Commentary via Zerohedge
With US markets closed for holiday, it has been a quiet, low-liquidity European session, with Asia similarly subdued, while continued USD weakness, now in its 4th consecutive day, has been the main focus as Bloomberg’s dollar index approached its lowest level in three years, helping push the euro up to its strongest since 2014.
Indeed, in lieu of active equity markets, it's been all about FX and the tumbling dollar and overnight the EURUSD rose to a new three year high just shy of 1.23 before easing off, while cable briefly rose above 1.38 - its highest level since Brexit - and the Mexican Peso was well supported by an unconfirmed Axios reports that was Trump softening his stance on Nafta, at least until Reuters denies it.
The Euro was boosted by growing expectations of tighter monetary policy from ECB, while the chance of a pro-European Union coalition in Germany also boosted confidence in the continent.
“The latest leg up in the euro has clearly come from optimism that the German government is moving towards an agreement for a coalition government,” said Investec economist Victoria Clarke.
The SPD’s pro-European stance - leader Martin Schulz recently argued for a “United States of Europe” - also strengthens the case for investment in the euro.
“This follows an earlier move triggered by the crucial line in the ECB account which has got people thinking about when the first move on rates will happen,” said Clarke.
Euro zone money markets now price in a 70 percent chance of a 10-basis-point rate increase by the ECB by the end of the year, up from 50 percent a week before.
As Bloomberg notes this morning, "the dollar remains under pressure after capping five straight weeks of declines, even against a backdrop of solid U.S. growth. Traders appear to be more excited by potentially hawkish policy shifts from central banks in Europe and Japan, by the improving political outlook in the euro area, and by the synchronized nature of global expansion that’s also propelling emerging-market economies."
The strength in the euro pushed European stocks a touch lower, as exporters were hit by the currency strength. Europe's Stoxx 600 Index was down 0.1%, but still not far from multi-year high hit last week, even after advances in Asian stock markets, as the common currency provided a headwind to the region’s exporter-heavy gauge. The yuan touched a two-year high as the People’s Bank of China raised the currency’s fixing to the strongest since May 2016.
European equity markets have started the week in negative territory, taking a breather after the gains seen since the start of the year with the DAX underperforming due to exposure of currency-sensitive stocks amid a surging EURUSD. The UK construction and management company Carillion was in focus after the company was forced to go into voluntary liquidation as talks to rescue the company failed and trading in their shares was suspended. Serco shares rallied over 3% as markets bet that the company should be able to benefit from the collapse of Carillion, while Carillion supplier Speedy Hire fell over 10%. GKN shares have started the week positively after reports that they are considering spinning off a unit to fend off takeover interest and as Melrose said it’s planning to meet with shareholders following their rejected takeover offer.
Over in Asia, the MSCI Asia Pacific Index increased 0.6% to the highest on record with the largest climb in more than a week, even as Hong Kong’s Hang Seng index posted its first drop after a record 14 days of increases although the benchmark equity index erased a gain of as much as 1% as some of the biggest gainers over the past 12 months tumbled Monday afternoon. The Hang Seng closed down 0.2% after earlier climbing above its record closing high earlier; the index had climbed in the previous 14 sessions, its longest run on record.
Meanwhile, on the mainland, the Shanghai Composite closed 0.5% lower, ending its 11-day gaining streak.
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Asia’s emerging currencies rose amid fund inflows into the region and a weaker dollar. The yuan led the advance after People’s Bank of China boosted the currency fixing to the highest since May 2016. Government bonds were mixed. Strong U.S. stock market will give a tailwind to Asian equity flows, “which should be positive for the regional currency markets,” said Stephen Innes, head of trading for Asia Pacific at Oanda Corp. A soft U.S. dollar and a stronger Chinese yuan fix bode well for the regional currency sentiment, he said.
So, as noted above, the USD has started the week where it left off: lower. USD/JPY bore the brunt of the weakness, dropping below 111.00 before finding support ahead of 110.50. BoJ Governor Kuroda spoke overnight and although he mentioned that QQE with YCC will continue for as long as necessary; the BoJ Governor also offered a positive view on his nation’s economy and inflation on Monday.
The weaker USD has benefitted precious metals with gold higher and palladium now trading at a record high. Base metals also gained with LME copper up over 2% on the LME and zinc up to a 10-year high. WTI and Brent crude futures are both a touch lower as Brent failed to make a clean break above USD 70/bbl. Volumes are expected to remain light today owing to the Martin Luther King holiday in the US.
