Dollar Consolidates, Equity Advance Fizzles in Europe

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  • There is an update on Italian Prime Minister Renzi’s intentions
  • Eurozone flash PMI for November rose to 54.1 from 53.3
  • The German 2-year yield slipped to new record lows yesterday
  • Results of Norway’s Q4 oil investment survey were released
  • There are several US economic reports; FOMC minutes will be released
  • Bank Negara Malaysia kept rates steady at 3.0%, as expected
  • South Africa reported October CPI; Brazil reported mid-November IPCA inflation

The dollar is mostly firmer against the majors. The Aussie and the Swiss franc are outperforming, while sterling and the Norwegian krone are underperforming. EM currencies are mostly weaker. TWD, MXN, and PLN are outperforming, while RUB, MYR, and THB are underperforming. MSCI Asia Pacific was up 0.5%, while Japan markets were closed for holiday. MSCI EM is up 0.2%, with Chinese markets rising 0.2%. Euro Stoxx 600 is down 0.3% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is flat at 2.31%. Commodity prices are mixed, with WTI oil up 0.5%, copper down 0.4%, and gold flat.

The US dollar is trading inside yesterday’s ranges against the euro and yen. The dollar’s tone matches the consolidation in the debt market ahead of today’s slew of US data and tomorrow’s holiday. Tokyo markets were on holiday today.

After the major US indices set new record highs, Asian markets also advanced. The MSCI Asia-Pacific Index, excluding Japan (holiday) gained 0.6% in its second days of gains. The MSCI Emerging Market equity index is posting small gains for the third session. With today’s gains, it has moved higher in six of the past seven sessions. European investors did not get the memo, and after posting early gains, European equities have gone south. Minor losses are being recorded in late-morning activity, with the financials, information technology and utilities dragging the market lower.

Sterling is trading heavily. Its half cent loss (0.4%) is the biggest decline among the majors today. In the larger picture, it is within the range set on Monday. Hammond’s Autumn Statement appears to have been largely leaked.

Small spending increases for infrastructure and help for home buyers are expected to be featured. The market appears to feel comfortable with the projected Gilt and bill issuance. The projections for slower economic activity translate into a larger deficit, and cyclical expenditures seem to absorb the appetite for May’s wing of the Tory Party. That said, monetary policy, with a cheap lending facility, base rate cut, resumption of QE, and sterling’s decline have already been deployed to support an economy, which continues to perform well.

There have been two news developments. The first is an update on Italian Prime Minister Renzi’s intentions. The referendum at the end of next week looks likely to fail. There will no more polls. Renzi complicated the situation by threatening to resign if the referendum lost. Although he had backed away from this, his frustration appeared to grow and he returned to talking about his future. His trump card was to call for early elections.

The current parliamentary term ends in 2018. The problem is that electoral reform for the lower house has already been approved, but the referendum could reject reform of the Senate, leaving different electoral laws for the two Chambers. The Deputy Secretary of Renzi’s PD has suggested the election may be brought forward to next summer, though it is not immediately clear if Renzi would stay on until then.

Italian assets are mixed. Equities are heavy and the FTSE Milan is entering the downside gap created by yesterday’s higher opening. Italian bank shares are off almost 3% to the index’s lowest level since early October. It is the seventh decline in the past eight sessions. Italy’s 10-year bond yield has risen 6 bp, the most in Europe today. While the 2-year yield has risen a couple of basis points, it is up less than Spain’s comparable yield.

The second development is the flash euro area PMI. The composite November reading rose to 54.1 from 53.3. It is a new high for the year. The details were favorable. Employment, prices, and new orders all rose. The ECB meets on December 8, a few days after the Italian referendum. There are mixed economic signals. While the PMI suggests the region will end the year with trend growth or better, officials will still be concerned about the uneven nature of the economic growth and its fragility. Moreover, inflation is seeing little traction.

Note that the German 2-year yield slipped to new record lows yesterday. This is important. The dollar is not only being underpinned by the changing policy expectations in the US, but the widening of the interest rate differential is a result of both sides moving and diverging. Consider over the past week, the US 2-year yield has risen 8 bp, while the Germany 2-year yield fell 9 bp.

Results of Norway’s Q4 oil investment survey were released. Oil and gas companies slashed their investment forecasts for 2017 to NOK147 bln. This is down 3.6% from the previous estimate, and would represent a 13% drop from estimated spending this year. Statistics Norway noted that the planned reduction next year was “mainly due to lower estimates for exploration and shutdown and removal.”

There are several US economic reports today. These include durable goods orders, weekly jobless claims, new home sales, Markit flash manufacturing PMI, and the University of Michigan consumer confidence (and inflation expectations survey). Barring significant surprises, the data is unlikely to have more than a headline effect. The market is convinced that the Fed is poised to hike rates in the middle of next month. Expectations for Q4 GDP have also been lifted lately. The NY Fed’s GDP tracker rose 0.8 percentage points over the past week or so to sit at 2.4%. The Atlanta Fed (which updates its model today) was at 3.6% last week.

A common retort to our bullish dollar outlook is that the market has “priced it in,” usually referring to either a Fed hike or more stimulus fiscal policy. While next month’s rate hike does in fact seem to be discounted, investors remain less sanguine about next year. The December 2017 Fed funds futures contract implies a yield of 97 bp. That would seem to imply that one hike next year is fully discounted (that would give a mid-point of 87.5 bp). The market appears to have gone a long way toward pricing in a second hike, but is not fully there.

The FOMC minutes from the meeting earlier this month will be released later this afternoon. Participation will lighten up by then, and the minutes are unlikely to tell investors anything that they did not already know. Most participants anticipate a hike shortly.

Lastly, we note that the January light sweet crude oil futures are edging higher for the fifth session. While ideas that an agreement will be struck has been fanned by numerous press report, we continue to have nagging doubts. Yesterday we noted that many of the biggest cheerleaders are coming from places like Iran and Iraq that seek exemption from any agreement. Today we note that proposals presented at yesterday’s technical meeting called for those two countries to participate in cuts. Meanwhile, to prepare for a freeze in output, some producers, like Russia have boosted production. That said, technical considerations are still favorable for higher prices.

Bank Negara Malaysia kept rates steady at 3.0%, as expected. Malaysia reports October CPI Friday, which is expected to remain steady at 1.5% y/y. While the central bank has no explicit inflation target, low inflation allows the bank to remain on hold for the time being. The next move will depend in large part on external factors, as the weak ringgit is likely to prevent further easing near-term.

South Africa October CPI rose 6.4% y/y vs. 6.3% expected. SARB meets Thursday and is expected to keep rates steady at 7.0%. Inflation is moving further above the 3-6% target range, and recent ZAR volatility is likely to keep the central bank cautious. While the weak economy precludes further rate hikes, we see no easing until well into 2017, if at all. Here too, much depends on the rand.

Brazil mid-November IPCA rose 7.64% y/y, close to consensus and down sharply from 8.27% in mid-October. This is still be above the 2.5-6.5% target range, but is the lowest since mid-February 2015. While the central bank has started the easing cycle, recent BRL volatility is likely to keep it very cautious. Next policy meeting is November 30, and another 25 bp cut to 13.75% seems likely. CDIs are pricing in slightly more than 25 bp, while analysts are evenly split between 25 bp and 50 bp.