Marc to Market
Stocks Slammed and Yields Drop as Virus Containment Fails
Mon, 24 Feb 2020 04:01:50 PST

Overview: The ring of containment of Covid-19 has grown from China. The new frontline is Japan, South Korea, Italy, and Iran. A lockdown of around 50k people near Milan and Austria blocking trains from Italy is scaring investors. Asian markets fell, but South Korea bore the brunt with a nearly 4% decline. The national holiday in Japan spared local equities. Europe's Dow Jones Stoxx 600 was marked sharply lower at the open and trended lower throughout the morning. The record high was reached on February 19 (~434) and is now approaching the year's low set on January 10 (~410). It is off about 3.7%. US shares are also selling off, and the early indication is for around 2.5% gap lower opening of the S&P 500. Bond yields are also falling. Asia-Pacific yields were off 2-4 bp, while core European bond yields are 5-7 bp lower, and the US 10-year yield is off around eight basis points to dip below 1.40%. The US 30-year yield is about seven basis points lower at a new record low near 1.84%. The major currencies fall into four buckets today. The yen, which some feared was losing its safe-haven status, is the only currency gaining against the dollar tody (~0.25%). The euro, Swiss franc, and Danish krone are off about 0.3%. The dollar-bloc and Swedish krona are off about 0.6%, and the Norwegian krone is off around 1%. Emerging market currencies are under pressure the JP Morgan Emerging Market Currency Index is 0.5% lower, with the Mexican peso and South Korean won leading with approximately 1% losses. Gold has soared more than 2% to $1680-$1690, and April WTI is off about 3.5% to $51.50.  

Asia Pacific

China added to the confusion by announcing the easing of the travel ban for Wuhan, where the virus initially emerged, only to rescinded it within hours. Apparently, it did not have senior leadership approval, and the lockdown of the 1l mln or so residents remains in place. Meanwhile, other reports suggest that Beijing is pushing to resume economic activity as soon as possible, and this is leading to other concerns that it may be premature. At the same time, the virus does not yet appear contained. 

The IMF shaved its GDP projection for China to 5.6% this year, which seems wildly optimistic, but then China's GDP is whatever it says it is. It is hard to see how China escapes a contraction in Q1, and even under the most optimistic scenarios, recoups it fully in Q2 (V-recovery) and grows near trend in H2. That would still put growth for the entire year closer to 3%.   

Infections in South Korea have jumped from about 30 to over 750 in the past week. South Korea appears to be preparing for a fiscal and monetary response. A KRW10 trillion (~$8.2 bln) supplemental budget is being discussed. The central bank meets later this week (February 27) and is expected to deliver a 25 bp cut.

Last Thursday, the dollar rallied from about JPY111.10 to nearly JPY112.35. Before last weekend, the dollar pared its gains to around JPY111.50 and today to about JPY111.20, to meet the (38.2%) retracement of its recent run-up. The next target is just below JPY111 and the JPY110.65. The JPY111.60 area offers nearby resistance. The Australian dollar was trying to bottom at the end of last week, but the lack of containment of Covid-19 has sent it to a marginal new decade-low (~$0.6585). Resistance is seen in the $0.6640-$0.6660 area. The PBOC set the dollar's reference rate at CNY7.0246, in line with the bank models. It rose to about CNY7.04 before stabilizing near CNY7.03.  


The number of cases in Italy, especially northern Italy, has risen sharply. The Venice Carnival has been canceled, and schools have been shuttered. The restricted movement has impacted about 50k people around Milan, according to reports. This will likely qualify as sufficient of an emergency to permit a fiscal response. Reports suggest Austria has halted a few trains from Italy.  

Germany's February IFO survey was mixed. The current assessment slipped to 98.9 from 99.1, but the expectations component edged up to 93.4 from 92.9. The combination saw the overall climate measure tick up to 96.1 from a revised 96.0 in January. It sparked a short-lived bounce in the euro to about $1.0840. Separately, in the Germany city/state of Hamburg, the SPD held on to win a plurality, and the Greens also did well. The CDU saw its support fall to a new record low (~11.2%), and both the FDP and AfD both barely squeaked past the threshold for the local parliament. The CDU is without a party leader, and it was decided earlier today to hold a convention in late April to choose a successor to AKK, and likely Merkel herself.  

The UK Parliament returns from its recess today. The new points-based immigration proposals and anti-terror legislation are on the top of the agenda. Formal talks with the EU on the post-Brexit trade relationship are to start on March 2, and the UK budget is to be presented on March 11.  

The euro is consolidating in its pre-weekend range (~$1.0785-$1.0865). It needs to resurface, and ideally close above $1.0820 to keep the correction intact. The intraday technicals suggest a reasonable chance for this. Still, with last Friday an exception, the North American participants have often been more bearish toward the euro than the other centers. Sterling is also confined to the previous session's range (~$1.2880-$1.2980). A break lower would immediately target $1.2840. A close above $1.2930 would point to more consolidation.  


The Chicago Fed's National Activity (January) report and the Dallas Fed's (February) manufacturing survey are hardly the data that drives the capital markets even in the best of times, and today, it is an even greater stretch. Investors have been given two warnings--one from Apple and one from last week' preliminary PMI--that they may be a larger impact from Boeing and the disruption from Covid-19 than officials and many (equity) investors seem to recognize. The implied yield of the December funds futures has fallen nine basis points today to 1.06%. The current average effective fed funds rate is 1.59%, which means that the market has now discounted a little more than 50 bp of easing. The Fed's Mester (voting member) speaks today, but the chorus of officials have shown little sign of softening their stance, though next month's FOMC meeting is likely to be a different story (spoiler: dovish hold).

The sharp drop in oil prices and risk-appetites have sent the Canadian dollar sharply lower. The US dollar has surged to briefly poke above CAD1.3300 after finishing last week flirting with the 200-day moving average (~CAD1.3215). The high set two weeks ago, near CAD1.3330, is the next key chart point. The intraday technicals suggest the extreme may be passed, and a test on CAD1.3260 would boost the confidence of this view. The dollar closed below MXN19.00 ahead of the weekend despite intraday penetration. However, the greenback's rally has continued today, and the peso, being a liquid and freely accessible currency, is bearing the brunt of the EM sell-off today. The greenback is approaching MXN19.20 and the 200-day moving average, which has not been violated since early December is found just above MXN19.21 today. Increased volatility is forcing an unwind to the popular carry trade.  


The Rubber Band Snaps Back: Dollar Correction Begun
Sun, 23 Feb 2020 04:22:56 PST

An exogenous shock disrupts relationships and patterns.  It may be a useful reminder the correlation does not mean 100% co-movement.  The strongest currency in the world last week was the Swiss franc, a safe-haven that rose by almost 0.5%.  The weakest major currency, and third weakest overall, was the Japanese yen, also a leading safe-haven.  The second strongest currency was the Canadian dollar.  Our reading of the charts gave us the most confidence in it.  Its modest 0.35% gain contrasts with the performance of the other dollar-bloc currencies that fell by around 1.25%.  

The dollar raced higher for most of the week.  It was if, in this giant card game, the coronavirus provided an opportunity to change cards.  And after a quick review, investors doubled up on the long US card.  The sense of a new divergence lifts the dollar.  New highs since April 2017 were seen against the euro.  The US dollar rose to fresh 10-year highs against the Australian dollar.  The dollar visited levels not seen since 2001 against the Norwegian krone.  On February 19, the dollar rose a little more than 1.3% against the yen, reaching a seven-month high.  The single-day advance was larger than any weekly gain since the middle of July 2018.  

The dollar's gains came to a halt as the fuel for the rally, the economic divergence, was called into questioned into question, ironically, by the diverging flash PMI reports.  The somewhat better than expected EMU composite helped stabilize the euro, but it was not until the weaker than expected US report got the ball rolling.  This looks like the end to this leg up for the US dollar and barring new shocks, a consolidative/corrective phase may be at hand.  

Dollar Index:  The century level was almost seen as the rally was extended to fresh highs since Q2 17.  The loss ahead of the weekend was not signaled by any reversal pattern or drop in the momentum indicators.  Nevertheless, the impulsive nature of the decline, with a modification of the macro narrative, and the turning lowe the said momentum indicators warn that additional near-term losses are likely.  With the conservative assumption that the move that is being correct is this month's, not the December 31 low, the first retracement objective is near 98.95. More significant support is in the 98.60 area, which houses a retracement objective (50% around and the 20-day moving average).  A move back above 99.60 would call this more bearish into question.  

Euro:  The euro recorded a single advancing session in the first two weeks of February, and even before the weekend's punctuation, it had posted two gains last week.  The roughly 0.65% rally ahead of the weekend was the largest of the year so far.  A shelf has been carved that extends to around $1.0780.  Both the MACD and Slow Stochastics are turning higher from over-extended territory.  Initially, initial potential may extend back into $1.0935-$1.0975.

Japanese Yen:   The dollar exploded higher against the yen in the middle of last week,  jumping almost 1.4% to a seven-month high near JPY111.60.  Follow-through buying the next day lifted it closer to JPY112.25. It broke through a multi-year downtrend that is found near JPY110.  If the high is in place, then the conservative assumption is that last week's move from about JPY109.65 is being corrected.  A break of JPY110.65 would signal a deterioration of the dollar's technical tone.  

British Pound:  Relatively firm UK data and fading ideas of a rate cut might have been more supportive for sterling if it had not been for the pesky dollar and Brexit, the other gift that keeps on giving.  It had begun the week with a four-day slide reversing in full the previous week's five-day rise.  The streak was snapped ahead of the weekend with around a 0.65% rally that took it back to ~$1.2980. A move above $1.30 would be helpful, but a foothold above $1.3070 would be significant.  It is the recent high, and it is the neckline of a potential double bottom ($1.2850-$1.2870) that would project toward $1.3250-$1.3270.  

Canadian Dollar:  A favorable outlook for the Canadian dollar was our highest confidence call last week.  It was second among the majors (behind the Swiss franc), with about 0.25% gain against the US dollar.  One-week volatility jumped, and that absorbed the risk-off shock, not the exchange rate so much.  The US dollar slipped to a new low for the month near CAD1.3200 ahead of the weekend.  Even though the US dollar failed to close below its 200-day moving average (~CAD1.3215), the technical indicators still point to greater downside potential.  A break of CAD1.3185 could target the CAD1.3100 area again.  

