from the US session.

Risk appetites like the confluence of political and economic developments.  European peripheral bonds are firmer, while core bonds are mostly heavier.  MSCI Emerging Market equity index is extending its rally into a sixth consecutive session and the nearly 2% gain thus far today is the most since last July.  The MSCI Asia-Pacific Index rose nearly 1.5%, for a five-day streak.  European markets are following suit.  The Dow Jones Stoxx 600 is up 0.6%, after a gap higher opening.  It is the second advance in a row, and six of the past seven sessions.  

Materials are up the most, followed by energy and financials.  Iron ore prices edged higher to bring this week’s rise to 11%.  Rebar steel eased after yesterday’s rally lifted it its highest closing level since December 2013.  Oil prices are up about 1%, helped by the first decline in US inventories this year and the heavier dollar tone.

The US session features February housing starts and permits, weekly jobless claims, JOLTS, and the March Philadelphia Fed.  Given the Fed’s move, we suspect the market will not be particularly sensitive to the data.  Attention may shift to a fiscal policy where President Trump has provided an outline for the budget for the remainder of the year.  It looks to increase defense and security spending (and a little for education) whilst cutting other programs, such as the State Department and Environment Protection Agency, deeply.  The opposition from the Republican Party appears to be based more in the Senate than the House.

Central Bank of Turkey is expected to tighten policy with a 75 bp hike in the late liquidity window rate to 11.75%.  Lately, the central bank has tightened by forcing banks to borrow at this window rather than at the overnight rate of 9.25%.  We still think reliance on back door tightening reflects Erdogan’s heavy-handed tactics to prevent outright rate hikes.  

Chile central bank is expected to cut rates 25 bp to 3.0%.  CPI inflation eased to 2.7% y/y in February, below the 3% target for the fifth straight month.  After the easing cycle started with a 25 bp cut to 3.25% in January, the central bank then stood pat in February.  As such, we think it will cut again today.

 

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Debt Ceiling Primer

March 15th, 2017 1:53 pm

Via Stephen Stanley at Amherst Pierpont Securities:

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Firm PPI Dissected

March 14th, 2017 9:47 am

Via Stephen Stanley at Amherst Pierpont Securities:

The PPI was firmer than expected in February, rising by 0.3% for both the total and core indices.  This comes on top of a +0.6%/+0.4% performance in January.  Energy prices were somewhat firmer than I had anticipated at the wholesale level, rising by 0.6%, but the main surprise relative to my forecast was broad-based firmness in the core.  After January’s outsized gain, I had looked for a bit of a breather.  However, price pressures continued to build.  While there is very little in the core PPI that passes through directly, even roughly, to the CPI in the same month, I find these PPI results to be ominous for the near- and medium term inflation outlook.  The bulk of the firmness in the PPI came once again in the services categories.  While even the concept of a “producer” or wholesale price for a service product is often questionable, the BLS is certainly measuring something, and what statisticians are finding is that a variety of services are becoming more expensive.  In January, it was mainly airfares and banking and investment services.  Last month, it was banking services (again), insurance, legal fees, architectural and engineering services, hotel rates, restaurants, and the infamous wholesale and retail trade margins.  Again, none of this will feed through directly into the February CPI, but the evidence is building to support my argument that a tight labor market will eventually show itself in services price inflation.  A broad-based rise in the core PPI driven by an array of services categories should be viewed as much more impactful than a scenario where a handful of goods categories drove the advance.

Today’s results are especially troubling because I had drawn up a similar scenario for the February CPI as for the corresponding PPI.  After both releases showed big advances in January, I had anticipated a pullback to, if anything, below-trend advances in February.  Clearly, I am 0-for-1 on that count.  As for the February CPI, I am going to stick to my guns.  I am not making any dramatic changes to my estimates, though I do feel more comfortable with my numbers.  I look for a 0.1% rise for the headline, held down somewhat by a fall in energy prices, and a 0.2% increase for the core.  Before today, my estimates for both were closer to rounding down than up, so the small tweaks that I made to the CPI forecast (predominantly to the headline) make me feel better at the margin about my point estimates.

Meanwhile, the handful of PPI categories that are used in calculating the corresponding components of the PCE deflator were not particularly high.  A quick perusal of those numbers suggests nothing out of the ordinary in terms of how the core CPI and core PCE deflator will compare for February.

