Yen Surrenders Yesterday’s Gains, Euro Struggles

Exchange currency EURO with YEN unit on a stone background

  • The BOJ met left policy on hold, as widely expected
  • Turkey, Germany, and Switzerland were hit by terrorist strikes yesterday
  • The Italian bank drama continues
  • RBA minutes were released
  • Turkey’s central bank kept the benchmark rate steady at 8.0%, as expected; Hungary’s central bank is expected to keep rates steady at 0.9%

The dollar is mostly firmer against the majors. The Swedish krona and the Loonie are outperforming, while Kiwi and the yen are underperforming. EM currencies are mostly softer. RUB and SGD are outperforming, while KRW and MXN are underperforming. MSCI Asia Pacific was down 0.4%, even with the Nikkei rising 0.5%. MSCI EM is down 0.3%, with Chinese markets falling 0.6%. Euro Stoxx 600 is up 0.1% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 3 bp at 2.57%. Commodity prices are mixed, with Brent oil up 0.4%, copper down 0.6%, and gold down 0.4%.

The yen’s incredible ride this year has been recapitulated in recent days. Consider that before last weekend, the US dollar reached a little above JPY118.40. At its extreme yesterday, the dollar fell to JPY116.55. Today it traded near JPY118.25 in the European morning, where it was encountering some offers.

The BOJ met and left policy on hold, as widely expected. Since September, it has targeted the 10-year yield at zero, which in practical terms may mean +/- 10 bp. This appears to have reduced the amount of bonds it is buying, and some see in this a tapering. In addition, Bloomberg estimates that about JPY40.5 trillion of bonds on its balance sheet will mature next year.

The BOJ will provide new forecasts next month, but the Cabinet did so today. It is projecting 1.5% GDP growth in 2017, up from 1.2%   Nominal growth is put at 2.5% compared with 2.2% forecast in September. The budget will be JPY97.5 trillion, a small (0.8%) increase from the previous estimate. More spending is customarily provided in one or more supplemental budgets.

Japanese shares opened weaker but reversed as the yen weakened. The Nikkei snapped a nine-day advance yesterday, but closed 0.5% higher. At stake is a six-week advance. Financials and energy were the only sectors to close lower. In addition to Japan, Korean, Taiwanese and Australian markets advanced, but it was not enough and the MSCI Asia Pacific Index fell 0.5%.

Turkey, Germany, and Switzerland were hit by terrorist strikes yesterday. The political implications are seen strengthening the populist-nationalist and anti-immigration forces. European markets are resilient. The Dow Jones Stoxx 600 is up about 0.25% in late London morning turnover, thinned by the holiday. It has recorded a marginal new high since the very start of the year today, led by health care, financials and energy.

The Italian bank drama continues. Bank shares are higher amid reports that the Cabinet has agreed to request as much as 20 bln euros authorization from parliament to provide precautionary public guarantees to Monte Paschi (and a couple of smaller banks). Monte Paschi’s share offer expires tomorrow for retail investors and Thursday for institutional investors. It is seeking to raise 5 bln euros, though its market cap is around one tenth of that.

Unicredit, Italy’s largest bank has indicated it will seek to raise around 15 bln euros early next year, which is roughly the size of its market cap. Earlier, Fortress, which has bought bad loan portfolios from Italian banks since 2000 (~22 bln euros) expressed interest in part of Unicredit’s non-performing loan portfolio.

There are two challenges for the new technocrat government led by Gentiloni, the fourth unelected prime minister. First has to do with the size of assistance that Italian banks need. This is slightly easier than the second challenge, which is the form of the aid. Unlike earlier in the crisis, there are now rules in place to protect taxpayers (conditions on state aid). The various Italian governments have acted too slowly, and when they finally did act, it was too small. Too little, too late. Italian bonds are under-performing Spain and Portugal today, though the 0.55% rise in Italian equities today is among the strongest.

RBA minutes were released. It noted that it has sought to balance the benefits for the economy of low rates with potential risks to household balance sheets. The RBA also noted “considerable uncertainty” with regards to momentum in the labor market. Overall, the cautious tone supports the notion that the RBA is on hold for now. Still, AUD is on track to test the May low near .7145, and a break below the .7200 area sets up a test of the January low near .6825.

During the North American session, there are no US data reports. There are no Fed speakers either. Canada reports October wholesale trade.

Turkey’s central bank kept the benchmark rate steady at 8.0%, as expected. The market was split on this, while most saw a 25 bp hike to the top of the rates corridor to 8.75%. We had hoped that recent lira weakness would push the bank into hiking rates again. However, we know that the bank is under pressure not to tighten further. USD/TRY is likely to make new all-time highs above 3.60 on market disappointment with the decision. With the lira remaining weak and oil prices rising, we think price pressures are likely to pick up and will ultimately require further tightening in 2017 as well.

Hungary’s central bank is expected to keep rates steady at 0.9%. It has kept rates steady since the last 15 bp cut back in May. However, it has eased via unconventional measures since then, pushing market interest rates even lower to new record lows. CPI rose 1.1% y/y in November, the highest since September 2013 and approaching the 2-4% target range. Base effects should boost it further in the coming months. Taken in conjunction with the recent proposal to boost the minimum wage next year, we think further easing is unlikely.