In Fixed Income markets, Bunds and Gilts both extended gains before fading to stand some 20 ticks above parity, with the former seeing further strength on a break of Friday’s Eurex session high to reach 160.76 (+38 ticks on the day), but unable to really challenge the next resistance area on some intraday or short term charts between 160.85-90. 0.5% in 10 year cash is now support rather than psychological resistance and the level is holding, while Gilts probably saw some selling ahead of 124.00 as the Liffe high so far is 123.97 (+37 ticks). Turnover remains light and will likely stay subdued without US participants, but this could result in some exaggerated price action/moves. UST futures are trading, but again amidst low volumes and modestly firmer with a slight flattening bias for choice. The cash UST market closed all day; large redemptions across EGB markets potentially underpin.
In commodities, precious and industrial metals are well supported by the USD move, while Brent crude edges lower after failing to hold above $70/bbl again. Brent crude futures fell 19 cents to $69.68 a barrel, while U.S. crude was lower 12 cents at $64.19.
As a reminder, US markets are closed today for Martin Luther King day.
Key Bloomberg Headlines
- German Coalition: SPD’s Schneider and Nahles both hopeful on future coalition agreement
- Carillion Files for Liquidation After Failing to Get Bailout
- German grand coalition deal rejected in state of Saxony by one vote
- Bundesbank has decided to include yuan in currency reserves
- U.K. January Rightmove house prices 0.7% vs -2.3% previous
- Kuroda expects CPI to pick up toward 2% target; BOJ will ’continue easing’
- Oil Trades Near Three-Year High as Iraq Joins Call to Keep Cuts
- China Sovereign Wealth Fund: To gradually increase direct investment in the U.S.
- President Trump is said to soften his attitude toward Nafta: Axios
- Middle East: U.A.E. alleges that Qatar fighter jets intercepted a civilian airliner; Qatar denies incident
- Fed’s Rosengren says inflation could pick up faster than expected; flatter curve a consequence of larger central bank B/S, not sign of recession
DB's Jim Reid, who does not have the day off today, summarizes the overnight wrap.
It will be a quiet start to the week though with the US out on holiday. However last week felt like the most exciting for some time - especially in bond markets - with a rare US Core CPI beat on Friday being the final twist in the tale. A central theme of our 2018 view is that inflation will come back to be a theme in financial markets so the beat was some encouragement to our thesis. As we've discussed many times, over the last 2-3 decades US inflation has lagged GDP growth by around 18 months (15 months for the PMIs) and we think that in 2017 markets were too impatient waiting for strong growth to immediate impact inflation. The reality was perhaps that disappointing inflation was to a large part responding to the disappointing growth in late 2015/early 2016 when the energy/ commodity crisis was in full swing.
This week isn’t a bumper week for events but China’s big monthly data dump on Thursday and the threat of the US shutdown materialising on Friday are the highlights. According to our economists, the consensus remains that Congress will pass another four-week continuing resolution in order to hammer out a comprehensive budget agreement, but the risk of a government shutdown is not negligible. The rest of the week ahead is at the end today. For the full week ahead with a cut out and keep table please see “Next week... this week”.
In government bonds on Friday, 10y treasury yields rose to an intraday high of 2.590% (+c.5bp) following the beat on CPI before stabilising back to 2.548% and closing only 1bp up for the day. The UST 2y rose 2bp to 2.0% - the highest since September 2008. European bonds were mixed with 10y Bunds yields up 3.5bp intraday but closed marginally lower (-0.2bp) after the Bundesbank’s Weidmann played down the chance of an imminent rate hike and noted “as far as central bank rates in the Euro area are concerned…the immediate risk of change is currently low”. Elsewhere, Gilts were weaker (10y +3bp) while peripherals outperformed with yields down 3-7bp, led by Italy. The latest poll by Istituto Ixe showed support for Italy’s Democratic Party rose to 23% while support for Five Star Movement fell 1.2ppt to 27.8%.
Despite the beat on CPI and retail sales in the US, the US dollar index fell 0.96% while the Euro jumped 1.41% to a fresh three year high of 1.220 as Germany’s Merkel and SPD reached a preliminary accord to form the next coalition government. Sterling also rose 1.40% to a post Brexit vote high, partly supported by a Bloomberg report that noted the Finance Ministers of Spain and the Netherlands are considering a Brexit deal that keeps the UK as close to the EU as possible.