Australian Dollar:  After being sold to new decade-lows below $0.6600 in Asia ahead of the weekend, the Aussie reversed higher amid broad US dollar weakness. It reached almost $0.6640 before consolidating.  After unable to sustain upticks for the past six sessions, the Aussie's gains of less than 0.2% seemed begrudging.  The technical indicators are not showing that a bottom is in place. An increase above the $0.6660 may help stabilize the tone, but to be anything meaningful, a convincing move above $0.6700 is needed.   

Mexican Peso:  The peso had a bad week, but it ended on a good note.  The US pushed above MXN19.00 ahead of the weekend, which it has done a handful of times since breaking below it in the middle of last December.  It has, however, consistently failed to close above it, and February 21 was no exception.  Some of the carry-trades in which the euro and/or Swiss franc are used to fund a long peso/cetes position unwound.  Consider that the Swiss franc appreciated by 2.25% against the Mexican peso last week.  The peso is bought to invest in short-term peso bills that yield close to 7% annualized (3-month cetes).  This is why the carry trade has been described as picking up pennies in front of a steam roller.   

Chinese Yuan:  The dollar rose in the past four sessions against the yuan, and stopping ahead of the weekend a little short of the CNY7.05 target we suggested (at around CNY7.0425).  The PBOC did set the dollar's reference rate higher several times last week than the bank models suggested, which appears to signal a comfort level with a weaker yuan.  With the shocks China is facing, and the easing of monetary and easier fiscal policies, a weaker currency would be the result even for less managed currencies.  Chinese officials would have political cover, too, if it wanted to pursue a weaker yuan.  The US played its currency manipulation card last year and took it back.  Playing it again now would weaken its value.  With the dollar pulling back ahead of the weekend in the North American session, the yuan may begin off the new week on a firmer tone.  The dollar may consolidate and straddle the CNY7.0 area.  

Gold:  The increasingly precious metal sparkled last week, gaining 3.75% or almost $60.  It has rallied alongside the dollar, though some suggest it is an alternative.  It was the biggest advance though came before the weekend (~1.5%), as the dollar fell.   Since gold broke above $1400, we have suggested a medium-term target near $1700, which not seems somewhat cautious.  It reached $1800 in 2008 and may offer a stronger hurdle.  However, the fact that gold finished above its upper Bollinger Band for the fourth consecutive session is cautionary even though the Slow Stochastic and MACD are still reflecting the upside momentum.  Initial support may be seen in the $1620-$1630 area.  

Oil:  We are tracking a potential double bottom in April WTI that we identified last week, with a measuring objective near $55.50. It peaked on February 20, around $54.65, and retraced a little more than a third of its rally and fell to about $52.65.  However, it recovered by nearly a dollar by the end of the session.   This leaves it in a fine position to continue the recovery in the coming days.  The five-day moving average has crossed above the 20-day for the first time since the second week of January.  

US Rates:  Investors bid up US debt securities pushing yields to incredibly low levels.  The 30-year offers a record low yield a little more than 1.90%.  The 10-year yield dropped below 1.45%, seen last September.  The lion's share of the 11-12 decline in these yields can be accounted for the shift in the outlook for Fed policy.  Specifically, the implied yield of the December 2020 fed funds futures contract fell nine basis points.  It now discounts 44 bp of easing this year.  Nary a Fed official has shown any indication of recognizing the wisdom of crowds on this. Still, if the flash PMI is any indication and Apple's earnings warning is any indication, they will come around. 

S&P 500:  The S&P 500 gapped higher at mid-week and set new record highs before selling off the following day and then again ahead of the weekend.  That mid-week gap may have been exhaustion.  The MACD did not confirm the record high and is leaving a potential bearish divergence, while the Slow Stochastic has flatlined in overextended territory.   The S&P has spent around half a dozen sessions below its 20-day moving average in the past four months.  Perhaps that is one way to quantify buying on a pullback.  That moving average is found near 3323 to start the new week, and there is an old gap roughly 3306 and 3317 whose vacuum may attract.   If this area does not hold, consider that the benchmark finished last month near 3225.50.  


Sources of Imbalance and the Pushback Against New Divergence
Sat, 22 Feb 2020 07:41:29 PST
The US dollar's surge alongside gold has eclipsed the equity market rally as the key development in the capital markets.   Even the traditional seemingly safe-haven yen was no match for the greenback.  The dollar appeared to have been rolling over in Q4 19, as the sentiment surveys in Europe improved, Japanese officials seemingly thought the economy could withstand a sales tax increase, and data suggested the Chinese economy was gaining some traction.  

However, 2020 has begun with new divergence.  The Covid-19 virus has not only crippled the Chinese economy, but its sheer size and magnitude of its integration in the global supply chains have far-reaching knock-on effects.  Asia-Pacific economies that were increasingly reliant on Chinese input and demand are the most vulnerable.  Estimates suggest that the world's second-largest economy is operating well less than 50% of capacity.  Indeed, the extension of the stoppages and disruptions increase the likelihood that the Chinese economy contracts in Q1.  The supply chain disruptions are adversely impacting Japanese and Korean automakers.  German automakers derived a substantial share of their profits from China, and car sales continue to weaken.  Volkswagen, for example, has ceased production at a third of its 33 plants in China, which accounts for around half of its total production.  Chinese autos sales in the first half of February were off 92% from a year ago.  

Japan's sales tax increase in October and the typhoons dealt the world's third-largest economy a significant blow and a deep quarterly contraction of 1.5%.  Despite government efforts to soften the blow through incentives to consume, the impact was nearly as much as the previous sales tax hike. This self-inflicted shock, coupled with the slowing of China and the typhoons, leaves the Japanese economy vulnerable.  Japan's exposure to China, through trade and tourism, maybe a sufficient knock for the fragile economy to lead to a contraction here in Q1.   It would be the second consecutive quarterly contraction, a rule of thumb often used to mark a recession, and underscores the fact that negative interest rates do not prevent economic downturns.   

Arguably, the tightening of Japan's fiscal policy through the tax increase was partly offset by the other fiscal incentives to blunt the contractionary impulse.  Yet the measures appeared to have minimal impact at best.  The tax, which has been increased in a few steps, was initially foisted on Japan by multilateral institutions but took on a political life of its own in Japan beyond the economic arguments.   Pundits and journalists shake their heads at what appears to be a self-defeating policy.  However, German's reluctance to use its fiscal space is seen as not just folly but dangerous, as well. 

The European Central Bank, the IMF, and many American and British economists do not understand why Germany is not borrowing money at negative interest rates to fund public investment. Even the German Bundesbank has accepted that the fetish for the "black zero," which both parties of the coalition government have supported in word and deed, is doing harm. Often, the conversations have an air of "America is from Mars, and Europe is from Venus." Little illustrates this insight, like the appreciation that "guilt" and "debt" are derived from the same word in German and Dutch.  In America, in contrast, debt and bankruptcy have been liberated from moral stigma.  It is about using OPM or other people's money.  The ability to service one's debt has become the issue, not the debt itself.  Between student loans, mortgages, auto loans, and credit cards, Americans spend most of their lives in debt. 

The magnitude of the Trump Administration's tax cuts and spending increases during a non-recessionary period seems virtually unprecedented. However, it did not boost growth for more than a couple of quarters.  It failed to lift US productivity, spur capital expenditure, accelerate wage increases, or boost the growth potential.  Nor did it help its major trading partners, like Canada, Mexico, China, or Europe. 

Yet, somehow if Germany would just borrow more money and boost public investment EMU's problems would be ameliorated.  It is not immediately evident that if Germany jettisoned the "black zero" and ran a small deficit that it necessarily would aid the periphery in Europe, let alone the United States.   It would do little to lift Italy out of what appears to be a prolonged stagnation.  It would do little to counter the strikes and social push back against French President's Macron's neoliberal labor and pension reforms, for example, or help resolve the deadlock following the recent Irish election.  It would not help forge an agreement on the EU's seven-year budget, or help complete the monetary and banking union.     

In international economic relations, the role of creditor and debtor are key.  Traditionally, the burden of adjustment is on the debtor.  Think about Bretton Woods.  The US (Harry Dexter White) took the classic creditor position, and the UK (John Maynard Keynes) represented the debtors' interest in the post-war financial order.  The bancor, an international reserve asset that Keynes proposed instead of the gold-dollar regime, and not too dissimilar from BOE Governor Carney's recent proposals of a digital reserve asset that is not a national currency, was in the debtors' interest and successfully rebuffed.   

Or consider the burden of adjustment under Bretton Woods.  It was entirely placed on the debtor.  It to change its policy settings, intervene and/or accept a devaluation.  The innovation under the European Exchange Rate Mechanism is that it obligated the creditor/surplus countries to bear some of the adjustments, too (such as intervention).  

The US is no longer the world's creditor, which is a significant way that Pax Americana is unlike Pax Britannica or Pax Romana.  American debt is the coin of the realm.  Even under Bretton Woods, the US insisted on the mark, franc, and yen appreciation, rather than the dollar depreciation. As a debtor, the US self-interest, naturally, is to blame the creditor and seek their adjustment.  As a consequence of the combination of US monetary and fiscal policy in the context of the policies being pursued in the other major center, global imbalances are rising, and the strength of the dollar appears to be one shock absorber.  

With the US having successfully negotiated trade agreements with South Korea, Japan, Canada, Mexico, and China, the Trump Administration's trade focus is turning to Europe.  Complementing the criticism of its European trade practices is the attack on the fiscal stances of a few EMU countries.  Yet, the US current account deficit is, by definition, a result of the imbalance between savings and investment.  What America's right and left have in common is a penchant for externalizing its problems and attributing its challenges to foreign mischief.  