More broadly, even if I am right, and the February CPI is reasonably well-behaved, the specter of services prices creeping higher for two months in a row (the PPI for services rose by 0.3% in January and 0.4% in February) should send a chill up the spines of Chair Yellen and others at the Fed.  Labor markets are not going to ease up for a long time; they are only going to get tighter.  The FOMC’s Goldilocks inflation projections are looking increasingly unrealistic.  Yes, we will reach 2% (and sooner than the Fed thinks), but that will be no more than a quick bathroom break on this inflation road trip, not the final destination.

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Subprime Auto Losses

March 10th, 2017 3:25 pm

Via Blooomberg:

U.S. Subprime Auto Loan Losses Reach Highest Level Since Crisis
2017-03-10 19:55:03.994 GMT

By Matt Scully
(Bloomberg) — U.S. subprime auto lenders are losing money
on car loans at the highest rate since the aftermath of the 2008
financial crisis as more borrowers fall behind on payments,
according to S&P Global Ratings.
Losses for the loans, annualized, were 9.1 percent in
January from 8.5 percent in December and 7.9 percent a year ago,
S&P data released on Thursday show, based on car loans bundled
into bonds. The rate is the worst since January 2010 and is
largely driven by worsening recoveries after borrowers default,
S&P said.
Those losses are rising in part because when lenders
repossess cars from defaulted borrowers and sell them, they are
getting back less money. A flood of used cars has hit the market
after manufacturers offered generous lease terms. Recoveries on
subprime loans fell to 34.8 percent in January, the worst since
early 2010, S&P data show.
With losses increasing, investors in bonds backed by car
loans are demanding higher returns, as reflected by yields, on
their securities. That increases borrowing costs for finance
companies, with those that depend on asset-backed securities the
most getting hit hardest.
American Credit Acceptance, one of nearly two dozen
subprime lenders to securitize their loans in recent years, had
one of the highest cost of funds last year with yields on its
securitizations as high as 4.6 percent, even as the two-year
swap rate benchmark hovered around 1 percent, according to a
report from Wells Fargo & Co. American Credit Acceptance didn’t
respond to a request for comment.
Lenders’ profits are eroding amid steep competition to win
new borrowers, S&P analysts said in February.
Performance of prime credit bonds has also worsened to
levels last seen in 2010. S&P blamed the weakening on “a couple
of regional banks whose auto loan ABS transactions we began
rating in 2014.”
Longer-term loans to finance the purchase of new and used-
cars, sometimes stretched to as many as 84 months, have also
hurt lender recoveries by putting borrowers underwater faster,
and leaving lenders with an asset worth far less after
repossession.

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FX

March 10th, 2017 6:45 am

Via Marc Chandler at Brown Brothers Harriman:

US Jobs Data – Deja Vu All Over Again?

• Many seem to recognize the risks of long dollar positions today going into the jobs report
• Euro short covering spark came from Draghi, who made it clear that the ECB’s risk assessment was shifting toward a more balanced view
• While we recognize the dollar has scope to weaken a bit more, we suspect it will not be a repeat of last week
• Brazil reports IPCA inflation, which is expected to rise 4.86% y/y vs. 5.35% in January
• Korea’s Constitutional Court upheld parliament’s motion to impeach President Park

The dollar is mostly softer against the majors ahead of the jobs report.  The euro and Swedish krona are outperforming, while Nokkie and the yen are underperforming.  EM currencies are mostly firmer.  TRY and ZAR are outperforming, while THB and TWD are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 1.5%.  MSCI EM is up 0.2%, with China shares flat.  Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is flat at 2.60%, the high from last December.  Commodity prices are mostly higher, with oil up 0.4%, copper up 0.6%, and gold down 0.4%.

A week ago, after nine Fed officials had spoken, the market widely expected Yellen and Fischer to confirm that the table was set for a rate hike later this month.  They did, and the dollar and US interest rates rose.  Now, after a strong ADP jobs report (298k), everyone recognizes upside risk to today’s national report, and the dollar has lost its upside momentum against most major currencies except the Japanese yen.  