As a reminder, our FX team has a target of 1.30 on EUR/USD in 2018. George Saravelos suggests that although the Fed is hiking rates, US rate differentials are widening and the dollar has become a G10 high-yielder, the dollar is not responding. He thinks current dynamics look very similar to the 2004-06 Fed cycle. Back then the dollar weakened even as the dollar became one of the highest-yielding currencies in the world. Weaker flows into the US mattered more than rising rates. Our FX team believe flows will matter more in 2018 too, and these are decidedly EUR/USD positive. Refer to link for more details.
This morning in Asia, the BOJ’s Kuroda reiterated that the central bank will continue its stimulus program for as long as needed to achieve its price target. He also noted a moderate economic expansion is now under way which will help accelerate inflation towards the BOJ’s 2% target. Equities are broadly higher. The Hang Seng led the gains and is up for the 15th consecutive day (+0.94%), while the Nikkei (+0.29%), Kospi (+0.24%) and China’s CSI 300 (+0.75%) are all modestly higher. Elsewhere, Axios reported that President Trump is softening his stance towards exiting NAFTA according to five unnamed sources who have spoken with the President. In China, the RMBUSD is up 0.71% to the highest since December 2015 after the central bank strengthened the yuan fixing by 0.55% (the biggest increase in fixing in three months).
Now recapping other markets performance from Friday. US bourses were all higher with the S&P up 0.67% to a fresh high, marking the 8th up day out of 9 trading days. Within the S&P, gains were led by consumer discretionary and financial stocks, following a solid beat in December retail sales as well as better than expected guidance on tax cuts by JP Morgan. European equities were broadly higher with the Stoxx 600 (+0.31%), DAX (+0.32%) and FTSE (0.20%) all modestly up. Within the Stoxx, gains were broad based with only the consumer staples sector modestly in the red.
In commodities, Brent crude consolidated further and rose 0.88% to $69.87/ bbl. Elsewhere, precious metals gained c1.2% (Gold +1.15%; Silver +1.30%) while other base metals were mixed but little changed (Copper -0.49%; Zinc flat; Aluminium +0.40%). Palladium jumped 3.62% to a fresh record high.
Away from the markets, the Fed’s Rosengren has reiterated his views of potentially changing the Fed’s policy framework. He said this could be done by setting a target range for inflation instead, potentially 1.5%-3% and then deciding on an optimal level within that range, perhaps on a yoy basis or longer. Elsewhere, he conceded the plan could risk generating uncertainty about inflation in the medium and long term.
Over in Germany, Ms Merkel has reached a preliminary accord with the SPD to form the next coalition government. The initial agreements between the parties include: modest middle class tax cuts, focus on strengthening the EU and to contribute more to the EU budget and a potential increase in clean power share from 38% to 65%. Over the weekend, SPD delegates in the state of Saxony-Anhalt rejected the potential for another grand coalition with Ms Merkel’s party by one vote. Notably, the vote is non-binding on the SPD party, but partly illustrate the potential hurdles before a final deal can be reached. Looking ahead, the SPD will vote on the preliminary accord in their full party convention on 21 January. If successful, the two sides will move onto another round of formal talks.
Turning to Brexit and this week’s Parliamentary vote on PM May’s proposed EU withdrawal bill. Both the Opposition Labour Party leader Corbyn and Scottish First Minister Sturgeon have noted they are against the bill in its current form, with Mr Corbyn noting “if our tests are not met by the government, then we will vote against the bill”. Notably, given PM May’s alliance with Northern Island’s DUP, it is likely she would have sufficient votes to pass the bill. Elsewhere, Mr Corbyn noted Labour is “not supporting or calling for a second referendum” on Brexit.
We wrap up with other data releases from Friday. In the US, the December core CPI was above expectations at 0.3% mom (vs. 0.2%) which lifted annual inflation to 1.8% yoy (vs 1.7% expected). The 3 and 6 month annualized core inflation are higher and now at 2.5% and 2.2% respectively. In the details, car prices rose +0.9% mom, housing +0.3% and lodging away from home +0.8% mom, while price of apparel fell 0.5% mom. Elsewhere, the December retail sales (ex-auto) was also above market at 0.4% mom (vs. 0.3% expected) with a strong 0.3ppt upward revision for the prior month. Finally, the November business inventories was in line at 0.4% mom. Factoring the above, the Atlanta Fed’s GDPNow model now estimate 4Q GDP growth of 3.3% saar versus 2.8% saar previously.
The final reading for France and Spain’s December CPI was revised 0.1ppt lower to 1.2% yoy (vs. 1.3% expected). Elsewhere, Italy’s November IP was lower than expected at 2.2% yoy (vs. 3.3%).