US policymakers and America's chattering class that provide its narrative have begun an offensive.  The trade confrontation element is well known.  It needs little comment, but to say that in the Phase 1 deal with China, the US abandoned its traditional emphasis on a rules-based settlement in favor of an outcome-oriented approach.  It represents a reversion back to a zero-sum approach and strengthens those forces seeking to defect from the free-trade regime.

Another front in the offensive is the moral, righteous criticism of countries that keep their expenditures aligned with their revenues.  They are chastised for what historically is understood as fiscal prudence and living within one's means.  Many of these creditor countries in Europe have stronger and broader social safety nets than America, and in other ways, offer a larger basket of goods to its residents and citizens.  They have higher tax burdens than the US.  Also, they have fewer monopolies that facilitate lower consumer prices for essential modern goods, internet access, health care, and higher education.  In addition, they rely considerably less on their penal system for social control.  

Surely the driver of the US imbalance with the world is America's own fiscal policy--last year a 4.7% budget deficit as a percentage of GDP. And this during an economic expansion with historically low levels of unemployment. Many economists see the deficit rising toward 5% of GDP.  Without addressing the real culprit, Americans complaining about Germany's fiscal policy appear as a self-serving way to deflect attention: talk about how bad the 2019 German budget surplus of 1.2% of GDP is rather than the US deficit that dwarfs it in both dollar terms and broader impact.    

Even if Germany boost its spending and even if this raised growth, the US current account deficit would not necessarily be reduced one red cent. Isn't this what has been confirmed in 2019 trade figures?  The smaller US bilateral trade deficit with China was offset by larger bilateral deficits elsewhere.  And as economic activity shifted because of tariffs, other countries move into US cross-hairs, like Vietnam and Malaysia.  

To be sure, the US fiscal excesses do not meaningfully explain why last year, Germany had a current account surplus of 7.3% of GDP.  Germany exports around 40% of all the goods and services it produces (GDP).  Its reliance on foreign aggregate demand to employ German labor and capital arguably reflects a fundamental domestic imbalance and suppressed domestic demand,

There are good internal economic and political reasons for Germany's political and economic elite to endorse stimulus measures.  The two main parties have seen their public support fall sharply in recent years and are at risk of being outflanked by the AfD on the right and the Greens on the left. The cost of the fiscal prudence has been to starve the country from modernizing and moving toward sustainable infrastructure.  A thoughtful effort could boost Germany's economic competitiveness.  New efforts to close the income and wealth gap could also boost domestic demand and reduce German dependence on exports and thereby blunt the criticism levied against it. 

Most of the critical US economic data for January have beaten expectations, and judging from the Empire and Philly Fed surveys and weekly jobless claims, the upside momentum has carried into February.  Yet the market rightly looks past it.  If the Fed cuts in Q2 as we expect, it will be like last year, as insurance against the global risks.  The  US 30-year bond yield is below the Fed's 2% inflation target and fell to record lows below 1.90% ahead of the weekend.  The 10-year yield is almost 10 bp below the 3-month bill yield.

The new divergence story got pushed back against by contrasting February PMI reports.  The US was unexpectedly weak, with the composite falling to seven-year lows (49.6 vs. 53.3 in January).  Both manufacturing (50.8 vs. 51.9) and services (49.4 vs. 53.4) disappointed.  The eurozone's was better than expected. 

The eurozone's flash February PMI suggested that new recession fears may be overblown.  Across businesses rising domestic orders seemed to offset weakness from abroad, and the labor market remains resilient.  The composite PMI rose to 51.6, its best since last August.  However, it could only have modest impact on the euro because after the simply dreadful industrial output figures, real sector data is needed to validate the soft data of surveys and sentiment. 

Japan will provide hard data for January: jobs, retail sales, and industrial production.  The reports come at a pivotal time for the yen.  As is well known, the yen tends to appreciate when US yields and/or stocks fall, though the correlations are not stable.  The yen is used as a funding currency to purchase higher-yielding or more volatile assets (risk).  When the risk asset is sold, the funding currency is repurchased.  It is the signal, but of course, speculative operators can anticipate and piggyback those flows.  This creates an echo around the signal.  To distinguish the two is like telling the difference between a wink, a twitch, and someone mimicking one or the other.  Context is key. 

In any event, the usual drivers of the yen did not seem particularly influential last week as the dollar soared to almost JPY112.25 from about JPY109.65 a couple of days earlier.  Fears that Japan's ties with China would deliver a sharp punch to the economy, through supply-chain disruptions, drying up of tourism and less demand for Japanese-made goods seemed to eclipse its so-called safe-haven appeal.  We expect the yen's traditional drivers to re-emerge, and in this context, it would suggest that the dollar is more likely to carve out a new range rather than continuing to accelerate.  Vol is rich if this is assessment is correct.  One-month vol finished last week above its 200-day moving average (~5.7%) and the 6%-threshold for the first time since mid-October. 

China reports its official PMI at the end of the week.  There is no question the direction, and the magnitude is subject to dispute.  The risk is asymmetrical in that few numbers will likely capture the impact of the images in the social media of the lockdown, which some estimates suggest is impacting more than 120 mln people.  The methodology of the reports of contagion in China is further confusing and underscores the underlying distrust. 

Even if there is a strong rebound in China beginning as early as Q2, it is unlikely to arrest the shift in the global supply chains spurred by the US-China trade conflict.  Public health issues need reliable and accessible information, and this is, arguably, a critical weakness in Beijing's model.  However, rather than use this as an opportunity to address it, it appears General Secretary Xi will make no concessions, which was signaled by the expulsion of the Wall Street Journal reporters and the talk of a crackdown on VPNs and removal of tweets that advocated free speech. 

If another country faced China's challenges, still high US tariffs on most of its goods, the fragile banking system,  a coronavirus that has stalled its economy, the currency would have been sold-off.  The yuan has fallen by 1.2% this month, and the offshore yuan slipped by 0.5%.   These are rather modest moves.  Consider that the Japanese yen fell 1.75% last week alone.  The greenback was sold after the disappointing US PMI, and it may signal a near-term high is in place against the yuan, stopping a little short of the CNY7.05 target. 


Covid-19 Contagion Outside China Keeps Investors on the Defensive
Fri, 21 Feb 2020 08:14:04 PST
Overview:  The spread of Covid-19 outside of China and early signs of the economic consequences again emerged to weigh on investor sentiment. Poor Japanese and Australian preliminary February PMI reports and some trade indications from South Korea saw most Asia Pacific equities sell-off. China was an exception. The small gain (0.3%), lifted the Shanghai Composite 4.2% on the week. Australia's benchmark also managed to eke out a minor gain (~0.12%) for the week after absorbing today's (0.33%) loss. Europe's Dow Jones Stoxx 600 was nearly flat for the week coming into today's session, and despite better than expected PMI news, it is off about 0.35% in late morning turnover. It had gained about 4.8% in the previous two weeks. The S&P 500 staged an impressive rally as once again, the pullback was bought. However, US shares are trading lower, with the S&P 500 trading near yesterday's lows. Asia Pacific bond yields tumbled, partly as catch-up, and partly driven by local data. European bond yields are a little lower, and the 10-year US Treasury yield has fallen below 1.50% for the first time since last September. The US dollar is mostly softer, with the Australian and New Zealand dollars are main exceptions, nursing about a 0.3% loss. Although the yen's typically drivers appeared to breakdown earlier this week, relationships appeared to return to status quo ante with lower US Treasury yields and weakness in equities underpinning the yen, whose roughly 0.3% gain is leading the majors. Gold is on fire. It is at new 7-year highs near $1635 to bring this week's gain to about $50 a little more than 3%. Oil prices lower, and the WTI for April delivery is halving this week's gains to about 1.4%.   

Asia Pacific

The steepness of Japan's Q4 contraction, 1.6% quarter-over-quarter, and the disruption of supply chains of people (Chinese tourists) and goods (supply chains) has fanned fears that the recovery is put off until Q2. The preliminary PMI, though it does not have a long history, has a somber message. Manufacturing stands at 47.6 down from 48.8. Here the weakness was exacerbated. Mild strength in services (51.0) turned south in a big way (46.7).  The composite reading fell to 47.0 from 50.1. The fragile recovery from Q4 shattered. BOJ Governor Kuroda quickly said it was not time to think of additional stimulus. Separately, Japan's January CPI figures were little changed. The headline year-over-year rate slipped to 0.7% from 0.8%, while the core rate (excludes fresh food) did just the opposite. 

The Australian dollar has been sold aggressively as growth concerns escalated given the wildfires and the disruption caused by the coronavirus. The February PMI confirmed these investor fears. Even though the manufacturing PMI actually rose (49.8 vs. 49.6), the decline in the services PMI (48.4 vs. 50.6) more than offset it. The composite fell to 48.3 from 50.2. Last year it averaged 50.5, though it was below the 50 boom/bust level in November and December.

South Korea's trade figures for the first 20-days of February give a sense of the dramatic disruption taking place. South Korea's average daily shipments during the period were 9.3% lower than a year ago. Overall, exports to China were off 3.7%, even though there were more working days. Imports from China dropped by 19%. Overall, South Korean exports rose 12% year-over-year, but this figure is distorted by the calendar effect, which added three working days compared to a year ago.    

The dollar tested JPY112.20 yesterday and pulled back to around JPY111.50 today. The JPY111.30 area corresponds with a (38.2%) retracement objective of this week's surge. However, the intraday technicals warn that the washout may not be completed and that the North American market may retest the JPY112.00 area. There is a $625 mln option struck there that expires today. It is the third consecutive weekly advance for the dollar, the longest since October. The Australian dollar is down for the fourth straight session. The last time it finished the North American session with a gain was on February 12. It has been sold below $0.6600 today to fresh ten-year lows. The Chinese yuan has also weakened for a fourth consecutive session today, and today's loss brings the week's decline to about 0.65%. The greenback briefly traded above CNY7.04 for the first time since mid-December.  


The eurozone flash PMI was better than expected. Still, the soft data can only dop so much for the sentiment after the large collapse in the real sector (industrial output) in December.  German manufacturing contraction slowed, and the February PMI manufacturing PMI rose to 47.8 from 45.3. The service PMI softened to 53.3 from 54.2. The compositing reading ticked to 51.1 from 51.2, which was still better than decline economists had forecast. In France, the manufacturing PMI disappointed, falling to 49.7 from 51.1. The services PMI was resilient, rising to 52.6 from 51.0. This resulted in the composite improving to 51.9 from 51.1.  