Many seem to recognize the risks of long dollar positions today.  There are three sets of possibilities.  First, the US jobs report is seen as strong, and the dollar sells off, as last week on “buy the rumor, sell the fact” activity.  Second, the jobs report could be strong, and the market sees the pace of Fed tightening accelerating, and the dollar rallies.  Third, the jobs report could be disappointing, and the dollar sells off.  In two of the three scenarios, the dollar weakens.  

On the other hand, what is different now compared with last week is that the dollar is softer before the event.  The US dollar’s momentum stalled yesterday, helped by a bout of euro short covering that helped trigger a broader short-covering advance in many of the major currencies.  The spark came from the ECB’s Draghi, who made it clear that the central bank’s risk assessment was shifting toward a more balanced view as the downside risks eased.  Nevertheless, the fact that the staff’s forecast that inflation next year will be lower than this year warns against over-emphasizing a subtle change in signaling.  

Most participants did not expect another rate cut from the ECB.  Most did not expect a new long-term loan facility, especially given that the current ones are still open.  Although Draghi said that asset purchases could be accelerated if needed, investors recognize that a gradual winding down is more likely than a fresh expansion.  With the negative deposit rate of 40 bp, there are some that think that the ECB could reduce the negativity before completely ending is asset purchase program.  But this does not appear particularly likely in the next several months, and, moreover, it may look a bit different if inflation peaks, as we expect, in Q2.  

While we recognize the dollar has scope to weaken a bit more, we suspect it will not be a repeat of last week.  Those that want to pick a near-term dollar top may be reluctant to make much of stand when it may be easier to do so after next week’s FOMC meeting.  This view still can see the euro moving toward $1.0640-$1.0680, and sterling testing the $1.22 area.  The Australian dollar can push toward $0.7545-$0.7560, while the US dollar can ease back to the CAD1.3430-CAD1.3450 area.  Such price action would leave the technical tone intact.  

At stake today is also the nine-day drop in US 10-year Treasury prices, which pushed the yield back to 2.62%, the highest since the Fed hiked in mid-December.  The nine-day move saw the yield rise by 30 basis points.  The yield is slightly lower now.  If there were a single factor to explain why the dollar is above JPY115, making a two-month high, we would suggest it is the rise in US yields, which drives the 10-year interest rate differential.  The dollar has not closed above JPY115 since January 11.

There are large option expiries today at JPY115 (~$1.3 bln) and JPY116 (~$1.3 bln).  We note that the January 19 high was set near JPY115.60 and the 61.8% of the dollar’s decline since the early January high is a touch below JPY116.  The dollar’s advance has also lifted it through a trendline drawn from the highs beginning at the JPY115.60 area.  That trendline, which some see as the top of a larger wedge, comes in now near JPY114.60.  This also corresponds with the 38.2% retracement of the dollar’s leg up since the mid-week low near JPY113.60.  

Both the UK and France reported disappointing January manufacturing data.  In France, manufacturing output fell 1.0%.  The market expected an increase of around 0.5%, while the December series was revised to show a 1.0% decline rather than a 0.8% fall.  The broader measure of industrial output fell 0.3% compared with expectations of a 0.5% gain.  

In the UK, manufacturing output fell 0.9%, which was a little more than the market expected.  A pullback had been expected after the heady rise in December which was revised to 2.2% from 2.1%.  Headline industrial output fell 0.4%, a tad less than the market expected.   Construction spending also disappointed.  It fell 0.4% in January; twice the loss the median forecast anticipated but also follows a strong December gain (1.8%).  Lastly, helped by the 1.6% rise in exports and a smaller 0.9% rise in imports, the UK reported a GBP1.966 bln trade deficit.  The median expectation in the Bloomberg survey was for a GBP3.1 bln shortfall after GBP2.026 bln deficit in December (which was initially reported as a GBP3.304 bln deficit).  

Canada also reports February jobs data.  A small decline is expected by the median forecast, as the market looks for some mean reversion after two months of more than 45k job gains.  In the past two months, Canada has grown 86k net new full-time jobs.  Given that Canada is roughly one-tenth the size of the US, it would be as if the US created 860k new jobs in December-January instead of the 385k it did.  

In summary, look for next week’s events (FOMC meeting, Dutch election, and G20 meeting) to limit the dollar’s downside, barring a significant disappointment that makes participants doubt the certainty of a hike next week.  Rather than a repeat of last week’s “buy the rumor, sell the fact”, we suspect the opposite will happen, with most of the dollar’s decline already likely seen since yesterday’s ECB meeting.  The two weeks of rising US yields (a tenth day of rising 10-year yields would be longest such streak since the mid-1970s) warns of a potential turning point in the market.

