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Overview
Market participants have returned from the New Year celebrations apparently with robust risk appetites. Equities and bonds are rallying, and the dollar has surged higher. The markets seem to be looking past the surge in China’s Covid cases and anticipate a recovery, helping Chinese equities lead Asia-Pacific bourses higher, where Japanese markets are still on holiday. Europe’s STOXX 600 is 1.6% higher in late morning turnover. US equity futures are also 0.8-0.9% higher. The 10-year US Treasury yield is off 13 bp, shedding most of last week’s gains. European benchmark yields are 6-11 bp lower.
The dollar has surged against most of the major currencies. Aside from the Scandis, yen and Canadian dollars, the other G10 currencies are off by more than 1%. The strong greenback gains seem like a bit of unwinding some of the weakness seen in thin holiday markets and what we suspect is an overdue technical bounce. Recall that the dollar traded heavily in December. More than that, the G10 currencies, except the Canadian dollar, rallied more than 5% against the greenback in Q4 ’22. Of note, today, with Tokyo markets closed, the dollar traded below JPY130 for the first time in six months. The Australian and New Zealand dollars are leading the losses, off around 1.5%.
Asia-Pacific
China’s abrupt shift from its zero-Covid policy, which apparently was faltering, is causing similar but a different set of economic disruptions. The human cost is mind-boggling in terms of infections and fatalities. Beijing is not very forthcoming, which is frustrating on numerous levels. Reports suggest President Xi is trying to bolster China’s foreign relations, but the lack of transparency about Covid and its massive aerial harassment of Taiwan in late December shows the limitations of such gestures. Appointing the former US ambassador as the new foreign minister should not be seen as a substantive change unless proven otherwise. The reversal of Covid policy on December 7 has further disrupted the already fragile economy. The “official” composite PMI fell to 42.6 in December, the lowest since February 2020 and the third month below the 50 boom/bust level.
No one wants to be bitten by the same dog twice. Caught by surprise, most seem to believe that the BOJ’s doubling of the 10-year bond yield’s cap to 0.50% is a prelude to it abandoning its negative interest rate policy here in the first part of the year. The swaps market has the policy rate slightly positive by the April 28 BOJ meeting. Governor Kuroda’s last meeting is March 10, and the swaps market has been flirting with a positive rate by then. The two-year yield is holding above zero for the first time for six-seven years. Fiscal subsidies and the appreciation of the yen on a trade-weighted basis (~9.5-10.0%) since the October low, coupled with weak demand, may slow inflation. In November, industrial production fell for the third consecutive month, retail sales (median forecast in Bloomberg’s survey was for a 0.2% gain) tumbled 1.1% from October, and the volume of exports fell 3.6% year-over-year. The Bank of Japan ended last year with an unprecedented three consecutive days of unscheduled bond purchases. The combination of fixed rate and fixed-amount purchases boosted December’s buying to around JPY17 trillion (~$128 billion), which appears to be a record amount.
In Asia, with Japanese markets still closed, the dollar fell to JPY129.50, the first break of JPY130 since last June. It recovered to nearly JPY131.50 before coming off again in the European morning. The sharp decline in US Treasury yields, where the 10-year is off more than 13 bp, is doing the greenback no favors. The next area of technical importance may be around JPY128.60. The Australian dollar initially rose to a two-and-a-half week high near $0.6835, before being sold a little through $0.6700. The retreat gives back the gains scored since Christmas. A close below $0.6700 could signal additional losses toward $0.6650 and possibly $0.6600. The $0.6800 area, stacked with expiring options in the second half of the week, should now offer resistance. The greenback also jumped back against the Chinese yuan after falling to nearly CNY6.8760, a four-month low. Chinese and Hong Kong equities rallied as some investors are trying to look through the Covid surge and focused on the re-opening and reports suggesting traffic increases in several large cities. The PBOC set the dollar’s reference rate at CNY6.9475, compared with the median forecast in Bloomberg’s survey for CNY6.9488.
Europe
The eurozone highlight of the week comes on Friday. It is the preliminary estimate of December CPI. For the second consecutive month, headline prices may have slipped by 0.1%. That will allow the year-over-year headline rate to slip back below 10% for the first time since August. The risk, as ECB President Lagarde noted, is that headline price pressures may increase later as government subsidies for energy end. Tellingly, the core rate is expected to be unchanged at 5.0% year-over-year. Before the New Year, Spain reported its preliminary December inflation figures. The harmonized headline measure fell to 5.6% from 6.7% (and a peak of 10.7% in July). However, this seems to be at least partly a function of energy subsidies. The core rate rose to a new cyclical high of 6.9% from 6.3%. Today is Germany’s turn. Based on state reports, there appears a little downside risk to the 0.8% month-over-month decline expected in the Bloomberg survey that saw the year-over-year rate falling from 11.3% to 10.2%. Separately, Germany reported an unexpected 13k decline in its unemployment, with the unchanged at 5.5%, following the downward revision in the November series.