The aggregate figures for the eurozone were better than expected, and new orders edged higher, despite softer foreign demand. The resilience of the labor market is also a constructive sign. The manufacturing PMI was at 47.9 in January and is now at 49.1. A year ago, it was at 49.3. The services PMI rose to 52.8 from 52.5 and matches the year-ago level. The composite was expected to slip to 51.0 from 51.3 in January but instead rose to 51.6. In February 2019, it was at 51.9. 

The UK preliminary February PMI is consistent with recent data suggesting that after stagnating in Q4, the British economy is faring better at the start of 2020. The manufacturing PMI moved back above the 50 boom/bust level to 51.9, which was better than expected. The service PMI slipped to 53.3 from 53.9. The net effect was to leave the composite unchanged at 53.3. Economists had forecast a decline.  

The euro is trading just inside yesterday's range. Just above $1.08, the euro is off about 0.25% for the week. It has risen in only one week so far this year, and that was the last week of January. It is carved out a range this week of roughly $1.0780 to $1.0850.  A meaningful low does not seem to be in place. Sterling is also trading inside yesterday's ranges. It has met offers in front of $1.2930, and the intraday technicals warn of downside risk in the North American session. Initial support may be near $1.2880. 


It is not simply that Asia and Europe have been hit by adverse developments, but the US data has generally surprised on the upside. The contrast (divergence) helps explain the dollar's strength, and the Dollar Index is approached 100, which it has not traded above since April 2017. On tap today is the PMI and existing home sales. Two Fed governors (Clarida and Brainard) and two regional presidents (Kaplan and Mester) speak. Canada reports December retail sales, and they are likely too old to have much impact. That said, a small gain is expected at the headline level, dragged down a bit by flagging auto sales.  

The US dollar briefly dipped below CAD1.3215 yesterday to make a new low for the month before reversing higher to reach almost CAD1.3270. It is consolidating in a narrow range down to roughly CAD1.3245. On the week, the Canadian dollar has outperformed the other majors, but the Swiss franc and is down less than 0.1% against the greenback. US dollar gains above the CAD1.3280 area would improve its technical tone. The Mexican peso is extended yesterday's nearly 1.5% decline. The US dollar has poked above MXN19.00 for after traded near MXN18.55 yesterday. It has traded above MXN19.00 a few times this year but has not closed above it since the first half of last December. We do not think that the underlying dynamics have changed and that the setback in the peso will offer new opportunities for the carry plays. However, given the increased volatility, participants will likely wait for next week.    


Covid-19 Hits Yen and Korean Won
Thu, 20 Feb 2020 03:54:28 PST

Overview: The increase of Covid-19 cases in South Korea and Japan, coupled with China's changing reverting back to its previous methodology of calculation, dropping clinically-diagnosed cases have again weakened risk appetites and sent the dollar broadly higher. Fears of a Japanese recession are sapping the yen's role as a safe haven, and this helps explain why Japanese equities did react as positively to the weaker yen than is often the case. Small gains were recorded in Japanese and Australian equities, while the Shanghai Composite rose 1.8% and the Shenzhen Composite rallied a little more than 2%. However, most bourses were lower. Europe's Dow Jones Stoxx 600 has been alternating between gains and losses for the past five sessions. As yesterday saw an advance, today's seeing losses to extend the sawtooth pattern into a sixth session. Consumer discretionary and information service sectors are the biggest drags (~0.5%), while industrials (~0.6%) and healthcare (0.2%) are the strongest sectors. US shares are paring yesterday's gains after yesterday's gap higher to new record highs in the NASDAQ and the S&P 500. Benchmark bond yields are narrowly mixed in Europe, leaving the 10-year German Bund near minus 42 bp to approach a three-month low. The US 10-year yield is hovering around 1.55%. The dollar's gains have accelerated, and only the Swiss franc among the majors is resisting. The JP Morgan Emerging Market Currency Index is off for its fourth consecutive session, the longest losing streak of the year. Gold is consolidating above $1600, and April WTI initially extended yesterday's rally to poke above $54 a barrel for the first time this month, after beginning last week below $50.  

Asia Pacific

The yen dropped like a rock yesterday after Tokyo got the ball rolling. The dollar reached its highest level in nine months near JPY111.60, after finishing in Tokyo near JPY110.25. It is pushed above JPY112 in Europe. The ties to China, exposure to the coronavirus, compounded by Japan's own domestic challenges (e.g., the sales tax increase last October) is bolstering fears that the world's third-largest economy is likely contracting for the second consecutive quarter. In industry news, there are reports that Nissan may have to curb domestic output unless shipments of parts from China resume shortly. South Korea's KOSPI (~-0.6%) and the won (~-1.2%) are among the poorest performers today. Traced to a religious cult, the number of Covid-19 cases in South Korea doubled. In South Korea, 2.5 mln people are being encouraged to stay at home.  

China's Loan Prime Rate, set by survey on the 20th of each month, eased in line with expectations. The one-year rate fell 10 bp to 4.05%, while the 5-year rate slipped five basis points to 4.75%. Indonesia also delivered the anticipated 25 bp rate cut of its key seven-day reverse repo rate to 4.75%. Elsewhere, Taiwan's January export orders tumbled 12.8%, nearly twice the decline economists forecast. In December, export orders rose by 0.9%.  

The Australian dollar was sold to new 10-year lows following the January employment report, but we suspect that it was more about the broader developments that the jobs data itself. The unemployment rate did tick up to 5.3% from 5.1% but reflected partly the increase in the participation rate (61.1% vs. 61.0%). Full-time jobs surged by 46.2k. This is the most since last March. It contrasts with the 12-month moving average that is closer to 12k. Part-time positions fell by nearly 33k. Perhaps the most troubling part of the report was the 0.4% decline in hours worked. The takeaway is that the market boosted the likelihood of a rate cut around the middle of the year.   

The PBOC set the dollar's reference rate above CNY7.0 for the second consecutive session, and the dollar rose to a marginal new high for the year (~CNY7.0260). The offshore yuan is weaker. Against it, the dollar briefly traded above CNH7.04. The PBOC does not appear to be engineering the yuan's decline. The dollar is approaching last year's high against the yen set in May near JPY112.40. The yen is such a creature of range-trading that when it is trending, it is often moving from one range to another. The new range may be JPY110-JPY115. However, the approaching fiscal year-end may make it difficult to establish the boundaries of the range, which often have to be discovered. The combination of risk-off, contagion, economic disruption fears, and some disappointment with the employment report sent the Australian dollar to new decade-lows (~$0.6620). There does not appear to be meaningful nearby chart support, and the downside momentum appears strong.  


The UK's economic data have improved since the election, and today's January retail sales gains were consistent with this generalization. January retail sales rose by 0.9%, which was a little more than expected, and the December decline was revised to -0.5% from -0.6%. Excluding auto fuel, retail sales jumped 1.6%, twice the gain expected by the median forecast in the Bloomberg survey. The previous speculation of a rate cut has been pared. The implied yield of the December 2020 short-sterling futures contract has risen from less than 50 bp late January to about 63 bp today.  

The EU-27 showed an impressive united front last year in negotiations of the withdrawal agreement with the UK. However, it is finding it more difficult to agree on a negotiating mandate for this year's trade talks. The UK is insisting on an agreement with year, no delays. Many observers were skeptical a deal could be reached in such a short period, and now there are nearly two months less. Today's EU leaders will continue to debate the seven-year budget.  

The EMU reports the preliminary February PMI. We suggest there are asymmetrical risks. The market is more likely to respond to disappointing data than it is to an upside surprise. The sharp contraction of industrial production figures at the end of last year has undermined previous survey data that should a recovery was gaining traction.  

The euro broke below $1.08 for the first time since 2017 yesterday and is straddling the area today. However, the push above $1.08 in early European turnover was greeted with new sales. The near-term technical potential extends to the old gap from the April 2017 French elections near $1.0740. The favorable retail sales report has done little to support sterling. The British pound has held just above this year's low set on February 10, near $1.2870. Below there support is seen around $1.28.  


Investors were buying the dip even before the US reported considerably stronger than expected housing starts and permits  (highest permits since 2007) for January and a dramatic 0.5% rise in the headline and core PPI, the highest since October 2018. This dip-buying prior to the data was manifest in the S&P and NASDAQ gapping higher to new record levels yesterday. The gains will be pared in the early going today, though buying on dip strategies continues to be rewarded.     

There are several economic reports today but are unlikely to be as supportive as yesterday's data. The Philadelphia Fed survey is the second Fed survey for February. Recall the Empire State manufacturing survey jumped to 12.9 from 4.8. The Philly Fed is expected to have softened to 11 from 17. The weekly jobless claims, which cover the survey week for the February non-farm payrolls, are expected to have edged a little higher. However, the four-week average is likely to fall. The US also reports January leading economic indicators. It fell last August through October before popping up in November, only to fall anew in December. The rule of thumb has been three negative readings are a recession signal. The US economy began the new year on a strong note, and this is expected to be reflected in a 0.4% rise in the LEI, which would be the most since last July.  

President Trump, who has often complained about the dollar's strength, has been quiet in the face of its recent push higher. Some jawboning ought not to be surprising, though its direct effect may be limited. The market seems to agree with the US President that the Fed ought to be cutting interest rates. Fed officials have given little sign that this is under consideration, but the market is discounting about 35 bp of easing, and the 2-10-year yield curve is flattening. At about 13.5 bp, it is the least steep in roughly four months. The 10-year yield is slipping below the three-month bill rate. 