Korea’s Constitutional Court upheld Parliament’s motion to impeach President Park.  This was our base case and the best possible outcome, since it removes one big source of political uncertainty.  A new election will be held within 60 days.  The three leading contenders (according to the most recent Gallup poll) to replace Park are Moon Jae-in and Ahn Hee-jung of the largest opposition Democratic Party of Korea, and Ahn Cheol-soo of the smaller opposition People’s Party.  Macro policy will remain prudent whoever is elected, but there are likely to be positive micro changes (with regards to how the chaebol operate) in the next administration.  

Brazil reports IPCA inflation, which is expected to rise 4.86% y/y vs. 5.35% in January.  Disinflation continues, which should allow the easing cycle to continue.  In light of the weak economic data, markets appear to be leaning towards a 100 bp cut to 11.25% at the next COPOM meeting April 12.  However, we lean toward a 75 bp cut to 11.50%.  Much will depend on the external environment then.  BRL is finally succumbing to overall EM weakness.  Retracement objectives from the December-February drop in USD/BRL come in near 3.2135 (38%), 3.2665 (50%), and 3.3200 (62%).  The 200-day MA comes in near 3.2650, so that area will be key.    

 

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FX

March 9th, 2017 7:22 am

Via Marc Chandler at Brown Brothers Harriman:

Pre-ECB Squaring Lifts Euro in a Strong USD Context

• Sandwiched in between the ADP estimate and the US jobs data, the ECB meets today
• Falling commodity prices and rising US rates have helped take the shine off the Australian dollar
• Chinese producer prices jumped but consumer price inflation slowed markedly
• We note that the BOJ tweaked its negative deposit rate regime today
• Czech February CPI rose 2.5% y/y; Mexico February CPI is expected to rise 4.82% y/y; Peru central bank is expected to keep rates steady at 4.25%

The dollar is mostly firmer against the majors.  The euro and Swiss franc are outperforming, while Nokkie and the dollar bloc are underperforming.  EM currencies are mostly weaker.  The CEE currencies are outperforming, while RUB and KRW are underperforming.  MSCI Asia Pacific was down 0.5%, even with the Nikkei rising 0.3%.  MSCI EM is down 1.2%, with China shares falling 0.6%.  Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a flat open.  The 10-year UST yield is flat at 2.56%, the highest since late December.  Commodity prices are mostly lower, with oil down nearly 3%, copper down 1.4%, and gold down 0.3%.

The euro tested the lower of its range near $1.05 in Asia before short covering in Europe lifted it back toward yesterday’s highs near $1.0575.  However, buoyed by the upside surprise in the ADP estimate of private sector jobs growth, the dollar is firmer against most other currencies today.  The US 10-year yield is up 20 bp this week.  Including today’s move, the US 10-year yield is up for the ninth consecutive session.  At 2.57%, it has convincingly broken the downtrend in place since the middle of last December when the yield peaked near 2.64%.

Sandwiched in between the ADP estimate and the US jobs data, the ECB meets today.  With the euro near the lower end of its range, falling for four of the past five weeks, the pain trade is that the ECB will be somewhat less dovish.  The signal could be a change in the forward guidance about rates remaining at current levels or lower.  The phrase “or lower” could be dropped, some believe, in recognition of the solid growth (above trend) and rising price pressures.

However, this does not appear to us to be the more likely scenario.  Core inflation is stable in the trough (now 0.9%, after bottoming at 0.6%).  However, the ECB cannot be confident that energy prices, and to a lesser extent some weather-related increase in some fresh vegetable prices, will fade in the coming months, leaving a return to disinflation in its wake.  This idea may deter the ECB’s staff from lifting their inflation forecasts very much.

Also, the ECB will be loath to take measures in the presently charged environment that could be destabilizing.  Comments from officials show no strong urgency.  The market is doing some of that work already in the sense that outside of a few exceptions, like Germany and the Netherlands, have seen short-term interest rates over the past month.