It may be lost over the holidays, but note that several monetary divergences have swung in the euro’s favor. Consider that since the end of October, the ECB’s balance sheet has been reduced by about 8.8%, while the Fed’s has shrunk almost 2%. The US 10-year premium over Germany has fallen from around 190 bp to almost 130 bp. The two-year spread favored the US by 250 bp at the end of October. It traded below 170 bp before Christmas. One caveat is that the speculative participants (non-commercials) have amassed a significant large, long position. It has swung from a net short position of nearly 50k contracts contraction in late August to more than 140k net long (125k euros per contract).
We have been struggling between a conviction that the US dollar peak is behind us and the momentum indicators that suggested it was oversold on a near-term basis. That dilemma is being resolved by today’s price action. The euro had been flirting with the upper end of its recent consolidative range around $1.07 at the end of last year. It has been sold to $1.0535 today through its 20-day moving average (~$1.0610) for the first time in nearly two months. Options for 1.2 billion euros at $1.0580 expiring today may have also contributed to the sell-off. The intraday momentum indicators are stretched, and that $1.0580 area may now offer resistance. Still, ahead of Friday’s US jobs data, we suspect there may be potential toward $1.0400-30. Sterling has been sold through the $1.20 shelf to almost $1.1900, its lowest level since November 30. Cable’s 1% decline is a bit less than most of the other majors, leaving aside the yen. That suggests that the rail strike activity may be disruptive for travelers and commuters but is not taking a special toll on the exchange rate. A break of $1.1890 could spur losses toward $1.1750-60. Initial resistance may now be seen in the $1.1950-70 area.
America
The data highlight for the first week of the new year is the employment report on Friday. As Fed Chair Powell has argued, there are several dimensions of the labor market, and not one data point captures them all. That said, there are several signs that the labor market, while still strong, is slowing. We will see it tomorrow with the JOLTS report on job openings, which has gotten a great deal of attention in this cycle. It is expected to fall to 10.0 million from 10.33 million in November. And if it does, it will be the lowest since June 2021. The median in Bloomberg’s survey calls for a 200k increase in nonfarm payrolls, which would be the least in two years. Private sector job growth is expected to fall below 200k for the first time since the end of 2020.
Average hourly earnings growth may tick down to 5.0% from 5.1%. It would match the three-month average, which is the slowest since October 2021. It is not the measure of labor compensation that Fed officials most often seem to talk about, but it is seen too high for price stability from core services. We also tend to put more emphasis on auto sales than others, and we note that auto sales are expected to have fallen around 3% at an annualized pace to 13.7 million (SAAR) from 14.14 million. Through November, US sales are running slightly more than 9% less than 2021. Still, after contracting in the first two quarters, the US economy appears to have grown by more than 3% (annualized) in Q4 for the second consecutive quarter. The latest estimate by the Atlanta’s Fed GDP tracking model is for 3.7%. It will be updated later today. Economists polled by Bloomberg are not as optimistic, with the median forecast at 1.1% (December 20), after a 0.5% forecast in the November survey.
The Canadian dollar often outperforms in a strong US dollar environment and when US stocks are bid. Today is no exception. After the Japanese yen, the Canadian dollar is the strongest of the G10 currencies, nursing less than a 0.5% loss. Still, around CAD1.3820-40, the greenback is at its best level since a little before Christmas. Nearby resistance is seen in the CAD1.3665-85 area and then slightly above CAD1.3700. Canada’s December manufacturing PMI tends not to be much of a market mover and is likely to have remained below the 50 boom/bust level for the fifth consecutive month. Emerging market currencies are mostly lower, led by central and eastern European currencies. The Mexican peso is fairly resilient, slipping around 0.20%. The dollar is trading near MXN19.51. The upper end of the post-Christmas range extends toward around MXN19.58, and additional resistance is seen in the MXN19.60 area, which also houses the 20-day moving average. In thin trading yesterday, the dollar extended its pre-New Year’s rally against the Brazilian real. The greenback rose 2.3% last week and another 1.5% yesterday to around BRL5.36. The next important chart area is closer to BRL5.43.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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