The Canadian and Mexican economic calendars are light today, and both currencies are under some pressure. The US dollar initially approached CAD1.32 in Asia, to set a new low for the month, but as risk appetites were sapped, the greenback rebounded smartly to trade through yesterday's highs (~CAD1.3260). An outside day is the making before the domestic markets open. The close is important, and a close above CAD1.3260 would strengthen the greenback's technical tone. We had identified the Canadian dollar as the strongest from a technical perspective last week. Today's losses offset the earlier gains, but with around a 0.2% decline for the week, the Canadian dollar is the best performing major behind the greenback. The US dollar traded at new highs for the week against the Mexican peso near MXN18.67. Nearby resistance is seen a little above MXN18.68. Speculative positions are near-record highs, and some carry plays (e.g., short yen long peso or short euro and long pesos) may have more staying power than those using the US dollar. A spike toward MXN18.80-MXN18.85 may see new peso buying emerge.  


Investors' Confidence Snaps Back
Wed, 19 Feb 2020 06:15:08 PST
Overview: After shunning risk yesterday, investors re-entered the fray today, and the animal spirits returned. The MSCI Asia Pacific Index snapped a four-day slide, and China's markets were among the few losers in the region today. Europe's Dow Jones Stoxx 600 recovered yesterday's losses in full and is again at record highs. US shares are also trading firmer and are poised to recoup yesterday's decline. Benchmark bond yields are narrowly mixed today with the European periphery outperforming, as one would expect in a risk-on mood. The US 10-year yield is near 1.54%. In the foreign exchange market, the dollar is a little heavier against most of the major currencies but the yen and Swiss franc. Emerging market currencies are mostly higher, and the JP Morgan Emerging Markets Currency Index gaining for the first time this week. Gold soared yesterday ($20.5), and it is pushing higher today to its best level since 2013, which seems somewhat incongruous with the risk-on sentiment. Oil prices recovered from early weakness yesterday and are building on those gains to help the April WTI contract reach new highs for February near $52.90.  

Asia Pacific

As reports continue to track a slowing of the rise of new infections of Covid-19,  the re-opening of the Chinese economy is being closely scrutinized. Given that the Lunar New Year usually disrupts activity for about a week, some observers think that the virus has meant a tripling or quadrupling of the shutdown. Indeed, varying by industry and province, estimates suggest the country is operating at 25%-40%. This may understate the disruption as reports indicate that small and medium-sized businesses' ability to pay workers who do return has been severely compromised. There is more talk that the Chinese economy will contract here in Q1. 

The first time in about two months, the PBOC set the dollar's reference rate above CNY7.0.  The CNY7.0012 fix was a little above where the bank model's projected (~CNY6.9988). However, the greenback's gains were pared, and it finished the mainland session near CNY6.99, which is about 0.1% lower than it settled yesterday.   

China's airlines have been struck hard as both cargoes and passengers have been dramatically reduced. Reports indicate the government is considering injecting cash into the companies and/or promoting consolidation. This is one example of how the virus may change the structure of the Chinese economy. Separately, the government is waiving or cutting social security obligations for firms in the coming months. Small and medium businesses will get a complete waiver for February through June, and large companies are given a 50% reduction until April.  

Japanese January trade figures showed improvement from December. Exports fell 2.6% year-over-year after a 6.3% decline in December. Economists had forecast a 7% fall. Imports did not improve as much as expected. After declining by 4.9% in December, imports were forecast to fall by only 1.8% in January but instead contracted by 3.6%. The result was a wider seasonally-adjusted deficit (JPY224 bln vs. JPY107 bln).  

The dollar is pushing above JPY110 and to challenge last month's high near JPY110.30. There are options that expire today and tomorrow at JPY110 ($1.1 bln and $2.5 bln, respectively). The push above there appears to be acting as if stops were triggered. A 4.5-year trendline comes in near JPY111, which may offer the near-term technical target. The Australian dollar is trading inside yesterday's range (~$0.6675-$0.6715). It is hovering around $0.6700, where an A$2.4 bln option will expire today. There is an A$1.8 bln option expiring there tomorrow too. A move above $0.6750 may be needed to stabilize the technical tone, but it does not look likely today.    


UK January CPI was firmer than expected.  Coupled with ideas that the budget (still to be delivered on March 11) and the resilience of the labor market (though not wages) have reduced the likelihood of a BOE rate cut in the coming months. Remember, Carney, steps down next month. The preferred CPIH, which includes owner-occupied housing costs, rose to 1.8% from 1.4% at the end of 2019. Much of this is due to the base effect. Consider that CPI itself fell 0.3% on the month, but the year-over-pace increased to 1.8% from 1.3%. The core rate edged up to 1.6% from 1.4%. All these readings were slightly higher than expected. Tomorrow the UK reports January retail sales figures and recovery from December's declines are forecast.  

The EU is trying to reach an agreement on its new seven-year budget, and a decision is hoped for tomorrow. A handful of northern EU countries want to cap it at 1% of gross national income, while the EC has recommended 1.1%, and most countries favor 1.3%. The main economic report of the week is Friday's flash PMI readings. Sentiment readings had generally been improving, but the significant drop in the December industrial production figures may mean that investors will need something more tangible. That suggests the risk of an asymmetrical response--where investors react more to a disappointing report and than one that is better than expected.  

Turkey's central bank delivered its sixth rate cut in the sequence. The 50 bp move (to 10.75%) brings the rate cuts to 13.25%. President Erodgan has consistently called for single-digit rates. The challenge comes from inflation. It is rising. Headline CPI stood at 12.15% in January. It has steadily increased since reaching 8.55% in October. Negative real rates threatened to fuel inflation and a weaker currency. The lira sold off on the news, with the dollar reaching almost TRY6.08. It finished last month near TRY5.96. The lira is off about 2.0% this year, after losing 11% last year.  

The euro is in less than a 10-tick range on either size of $1.08. Watch the 5-day moving average (~$1.0820). The euro has not closed above it since February 3. On the downside, the focus remains the lower end of the gap created by the first round of French election results in 2017, near $1.0740. Today there is an expiring option at $1.0785 for 1.2 bln euros that might be in play. North American participants seem to be more euro-bearish than Europeans judging from recent price patterns. For the fourth consecutive session, sterling is recording lower highs. It has not been able to push above $1.3025 today and is struggling to maintain a toehold above $1.30. A break of $1.2950 likely signals a retest on last week's low near  $1.2870. 


China's Xi seems to understand what some US officials are still in denial about. Tariffs are paid by importers. China announced it will allow importers to apply for exemptions for nearly 700 types of goods from the duties imposed on the US. The products include farm and energy products (e.g., soy, beef, pork, LNG, and oil) and some medical equipment. The exemptions will be effective for a year. These go beyond the halving of some duties at the end of last week that was in line with the Phase 1 agreement. China has also lifted its ban on importing live poultry from the US. A ban had been in place since the Avian flu (2015). After culling its swine herd last year, millions of chickens are being killed. The lack of food shipments is the main problem, leading to an estimated loss of 1% of the 9.3 bln grown chickens expected.  

Meanwhile, the US looks for new ways to limit disengage from China. New restrictions contemplated on Huawei, for example, seemed to have as great, if not greater, impact yesterday than Apple's warning. The US also announced that five Chinese news agencies were so closely tied to the government that going forward, they will have to operate under the rules that apply to embassies and consulates. Separately, President Trump pushed back against hardliners in the administration, seeking to block the sale of plane engines from a GE-Safran joint venture for single-aisle planes. Trump specifically cited not wanting to overuse the national security "excuse." He was quoted on the newswires: "I mean, things are put on my desk that have nothing to do with national security, including with chipmakers and various others. I've been very tough on Huawei. But that doesn't mean we have to be tough on everybody that does something."

The US reports January housing starts and permits. There is expected to be pay-back from the nearly 17% increase in December housing starts. Permits, which fell in December, are likely to have bounced back. January headline and core producer prices are expected to have firmed. Late in the session, the FOMC minutes from last month's meeting will be published. Despite official reassurances that the economy is in a "good place," the market continues to discount not just one rate cut but is roughly halfway toward pricing in a second one this year. Five Fed officials are also speaking today. Canada reports January CPI figures today. Firm inflation is one of the considerations discouraging the Bank of Canada from cutting rates. No relief is likely with today's report. The derivatives market anticipates a cut in Q3.  

From a technical perspective, the Canadian dollar looks poised to recover after testing the lower end of a six-month trading range. Today, the US dollar has given back yesterday's gains, leaving the greenback poised to test the 200-day moving average near CAD1.3215. Below there, initial support is seen near CAD1.3185. The Mexican peso remains resilient. Yesterday's dip was bought. The dollar is roughly in the middle of the MXN18.52-MXN18.66 range seen in the last couple of sessions. The high real and nominal rates continue to attract carry strategies.  


Apple's Warning Weighs on Sentiment
Tue, 18 Feb 2020 03:30:06 PST
Overview: Apple's warning that it will miss Q1 revenue due to the knock-on effects of the coronavirus seemed to be a modest wake-up call to investors, who, judging from the equity market, were looking beyond. Equities have fallen, and bonds have rallied. Japan, Hong Kong, and South Korean stocks fell by more than 1%, and only China and Indonesia were able to post gains. The MSCI Asia Pacific Index fell for the fourth consecutive session. Led by information technology, materials, and energy, the Dow Jones Stoxx 600 is giving back yesterday's gains and a little more. The S&P 500 is off by around 0.3% in electronic trading. Benchmark 10-year bond yields are mostly 2-4 bp lower, though Korean bond yields tumbled 10 bp (to ~1.53%) as President Moon called for emergency measures, which renewed speculation of lower rates by the central bank. The US 10-year yield is near 1.54% and is approaching the recent low of 1.50%. The US dollar is firmer across major and emerging market currencies, though, as one might suspect, the yen and Swiss franc are holding in best. Sterling joined the advancers after its employment report. Gold is up about 0.5% (~$1589), a little more than $3 from the month's high. April WTI initially opened above last Friday's high (after yesterday's holiday) and has proceeded to sell-off through last Friday's lows. A break below $50.80 would undermine the technical outlook.  

Asia Pacific

Japan's 5-year bond auction was 4.4-times oversubscribed, a little higher than last month's reception. Reports continue to point to strong foreign demand. The demand for Japanese government bonds, though, is not the same as the demand for yen. Dollar-based investors, for example, can buy JGBs and hedge the yen back into dollars and thereby earn a yield that is comparable and often better than US Treasuries. Japanese investors appear to like long-dated JGBs, which may be cheap relative to swaps or currency-hedged European bonds.  