Moreover, it seems that the pressures spurred by higher commodity prices may be peaking.  It is true that China’s PPI jumped to 7.8% year-over-year, which is the fastest pace since 2008 and is seen reflecting commodity prices.  However, this is partly a base effect as in the month of February producer prices actually fell (by 0.6%).  Oil prices have fallen, and today, the US WTI is below $50 a barrel for the first time this year.  Copper prices are lower for the sixth session and iron ore prices, off over 1% today, also appear to have rolled over.  Gold is falling as its down draft enters its fourth session (it has fallen in seven of the past nine sessions).

Falling commodity prices and rising US rates have helped take the shine off the Australian dollar, which is the strongest of the major currencies so far this year (up 4% even after this week’s 1% drop).  The Australian dollar broke out of the $0.7600-$0.7700 range last week.  It whipsawed back to into the range on Tuesday, but the slide resumed yesterday, and further losses are seen today.  The objective of the range breakout was $0.7500, and that has been taken out today.

Speculators in the futures market had shifted and taken a net long Aussie position, and the loss of $0.7500-$0.7520 warns that not only will longs have to be cut but momentum players may look to establish shorts.  The next target is near $0.7450, and then $0.7380.  The note of caution is that the Aussie is through the lower Bollinger Band (~$0.7525 today)

Falling oil prices and rising US yields have taken a toll on the Canadian dollar.  Recall the US dollar was testing support near CAD1.30 last month and is above CAD1.35 now, and looks poised to test the nemesis from the end of last year near CAD1.3600.

While Chinese producer prices jumped, consumer price inflation slowed markedly.  Economists had expected a slowing from the 2.5% year-over-year pace seen in January, but the 0.8% m/m pace was what they anticipated.  It is the slowest pace since January 2015.  It appears to be skewed by an early spring and good vegetable crop.  The Lunar New Year may have also distorted.  

Separately, China reported stronger bank lending in February than expected, but still a marked slowing from January.  The broader measures of aggregate financing, which also picks up the shadow banking activity, rose less than expected.  The CNY1.15 trillion increased compares with a median expectation of CNY1.45 trillion and the CNY3.737 trillion rise in January.

The yuan was weaker, falling to its lowest level since mid-January but recovering late.  The offshore yuan (CNH) fell below the onshore yuan (CNY), and the PBOC may have helped spur the recovery of both.  The offshore yuan has been stronger than the onshore yuan most of the year so far.  It was seen as a sign that the PBOC was trying to break the bearish speculation that helped create a troubling cycle of a weaker currency and capital outflows.

Rising yields appear to have forced the Bank of Japan’s hands as well.  The 10-year yield almost reached the BOJ 10 bp threshold after a poor reception to the MOF’s five-year bond auction.  The US 10-year yield premium over Japan reached 2.48 percentage points yesterday, the most in nearly three months.  This helped the greenback to test the JPY115 level that has largely capped the dollar since mid-January.

We note that the BOJ tweaked its negative deposit rate regime today.  It made a small change in the portion of the current account balances at the BOJ to which are exempt from negative rates (“macro add-on balances”) to 17% from 13%.

The softer yen helped Japanese equities edge higher and buck the regional trend that saw the MSCI Asia Pacific Index fall 0.5%, which is now at its lowest level in a month.  European stocks are also heavy.  The Dow Jones Stoxx 600 rose yesterday and snapped a four-day losing streak, but it is back on the downside today.  A close today below 371.80 would be the first below the 20-day moving average since February 7.  As one might expect, energy and materials are leading the push lower.  On the other hand, rising interest rates is seen as favorable for financials, which coupled with the real estate sector are leading the winners.

Sterling’s downside momentum appears to be stalling in front of $1.21.  Sterling is marginally lower today, for the fourth consecutive session.  It fell in the first four sessions of last week as well.  It has had only one advancing session in the past 10.  The Brexit drama over amendments to the bill allowing May to trigger Article 50 has weighed on sentiment, but it is likely a short-lived factor.  Interest rate differentials are also taking a toll.

The main focus is on the ECB and Draghi’s press conference.  Tomorrow’s US jobs data may deter aggressive profit-taking on the dollar today.  The US reports import/export prices, and weekly jobless claims.  Claims may bounce after falling to new cyclical lows.

Czech February CPI rose 2.5% y/y vs. 2.4% expected.  Inflation is the highest since November 2012, though still within the 1-3% target range.   Next policy meeting is March 30, and no change in policy or forward guidance is likely.  With inflation rising and the economic recovery intact, we think the CNB is on track to exit the koruna floor around mid-year.  When it does, we expect appreciation of the koruna on the order of 10-15%, which would in turn help limit inflation.

Mexico February CPI is expected to rise 4.82% y/y vs. 4.72% in January.  Banxico warned of above-target inflation for 2017 in its quarterly inflation report.  It also cut its 2017 growth forecast to 1.3-2.3% from 1.5-2.5% previously and its 2018 growth forecast to 1.7-2.7% from 2.2-3.2% previously.  As such, we do not think it will tighten further over the near-term.  Next policy meeting is March 30, and no move is likely if the peso remains somewhat stable.

Peru central bank is expected to keep rates steady at 4.25%.  Price pressures remain elevated, with CPI accelerating to 3.3% y/y in February from 3.1% in January.  This remains above the 1-3% target range.  Indeed, with the exception of a month or two here and there, inflation has remains above this range since mid-2013.  We believe further disinflation is needed to support the case for the first 25 bp rate cut.    

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Morning Musings

March 8th, 2017 9:07 am

Via Stephen Stanley at Amherst Pierpont Securities:

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FX

March 6th, 2017 7:28 am

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

• The week ahead features the ECB meeting and the US February jobs report
• Yellen confirmed the likelihood of a rate hike on March 15
• Anxiety over European politics remains elevated, but it has eased by nearly any metric one chooses
• The Reserve Bank of Australia will likely hew a neutral line when it meets this week
• Markets were rattled by news of North Korea missile launches over the weekend

The dollar is broadly firmer against the majors as follow-through selling from Friday was limited.  The yen is outperforming, while the euro and Nokkie are underperforming.  EM currencies are mixed.  ZAR and IDR are outperforming, while the CEE currencies are underperforming.  MSCI Asia Pacific was up 0.4%, with the Nikkei falling 0.5%.  MSCI EM is up 0.5%, with China shares rising 0.5%.  Euro Stoxx 600 is down 0.5% near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is down 1 bp at 2.47%.  Commodity prices are mostly lower, with oil down 0.5%, copper down 1.2%, and gold down 0.2%.

The week ahead features the ECB meeting and the US February jobs report.  The Reserve Bank of Australia meets, Europe reports industrial production, Japan reports January current account figures, and China reports its latest inflation and lending figures.  We frame this week’s discussion of the drivers in terms of four sets of questions and offer some tentative answers.  

1.  What is the significance of the price action following Yellen’s comments last Friday afternoon?  The US dollar reversed lower, snapping streaks against euro, yen, and sterling.  US interest rates eased.  Did Yellen contradict the other Fed officials, including Governors, about the likelihood of a near-term hike?  

Yellen, in fact, confirmed the likelihood of a rate hike on March 15.  She conditioned her statement on the US economic data to be broadly in line with the Fed’s expectations.  There seems to be a not very thinly veiled reference to the February jobs data on March 10.  With weekly jobless claims (and their four-week average) making new cyclical lows, the chances of a meaningful downside shock has been minimized.  In addition, average hourly earnings likely recovered from January’s disappointment.  

If anything, Yellen may have been a little more hawkish than was generally recognized.  In describing the current monetary stance, she said it was “moderately accommodative.” Previously she said it was “modestly accommodative.”  This may sound innocuous, but the Fed speaks in such nuances.  Although several Fed officials, including Yellen, deny the Fed has slipped behind the curve, there seems to be a sense that there is more accommodation that needs to be removed.  

The market has taken the data and official comments to indicate with a high degree of confidence that Fed will hike this month.  However, it has not priced the likelihood of three hikes this year.  While the odds of a March move, according to Bloomberg calculations, rose from 40% to 94% chance in the past week, the odds of a third hike by year end increased from about a one-in-four chance to a one-in-three.  

There was a typical “buy the rumor (that Yellen would confirm what nearly all of the other Fed officials have been saying) sell the fact (when she did)” activity in a relatively thinly participated Friday afternoon in North America.  The dollar had moved higher for several sessions in a row, and the market had priced in a March hike by nearly as much as it could.  The dollar moved more than two standard deviations (Bollinger Bands) against several currencies, showing the stretched nature of the price action.  