The minutes from the February 4 meeting of the Reserve Bank of Australia did reveal anything new to investors. The coronavirus represents a near-term material risk to the economy. It reviewed the case for a rate cut after three cuts last year. It judged that the risk of spurring more leveraging and house price increases offset the marginal benefits. The central bank's framing of the issue offers important insight to businesses and investors. Between the adverse shocks from the wildfires and the coronavirus, the market expected the trade-offs to shift toward the middle of the year and allow for the RBA to cut the cash rate to 50 bp. 

Some estimates suggest that China is operating at around half of what it was before the Lunar New Year. However, other reports, looking at transportation data, see this month's traffic at around 15% of the level seen last year. The arrivals to Hong Kong in February have collapsed to about 3k a day, a drop of 99%, according to reports.   

The Australian dollar fell every week since the start of the year until last week when it rose by 0.6%. The push below $0.6700 likely signals a return to the multi-year low set on February 10, near $0.6660. Below there is not much technical support until closer to $0.6300 from 2009. Note that tomorrow and Thursday, there are large options (A$1.5 bln and A$1.6 bln, respectively) at $0.6700 that will roll-off. The dollar continues to trade within last Thursday's range (~JPY109.60-JPY110.10). Although there are no significant options expiring today, tomorrow and Thursday, see large expirations of the JPY110 strike ($1.1 bln and $2.4 bln, respectively). If that helps block the dollar's upside, a break of JPY109.50 could signal a test on JPY109.00. The dollar rose by about 0.35% against the Chinese yuan to resurface above CNY7.0 and reached its highest level (~CNY7.0070 since February 4).   


The UK employment data was somewhat better than expected but could not lift the pall that hangs over sterling as harsh rhetoric by UK negotiator Frost keeps the risk of a no-deal exit from the standstill agreement at the end of the year, at elevated levels. Despite the uncertainty headed into the end of last year, the UK economy created 180k jobs in the final three months of 2019, which is about 20% more than economists forecast. However, average weekly earnings, including bonuses, slowed to 2.9% in Q4 19, the slowest since August 2018. Of note, the number of EU nationals working in the UK rose by 36k in Q4 from a year ago. 

Germany sentiment readings had appeared to be improving, but the dramatic fall in both factory orders and industrial output seems to have sapped it. The ZEW February survey was dismal. The assessment of the current situation unwound half of January's gain to fall to -15.7 from -9.5. It has been negative since last June. The expectations component had risen to 26.7 in January, climbing from -44.1 last August. It slumped back to 8.7 in February, a three-month low.  

The euro is holding yesterday's low near $1.0820, but the pressure remains strong. A break of $1.08 targets about $1.0740, the bottom of an old gap from April 2017 French elections. Resistance is now pegged in the $1.0840-$1.0860 area. Sterling is trading in a little more than a 30-tick range on both sides of $1.30. It has stalled near $1.3070 in recent sessions. Some demand for sterling is evident from the cross against the euro. The euro has reversed lower from GBP0.8350 and looks poised to fall below GBP0.8300 and test last year's low (December) near GBP0.8275.  


Apple reported that production is resuming at a slower than anticipated pace. Some estimates suggest only around 40%-50% of business activity had resumed by last weekend. Apple had previously planned on factories re-opening on February 10.  Non-Chinese sales, reportedly, are in line with previous forecasts.

The US is not letting the Phase One of the trade deal to end its efforts to stymie China's economic efforts. Reports suggest two new fronts in what we (and some others) have argued is a new Cold War. First, the US is considering blocking jet engines from the GE-Safran joint venture. Second, the US may move to close a loophole that allows sales of chips to Huawei made overseas by bringing the threshold to 10% made in the US, down from 25%. 

The US reports the February Empire State survey. Of the high-frequency data, it is among the first insights into a new month's activity. It is expected to have edged up to about 5, which would be the highest reading since last May. The Treasury's International Capital report (for December) is released after the close. However, it is notable through November, there were an average net sales of about $2 bln of US stocks and bonds. In the same period in 2018, the average was new purchases of $75 bln of US paper, and in 2017, the average of the first 11 months was almost $54 bln. At the same time, the US budget and current account deficits have grown.   

Canada and Mexico have light diaries today. Canada reports January CPI figures tomorrow.  Mexico's Finance Minister Herrera opined that the central bank has scope for additional rate cuts and noted that the IMF's director of the Western Hemisphere also argued along similar lines. Banxico has cut rates 125 bp through last week, and most economists expected another 50-75 bp in cuts this year.  

The risk-off mood has lifted the US dollar against the Canadian dollar after approaching the 200-day moving average yesterday (~CAD1.3220). Initial resistance is pegged near CAD1.3275, which corresponds to about a 50% retracement of the recent decline. The Mexican peso rose to fresh 18-month highs against the US dollar (~MXN18.5240) but could not sustain the gains and has backed off a bit. The greenback is testing the MXN18.64 area as North American dealers prepare to return to their stations. There is near-term technical potential toward  MXN18.67-MXN18.72.  

Dismal Q4 Japanese GDP Fails to Spur Yen Movement
Mon, 17 Feb 2020 07:06:35 PST
Overview: It is only a US holiday today, but the global capital markets are subdued. In the Asia-Pacific region, equities traded lower with China and Hong Kong, the main advancers. The MSCI Asia Pacific Index has fallen in only two weeks since the end of last November, and that was during the last two weeks of January. Europe's Dow Jones Stoxx 600 slipped in the previous two sessions but is recouping the losses fully today. It is being led by consumers, energy, and financials. US shares are firm in European turnover. Outside of a four basis point increase in China's 10-year benchmark, yields are little changed. In Europe, yields are within a basis point of where they ended last week. The dollar is a little softer against most of the majors. The yen, sterling, and Norwegian krone are slightly lower. Among emerging market currencies, Eastern and Central European currencies, which underperformed last week on firm alongside, Singapore, China, and South Africa.  Gold is paring the gains scored in the previous couple of sessions and is off around $3.  April WTI is steady.  

Asia Pacific

The coronavirus (Covid-19) contagion rates appear to be decelerating but have not turned down. The focus of observers seems to be shifting toward the number of severe or critical cases, which is running near 20%. China and  Hong Kong have already started fiscal initiatives, and after revising down growth forecasts, Singapore is not far behind. The Philippines, Thailand, and Malaysia have cut rates. Indonesia is expected to reduce rates later this week. China cuts its Medium-Term Lending Rate (MLF) by 10 bp today (to 3.15%). When the new benchmark, the one-year Loan Prime Rate, is set on February 20 (4.15%), it is expected to fall by at least 10 bp (though the risk is of a greater decline). That said, investors need to take claims of the PBOC's large injections of liquidity with a proverbial grain of sand. It did increase CNY200 bln at the new MLF rate and another CNY100 bln via a seven-day reverse repo. However, there was CNY1 trillion maturing today.  Net-net, the PBOC allowed draining of liquidity. India did not cut rates last month, reduced reserve requirements for certain types of loans, and announced a new loan facility similar to the ECB's long-term refinancing operations.

Japan's Q4 GDP preliminary Q4 GDP estimate was horrible. The median forecast in the Bloomberg survey anticipated a 3.8% annualized contraction, but instead, economic activity fell 6.3%. This reflects a 1.6% quarterly contraction rather than the 1% economist expected. Despite the tax hike in October being smaller than the 2014 increase and a number of measures by the government to cushion the blow, the economy contracted by nearly as much as it did then (7%). Private consumption plunged 11% in Q4 compared with 18% after the previous sales tax increase. Business investment fell by 3.7%, more than twice the projection. Although exports fell, imports fell by more, allowing trade to make a positive contribution. Of course, the economy suffered a blow not just from the tax increase but from a couple of typhoons today. Investors are looking past Q4 19, and there is concern that the coronavirus may spur another quarterly contraction, with tourism and trade being hit.  

Before the weekend, the dollar was confined to about a 20-tick range against the Japanese yen. Thus far today, the range is even narrower (JPY109.72-JPY109.88).Last week's range was about JPY10955-JPY110.15, which might limit the price action in the coming days. The Australian dollar spent most of last week between $0.6700 and $0.6750. The technical indicators seem to favor the upside, and a close above $0.6750 may be among the first signs the next leg up has begun. The dollar advanced against the yuan in the last three sessions, but the gains were shaved today. A weaker yuan is consistent with the more accommodative fiscal and monetary stance.  


A US energy official claimed that the Nord Stream 2 pipeline that would ship Russian gas to Germany under the Black Sea to bypass Ukraine has been thwarted. Whether this is true or aspiration has yet to be proven. US sanctions in December forced a Swiss underwater pipe-laying business to withdraw from the project. However, reports suggest that Russia's Gazprom's own pipe laying vessel may step-in to the vacuum. Several companies have invested nearly 6 bln euros as of a year ago in the project. In a different context, to be sure, Mexico's President has still not recovered his credibility among investors since canceling a nearly $14 bln airport project that was a third completed.

Investors continue to wrestle with the implications of the resignation of Javid and the appointment of Sunak as Chancellor of the Exchequer. The  Conservatives campaigned on fiscal austerity (reduce debt, keep net public investment below 3% of GDP, and run a balanced current budget). However, even before Javid resigned, the fiscal rules were being relaxed, and now the speculation is that a more expansionary budget will be delivered next month.  

The euro initially extended its recent losses in early Asia to almost $1.0820, but in quiet turnover has edged higher toward $1.0850. The high from the end of last week was near $1.0860. It has not settled above $1.09 since last Tuesday. Although the $1.08 level may hold in the near-term, a break of could quickly see another half-cent drop Sterling is trading mostly in a quarter-cent range below $1.3050. Last week's high was about $1.3070. Support is seen in the $1.2980-$1.3000 area.  