US interest rates have also approached important levels, and based on recent data, many economists were revising down estimates of Q1 growth.  The Atlanta Fed’s GDP tracker has it at 1.8% now, down from 2.5% on February 27 (though the NY Fed still sees it tracking 3.1%).  The US 10-year yield rose every session last week, the first time in nearly a year.  The two-year yield had risen every session last week as well, and even reached a six-year high before slipping lower ahead of the weekend.  The uncertainty of the significance of the last few hours of trading last week may make for cautious and choppy trading until short-term participants get their sea-legs back, but it is largely noise for medium and long-term investors.  

2.  What is happening in Europe?  Is it all about European politics?  Given solid PMI readings and evidence that price pressures are rising, will the ECB adjust its policy initiatives accordingly?

Anxiety over European politics remains elevated, but it has eased by nearly any metric one chooses.  The interest rate premium investors demand for holding French paper over German narrowed last week at both the two- and 10-year sectors.  The French 10-year premium has narrowed nearly 20 bp from its peak, while the two-year premium has been by around 13 bp.  There is scope for one major twist in the drama.  The beleaguered Fillon could pull out of the race and be replaced by Juppe, who could catapult toward the top of the polls.  Meanwhile, Le Pen has her own legal difficulties.  In the Netherlands, the latest polls suggest the populist-nationalists have also slipped recently.

More generally throughout the EMU, premiums narrowed, and importantly, the narrowing occurred in a rising interest rate environment.  Often the spreads have been more sensitive to the overall direction of interest rates.  The rising rates should also be kept in perspective.  Not just Germany, but France, the Netherlands, Italy, Spain, Portugal, and Ireland can all borrow for two years at negative interest rates.  Indeed, it appears that nearly all EMU members, save Greece, are paid to borrow for two years.  

ECB policy is on hold, probably through the Q3.  Draghi will likely be encouraged by the recent PMIs, which suggest that the region’s economy may even be accelerating a bit.  The staff will update its forecasts, and there is scope to lift growth and inflation projections a little.  That said, the January industrial production reports may be softer than the PMIs implied.  Draghi is likely to be disappointed that his calls for structural reforms continue to find few takers.  

Questions about the ECB’s inflation credibility will be rebuffed.  The increase in headline inflation is largely a function of higher energy costs, and secondarily seasonal foods (weather-related).  Many on the ECB want to look through this temporary impact.  Instead, they are focusing on the core rate, which remains in the trough near 0.9% (having bottomed at 0.6%).  We also think that relatively higher German inflation within the EMU is not an urgent problem. It is not the most desirable way for other countries to gain competitiveness over Germany, but it is one way.  

A month ago, it looked as if UK Prime Minister would formally trigger Article 50 on March 8-9.  However, that time frame is unlikely now that the House of Lords passed an amendment to the bill (seeking to protect the rights of EU citizens in the UK).  It seems procedurally more significant than substance, as some government officials were sympathetic with the sentiment.  It may delay the actually triggering by a week or so.  

3.  With the focus on the Fed and European politics, Japan and China may have slipped off radar screens.  What is happening there and what should we expect from this week’s data?  

Japan’s Prime Minister Abe may be disappointed by the US withdrawal from TPP negotiations.  However, he is probably happier with the Trump’s Administration plans for increased military spending on top of the increase that had already been planned, as well as its tough line toward China.  The Japanese economy is being lifted by capex, industrial output, exports, and fiscal support.  After the recent capex report, many expect Japan’s Q4 GDP will be revised from 0.2% to 0.4% (from 1.0% on an annualized basis to 1.6%).  

Japan will also report its January current account.  Seasonal factors are dominant.  The current account and the trade balance always (without fail for 20 years) deteriorate in January compared with December (and always improve in February).  Remember, unlike Germany, Japan’s trade balance does not drive the current account.  Investment income is typically larger than the trade surplus.  

Japanese shares have underperformed at the start of 2017.  The Nikkei is up 1.8% and the Topix is up 2.6%.  The Nikkei trails other G7 markets this year, while the Topix edges ahead of Italy and Canada.  The 10-year bond yield has been above zero since the middle of last November.  It has been confined mostly to a three to 10 basis point range, with the BOJ deterring moves above the range.  After being challenged late last year, the BOJ has regained the upper hand.  

The dollar-yen exchange rate remains strongly correlated to 10-year interest rate differentials.  The correlation is among the highest for the past 20 years.  With Japan’s side of the spread fairly stable, the movement of the US 10-year yields drives the differential.  The correlation between dollar-yen and the two-year interest rate differential is not as strong as the 10-year.  At 0.65, it has hardly been surpassed over the past two decades.  

China’s economy appears to have stabilized with the help of an explosion of credit.  After weakening in January, the dollar traded sideways against the yuan between CNY6.85-CNY6.90 since late January.  The dollar threatened to break higher but is likely to move back into the range after the weekend.  The yuan is up about 0.7% against the dollar so far this year.  The offshore yuan is up 1.15%, helped by a rate squeeze and possible intervention by Chinese officials.  The Shanghai Composite in underperforming the region.  The MSCI Emerging Markets equity index is up 8%, and MSCI Asia Pacific index is up 6.5%, while the Shanghai Composite is up 3.7%.

The economic data will be skewed by the Lunar New Year holiday.  The direction of the data may be more important than the exact magnitudes.  Reserves likely fell as capital outflows appear to be more than offsetting the current account surplus and capital account inflows.  The trade balance will likely to fall sharply, though imports and exports likely continue accelerating (due to the base effect).  Aggregate lending also likely fell sharply from elevated levels.  Producer prices are surging, but consumer price is set to moderate.  The Bloomberg consensus is for a 1.8% year-over-year pace in February after a 2.5% clip in January.  

4.  What is the Reserve Bank of Australia going to do when it meets?  The Australian dollar is the strongest major currency this year, with a 5.4% rise.  What is the outlook?  

The Reserve Bank of Australia will likely hew a neutral line.  It recently updated its macroeconomic forecasts.  There is little new that may be added.  The stabilization of the Chinese economy and the stable to stronger US and European economies have lifted the global outlook.  With a surge in iron ore, coal and copper prices, Australia enjoyed a sharp improvement in its terms of trade.  This is unlikely to be repeated, and instead, some deterioration is now likely.  The Australian dollar has repeatedly tried to break above $0.7700, but ultimately failed and was sold through $0.7600.  It recovered in late Friday turnover, but speculators who have built their largest net long position in the futures market may be looking for an opportunity to cut back on exposure.  Rate differentials are also moving against Australia (smaller carry).

The Canadian dollar lost nearly 2.2% against the US dollar last week.  Bank of Canada Governor Poloz insisted on seeing the glass has half empty, while US central bank officials were talking about the need to consider lifting rates against, the second hike in four months.  The two-year yield spread jump 14 bp to finish the week at 54 bp, the highest since early last year.  The US premium has steadily increased and has fallen only twice in the past 11 sessions.  

Canada’s merchandise trade surplus surged in Q14 2016, but it will be difficult to be sustained at the start of 2017.  Investors may also pay close attention to the performance of non-energy exports, which have been disappointing.    

Canada’s job creation in Q4 16  (~30.2k) was the strongest quarterly growth in four years. January continued the streak with a 48.3k increase.  Look for payback in February where the Bloomberg median expectation is for a loss of 2.5k jobs.  Canada created 15.8k full-time jobs in January and an average of 12.1k in Q4 16 and 6.1k on average in 2016.  

Speculators have their largest net long Canadian dollar position on in the futures market in four years.  The Canadian dollar may not benefit as much as other currencies if the US dollar begins weakening, but does seem to be vulnerable in a stronger US dollar environment.  

EM CPI and real sector data this week should support our view that Asian and EMEA central banks will have to tilt more hawkish this week.  Latam data should show further disinflation that supports a more dovish tilt in that region.  Polish and Peruvian central banks meet this week, but no changes are expected.

Markets were rattled by news of North Korea missile launches over the weekend.   Four ballistic missiles were reportedly fired into the waters surrounding Japan.  China condemned the launches, but it remains to be seen if it will take stronger action to rein in its client state.  We will send out a longer piece on South Korea today that discusses rising tensions on the peninsula.  

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Upcoming Week

March 4th, 2017 11:45 am

Via Stephen Stanley at Amgerst Pierpont Securities:

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Yellen Speech

March 3rd, 2017 2:11 pm

Via Stephen Stanley at Amherst Pierpont Securities:

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