At the weekend Munich Security Conference, a high-profile annual gathering, both US Secretary of State Pompeo and House Speaker Pelosi took a hard-line against China. They argued strongly against allowing Huawei, against which the US filed racketeering charges last week, to build out the 5G network. At the same time, the US is stepping up its efforts to defeat a Chinese national's bid to become the head of the World Intellectual Property Organization in next month's election. Despite the heated rhetoric, especially about domestic issues, there appears to be a broad bipartisan consensus in the US to make a greater effort to counter China's ambitions in the multilateral agencies. Nevertheless, the US unilateralist approach undermines its ability. The US belatedly and without coordination, tried to block China's push to head the Food and Agriculture Organization. It resulted in sapping support from the French candidate, allowing the Chinese candidate to win.

France's Alstom reportedly has struck a deal to acquire Canada's Bombardier's train business for more than $7 bln. The potential acquisition was first reported around three weeks ago. Some participants try to take a view on the foreign exchange market based on M&A deals. There is good reason to be skeptical. First, the acquirers often protect their international bid by taking out options, which may best address contingent risk. Second, the average daily turnover of the euro, according to last year's BIS survey, was near $2.2 trillion, and the Canadian dollar was about $330 bln. Its impact would quickly evaporate. Third, companies often consider borrowing the needed foreign currency rather than buying it and thereby neutralizing the foreign exchange exposure. That said, the technical indicators do seem to favor the Canadian dollar, which had weakened to the lower end of a six-month range.

Indeed, the Canadian dollar among the strongest currencies in what has been a relatively quiet foreign exchange session in Asia and Europe. The US dollar has been sold through the shelf formed in the second half of last week (CAD1.3235-CAD1.3240) to test the 20- and 200-day moving averages (~CAD1.3220). A break of CAD1.3185 would lend credence to the bullish technical case for the Canadian dollar. The peso is paring last week's rally. It gained in every session last week, including after the central bank cut rate by 25 bp. The peso was bought in late Asia today and initially extended last week's gains (~MXN18.5235), but some light selling pressure in Europe brought it back to MXN18.58. Although the intraday technical indicators suggest that the dollar's bounce may be nearly over, the risk may extend toward MXN18.62. The Dollar Index is in a narrow range of about 10-ticks (99.05-99.15) to trade within the pre-weekend range. Sentiment is constructive, but the technical readings are stretched.  

Strong Dollar Optics, Less Clear-Cut Details
Sun, 16 Feb 2020 05:31:13 PST

The dollar's performance last week is best understood as the fulcrum of the seesaw.  The major currencies that are perceived to be levered or growth and/or risk rose.  These are the dollar-bloc and the Scandis. The Swedish krona sold off before the weekend, perhaps as the market anticipates a weak CPI report that may reinforce ideas that the rate hike at the end of last year was not the start of a tightening sequence. 

Sterling actually led the advancers with a 1.2 gain.  It was firm all week but was bid higher on speculation that the new Chancellor of the Exchequer, often seen as the second most important person in the UK government, will support a more expansionary fiscal policy. It would, arguably, boost growth prospects take pressure off the Bank of England.

The euro, yen, and Swiss franc, and along with the Swedish krona, were on the other side of the teeter-totter.  The euro was the weakest of the majors, losing a little more than 1% on its way to its lowest level since April 2017.   The euro lost twice as much as the Swiss franc, so the cross fell to its lowest level since July 2015. 

Among emerging market currencies, eastern and central European currencies underperformed, while the Mexico peso edged out sterling to be the best performer last week.  The peso rose every session last week, unperturbed by the quarter-point rate cut.  Year-to-date, the peso is the strongest currency in the world, rising by a pinch more than 2% so far.  The JP Morgan Emerging Markets Currency Index snapped a four-week slide with an almost 0.3% gain. 

The two strongest technical indications are for a higher Canadian dollar and a continued recovery in oil prices.  Dips in the Mexican peso will likely see be seen as a buying opportunity for asset managers and hedge funds.  Recognizing that China heavily manages its currency, even if not by direct intervention, the political and economic considerations favor modest weakening fo the yuan.  

Dollar Index:  Two weeks into this month, and the Dollar Index has fallen once.  It sits at a four-month high near 99.15.  The MACD is getting stretched but moving higher.  The Slow Stochastic has begun leveling out.  It continues to hug the upper Bollinger Band.  The next immediate target is near 99.25 and then 99.65, last year's high.  There is also the psychological attraction of the 100-level.  The Dollar Index would have to fall through the 98.50 area to signal this leg is over.   Remember that the Dollar Index is not really a valid trade-weighted basket and instead is heavily weighted toward the euro, which has underperformed. 

Euro:  The euro fell out of bed in the first half of February.  It rose once above the previous session's high (February 13) by one-hundredth of a cent. It closed January a little below $1.11 and approached $1.0825 ahead of the weekend. The strength of the downside momentum is illustrated by the fact that it has closed underneath its lower Bollinger Band for the past three sessions.  There is an old gap on the daily and weekly bar charts from the 2017 French elections (first round)  that is found roughly between $1.0740 and $1.0820.  The MACD is stretched but trending lower, while the Slow Stochastic appears to be trying to bottom.  The $1.0900-$1.0925 area marks the nearby ceiling. 

Japanese Yen:  Last week's range (~JPY109.55-JPY110.15) was the narrowest weekly range this year.  The greenback is consolidating.  After rising in the first three sessions last week, it slipped in the previous two to finish a little higher for the second consecutive week.  The MACD and Slow Stochastic are tentatively rolling over though not from extended territory.  Initial support for the dollar is seen near the JPY109.45-JPY109.50 area that houses a (38.2%) retracement of the month's gain and the 20-day moving average.  Below there support is pegged in the JPY109.00-JPY109.20 band. 

British Pound:  The increased possibility of a stimulative budget helped sterling recover back above $1.30 for the first time in five sessions on February 13, spurred by the naming of a new Chancellor of the Exchequer.  Sterling rose in every session last week, something it has not done since April 2018.  The MACD and Slow Stochastic look to be turning higher. A move above the $1.3085-$1.3100 area opens the door to retest the month's high near $1.3215, provided the $1.30-level holds.  The euro lost 2.25% against sterling last week to trade below GBP0.8300 and is approaching last year's low (mid-December) near GBP0.8275. While the technical indicators suggest there is scope for additional near-term losses, it has closed below the lower Bollinger Band for the past two sessions (~GBP0.8325). 

Canadian Dollar:  The US dollar began the week rising to new four-month highs near CAD1.3330. It fell about 0.5% in the next two sessions before consolidating in the last two.  The greenback snapped a four-week advance by slipping about 0.4% against the Loonie.  The 3.4% rally in oil prices and the nearly 1.7% advance of the CRB Index last week (the first weekly advance this year) coupled with the risk appetite reflected in rising equities seemed to help fuel the Canadian dollar's recovery.  This is consistent with our reading of the charts.  The technical studies suggest the greenback's pullback has just begun.  Initial support has been encountered near CAD1.3235, and below there, in the CAD1.3215-CAD1.3220 area, the 20- and 200-day moving averages are found as is the (38.2%) retracement of the rally since January 22 low (~CAD1.3035).   A break of these supports will boost our confidence that the US dollar may return toward CAD1.3100-CAD1.3150. 

Australian Dollar:   The Aussie extended its recent losses to see its lowest level in a decade (~$0.6660) at the start of last week before bouncing to $0.6750 in the middle of the week.  It spent the previous two sessions consolidating at lower levels.  A break of the $0.6680-$0.6700 area now would suggest a durable low is not in place.  The low from the Great Financial Crisis was near $0.6000, and a secondary low was near $0.6250.  Still, the MACD and Slow Stochastic are turning higher, and the latter did not even confirm last week's new low.   A close above the 20-day moving average (~$0.6755 to start the new week), something not done since January 6 would lend support to those thinking the Aussie may be bottoming.

Mexican Peso:  The dollar has not bottomed against the peso.  Our MXN18,50 target is being approached.  A convincing break leaves the greenback with little support until the MXN18.00 area.  The MACD and Slow Stochastic are not generating strong signals but also have not confirmed last week's lows.  Note that speculators in the futures market have taken some profits recently.  The net long position, which reached a record at the end of January, has fallen for the past two weeks (through February 11).  Gross longs have fallen for three weeks.  Even after Banxico's 25 bp rate, Mexico's high real and nominal interest rates attract asset managers and levered accounts (some of whom use the yen, Swiss franc, and perhaps, more recently, the euro to fund the peso position). 

Chinese Yuan: Since returning from the extended Lunar New Year holiday, Chinese officials have accepted roughly a CNY6.95-CNY7.0260 range for the dollar.   The logic of the situation, i.e., a negative economic shock, easier monetary policy, and a push not to miss economic growth targets seems most consistent with a weaker yuan.  A move toward CNY7.05 would be unlikely to raise the American's ire.  

Gold: The price of the yellow metal rose by about $14.5 last week (~0.9%) after falling $18.7 (~1.2%) the prior week.  The MACD is trying to turn-up from a decline that began last month around the escalation of US-Iran hostilities. The Slow Stochastic is curling up.  Gold found support around $1550 after spiking to a little above $1611 in January. The month's high near $1592 is the next hurdle for gold, which finished last week at $1584. 

Oil:    The April light sweet crude oil futures contract ended a five-week 20% plunge with a 3.5% bounce.  The contract appears to have put in a double bottom (~$49.50-$49.60), and the neckline is about $52.35.  The high before the weekend was roughly $52.55, but the close was a few cents below the neckline.  The measuring objective of the double bottom is around $55.50, which corresponds with the 200-day moving average (~$55.70) and the (38.2%) retracement objective of the decline from last month's spike (~$65.00).  The MACD and Slow Stochastic have turned higher.  

US Rates:  The US 10-year yield is consolidating and was virtually unchanged last week, a little below 1.60%.  It was confined to roughly a 10-tick range of 1.54%-1.64%.  The technical indicators of the March note futures contract favors lower yields (higher prices).  A move above 131-08 in the futures contract warns of a retest of the highs seen at the start of the month (~132-00, around where it peaked last October too).  In yield terms, that means a return to 1.50%.  Even after Powell's testimony before Congress and a number of other Fed officials noting how well the economy is doing, the market continues to price in more than one rate cut this year.  The implied yield of the December fed funds futures contract is 1.25% compared with the average effective rate of 1.58-1.59%.  

S&P 500:  A small gap still exists after the S&P 500 gapped higher on February 11.  The gap is only pennies (3352.26-3352.72) but seems indicative of the strength of the market.  Of the past 19 weeks, the S&P 500 has fallen in four, and three were last month.  The MACD has been trending higher since early this month, but the Slow Stochastic is flattening near where is has peaked previously.  The 3385 area may need to be surmounted to sustain the recent momentum.  It is interesting to note that the S&P 500 dividend yield is 1.78% at the end of last week.  


Markets are Data-Driven, but which Data?
Sun, 16 Feb 2020 15:13:41 PST
Like a Newtonian law of motion, market participants will continue to rely on a particular trading style or system until it stops working. Betting that volatility stays low is a cash register for many, and there appears to be what Soros called "reflexivity" here, like a self-fulfilling prophecy.  Why is volatility low?  Because it is being sold in various ways besides directly selling options.  Buying equity pullbacks and selling euro bounces, for example, also seem to be expressions of short volatility.

There is little on next week's calendar that threatens to pull the plug on this cash register.  In other circumstances, the eurozone's preliminary February PMI could have potential.  It is to be reported at the end of the week ahead.  The composite had not fallen since last September when it reached 50.1.  In January, it was at 51.3, little above where it finished 2018 (51.1).  However, one of the most important reasons market participants pay attention to sentiment data, of which this purchasing manager survey is an example, is that it ought to shed light on real sector developments.

Yet the market was shocked by the magnitude of the decline in the December industrial figures.  The December manufacturing PMI for EMU eased to 46.3 from 46.6, having bottomed in September at 45.7.  The 2.1% decline reported last week was tipped by the national figures, but the aggregate decline was the largest since February 2016 (-2.2%), which itself was the biggest drop since early 2009.  While the flash PMI may pose headline risk, it is most unlikely to turn the market.

The ECB's course also appears set.  Lagarde has not "cleaned house" as Georgieva has at the IMF, and continues on the path set out by Draghi.   However, her presence has already been evident in the lack of sniping and media leaks. This represents an improvement in communication.  There have been reports in the media claiming a backlash against negative interest rates. Yet, Lagarde has given a spirited defense. Last week so did Germany's Executive Board member, Schnabel, who may be the first in her position to defend it (and vigorously).  The ECB's chief economist Lane also endorsed its efficacy.

China's economic data for January and February was always going to be distorted by the Lunar New Year holiday.  This year, because of the new coronavirus  (Covid-19), the data is, particularly, of little value.  In addition to monitoring the progress of the virus in China, where the cases and mortality are the highest, the setting of the Loan Prime Rate will be an important signal.

Recall the one-year Loan Prime Rate has become the new benchmark, and it is set by a survey of the leading banks.  In this sense, it is a more market-driven metric than previously administered attempts.  It is set on the 20th of every month and currently stands at 4.15%.  The median forecast in the Bloomberg survey looks for a 10 bp cut.  If it is wrong, it is likely because rates have fallen faster.  The PBOC granted banks this week funds that can be re-lent to businesses struggling to cope with the effects of the Covid-19 for 100 bp below the one-year Loan Prime Rate.

The signal from Beijing is to go for growth. Yet, the inclusion of CAT scan diagnosis (rather than the nucleic acid test) saw a jump in confirmed cases, and nearly doubling of fatalities. This raises new questions and prompts an extension of closures and disruptions.  While the initial reaction is this was a one-off adjustment, it is not immediately clear.  There are problems outside of China too, with some observers, for example, seeing that Indonesia's claim of having no cases, is a bit unlikely.  Also, there is concern in some quarters that the incubation period may be longer than initially estimated.

The political consequences are already materializing.  The death of Li Wenliang, a young doctor who was among the first to detect the virus and was harassed by local officials for doing so, and ended up being infected himself, is an unexpected catalyst for change.  It seems clear that public health requires clear and forthright communication, and yet in China (like several other places), this does not exist.  In fact, the lack of open and honest communication costs lives.  It is in this way that this experience is similar to the Soviet Union's Chernobyl tragedy in 1986.  A campaign pushing for open communication has begun on social media.

Another political fallout is the replacement of the Communist Party heads in Hubei and Wuhan.  However, the replacement of the Director of Hong Kong and Macau Affairs suggests that Xi may be using Covid-19 as cover to pursue a broader agenda.  It may not be so dissimilar from using the anti-corruption campaign to also punish rivals and secure greater power.   A common understanding is that there is a social contract between the Chinese people and the Communist Party.  The latter delivers the goods, literally: rising living standards, and the people defer to the Party.  However, the lack of trust that was simmering below the surface is becoming manifest.  This is another window of opportunity for a change, a concession to people, a civil liberty,  but the greater probability is the opposite.  Push hard for a quick resumption of economic activity and repress dissent.

At the start of the week, investors will learn just how bad last year ended for Japan with the first official look at Q4 19 GDP.  The tax hike and typhoons are expected to have led to a 1% quarter-over-quarter contraction and risk is on the downside.  The reason the market will not act much is that the data is historical, and there are no new policy implications.  More important is how the economy is doing in Q1. There are concerns about the disruption of trade due to Covid-19  and the sluggishness of consumption after the sales tax increase. This may translate into an economic contraction here in the first quarter. 

Japan's January trade figures will be released.  The interest lies not in the balance itself but the components.  Exports were off 6.3% year-over-year in December, which of course, was before the public knew about China's new virus.  Recall that in December, Japan's exports of semiconductor fabrication equipment to China jumped by 60%. This is important too because semiconductor chips (design and manufacturing) are seen to be a bottleneck for China. 

Japan reports CPI and the preliminary February PMI.  The composite PMI was at 50.1 in January.  Any decline would fan recession (two quarters of contraction) fears.  While much has been done in the name of the core inflation (excluding fresh food), it tends not to elicit much of a market reaction.  The headline may ease from 0.8% to 0.6%, while the core rate is likely steady at 0.7%. 

The UK reports employment CPI, retail sales, and the flash PMI.  A couple of weeks ago, the market was particularly sensitive to speculation that Bank of England Governor Carney would cut rates at his last meeting.  Not only wasn't it delivered but now the data might not be so important either.  The two dissenters at the BOE have been unable to convince any colleagues to join them, and the new governor is unlikely to start his tenure with a rate cut.  The market is fully pricing in a 25 bp rate cut around the middle of Q3.  Meanwhile, the fiscal rules were already relaxed before Chancellor Javid unexpectedly resigned as a consequence of the cabinet and staff shuffle.  The market anticipates an expansionary budget when it is presented in less than a month.  

Last week, the Reserve Bank of New Zealand flagged that its easing cycle was over, and the markets believed it.  The currency rallied, and yields rose.  The Reserve Bank of Australia and the Bank of Canada are in somewhat different positions.  The Bank of Canada withstood three Fed cuts last year and stuck to its neutrality.  It has since softened its tone, and the January employment data was sufficient to refute any sense of urgency.  The January CPI report, due in the middle of next week, is expected to reinforce this message.   After finishing last year at 2.2% (November and December), it is forecast to rise to 2.4%, which would match last May's pace, which itself was the strongest since the 2.8% rate in August 2018.  The core measures are expected to remain broadly steady 2.0%-2.2%.  

The Reserve Bank of Australia's cautious optimism rests on the labor market, which naturally draws attention to the January employment report.  The market is expecting the RBA will cut the cash rate by 25 bp in June or July.  Australia created an average of almost 22k net new jobs a month last year after nearly 21k a month in 2018.  The median forecast in the Bloomberg survey calls for a 10k increase last month.  Full-time positions grew by an average of 12.7k month in 2019 and 13.5k in 2018.  This may overstate the recent trend.  Full-time jobs fell in Q4 19 for the first time since Q1 18.  If the Australian dollar sells off on a strong report, it would be revealing about psychology and positioning.  It has depreciated by 4.4% so far this year to multiyear lows.  According to the OECD's measure of Purchasing Power Parity, the Aussie is less than 1% undervalued (~$0.6720).

The key to the dollar's outlook and to Fed policy does not hinge on the high-frequency data that will be reported in the week ahead.  The market continues to discount one rate cut fully and is roughly half-way toward factoring a second cut.  The logic is the same as last year.  The PCE deflator measure of inflation, which the Fed targets, is at 1.6%.  The target is 2%.  Officials continue to see mostly international risks and continued weakness in the industrial sector (contraction four of the past five months), indicating that some risks are, in fact, materializing.  The economy, they assure us, is in a good place, but that does not preclude taking further insurance out, possibly in Q2, extending the business cycle further and pushing the envelope of full employment.

Last week's retail sales and industrial production reports for January told investors and policymakers that the new year has begun pretty much the way 2019 ended.  The consumer continues to shop but at a more subdued pace.  It should not be surprising as investors also learned last week that real weekly pay is flat year-over-year even though average hourly pay has increased (higher hourly is offset by working a few hours).  Revolving debt (credit cards) has increased to pick up some of the slack.

The production cuts at Boeing are being felt.  Aerospace and parts output fell 9.4% in January, and without it, manufacturing output may have gained 0.3% instead of contracting by 0.1%.  On the other hand, auto production picked up, and without it, manufacturing output would have fallen by 0.3%.  Manufacturing accounts for around three-quarters of industrial output (which includes mining/drilling and utilities).  The output of utilities also fell in January due to unseasonably warm weather that helped other sectors.  More troubling is the continued decline in capacity utilization.  At 76.8%, it is the lowest in nearly 2.5 years.  The low usage rates are associated with weaker profitability and deter new capital expenditure. 

The Empire State and Philadelphia manufacturing surveys may draw attention because, outside of weekly jobless claims, they will offer the first insight into economic activity in February.  The Fed's term repo will also attract interest.  Despite the last three repos being oversubscribed, the Fed announced it would reduce the amount it would make available, and taper further next month.  The Fed is implicitly assuming that it is the cheapness of the funds it makes available that attracts the strong demand and not a shortage of reserves.  


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