Dollar on the Defensive Despite Firmer Rates

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  • Markets appear to be growing increasingly frustrated with emerging priorities of the new US Administration
  • AUD is the worst performing major after a disappointing CPI report
  • The US and Canada’s economic calendars are light, offering little distraction from political events
  • Korea Q4 GDP grew 2.3% y/y vs. 2.2% expected and 2.6% in Q3

The dollar is broadly weaker against the majors. Sterling and the Scandies are outperforming, while Antipodeans are underperforming. EM currencies are mostly firmer. ZAR and the CEE currencies are outperforming, while the TRY and CNY are underperforming. MSCI Asia Pacific was up 0.5%, with the Nikkei rising 1.4%. MSCI EM is up 0.3%, with China markets up 0.3%. Euro Stoxx 600 is up 1% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 1 bp at 2.48%. Commodity prices are lower, with oil down 1.1%, copper down 0.3%, and gold down 0.4%.

The US dollar is softer against nearly all the major currencies. Participants appear to be growing increasingly frustrated with emerging priorities of the new US Administration. They want to hear more details and discussion of the tax reform, deregulation, and infrastructure plans. However, the priority today is on authorizing the construction of a wall between the US and Mexico and possible action on immigration from “terror-prone” countries, according to press reports.

Sterling is the strongest of the major currencies. Having reached almost $1.26 today, it is at its best level since December 14, when the Fed hiked rates for the second time in the cycle. After an initial wobble, sterling recovered smartly after the Supreme Court’s decision yesterday requiring a both chambers to vote on a bill to trigger Article 50. The general sentiment appears to be that while different amendments will be submitted, the small Tory majority may be sufficient to frustrate the most dramatic proposals, such as having a second referendum on the entire deal.

We anticipated that the court ruling would prove anti-climactic and that sterling was poised for additional near-term gains. Yesterday’s knee-jerk reaction saw sterling fall to test the trendline drawn off the early September and December highs, and the neckline of a possible head and shoulder bottom pattern (~$1.2425 and $1.2415 respectively) and recover to close on its highs. Today, follow through buying has lifted it further. The intraday technical readings are stretched. A support band between $1.2500 and $1.2550 may be sufficient to deter sharper losses.

On the other hand, the Australian dollar is the weakest of the majors, being the only one lower against the dollar. It is off about 0.6% after a disappointing CPI report. To frame the issue, recall that the Australian dollar fell in each of the last three months of 2016, and four of the last five months. However, this month has been a different story. It is the strongest of the majors, gaining around 5% coming into today’s session.

The Q4 CPI miss was not major, but it has spurred talk that the central bank could cut rates again, with some thinking as early as next month. Consumer prices in Q4 rose 0.5% instead of 0.7% as it did in Q3 and as the median forecast in the Bloomberg survey had expected. The year-over-year pace was 1.5% (up from 1.3%), just off the 1.6% anticipated. The trimmed mean and weighted median were also 0.1 percentage points less than expected. While the RBA cannot be pleased with the sharpness of the Australian dollar’s appreciation, we are not convinced that the miss on Q4 CPI is sufficient to push the central bank into another rate cut.

Despite firm US yields after yesterday’s seven basis point increase in the US 10-year yield yesterday, and rising equities, the dollar is practically flat against the yen. Earlier, Japan reported a larger than expected December trade surplus (~JPY641.4 bln, more than twice the Bloomberg median). The December trade balance is nearly always better than November’s but what stands out is the jump in exports. The 5.4% rise year-over-year is nearly five times larger than expected and snaps a 14-month contraction. Of note, exports to the US rose 1.3% from a year ago, while exports to the EU were off 4%. The big story is the 12.5% jump in exports to China, its largest trading partner. On a value basis, exports of auto parts and electrical circuits each rose 38%.

The contraction of imports continued. The 2.6% decline year-over-year was larger than expected, though it is the smallest contraction since first going negative at the start of 2015. The combination of stronger exports and weaker imports allowed Japan to report its fourth consecutive trade surplus. It may spur economists to revise up Q4 GDP forecasts, and turn more optimistic on Q1 17. Both the Topix and Nikkei rose for the first time this week. The 1.0% and 1.4% respective gains were the best since January 4 the first trading session of the year for Japan.

The Japanese equity gains were part of the regional rally after the US S&P 500 rose to new record highs yesterday. The MSCI Asia Pacific Index rose nearly 0.5% to record its highest close since late September. Led by financials and industrials, European shares are rallying as well. The 1% gain of the Dow Jones Stoxx 600, if maintained would be the largest since the day before the Fed hiked last month. The gap higher today suggests the nearly monthly long correction after a 5.7% rise in December.

The German IFO disappointed, but the market reaction was minimal. Essentially the assessment of the current situation improved slightly, but the expectations components softened. This combination weighed on the business climate measure (109.8 vs. 111.0), which is still at elevated levels.

While we continue to think that the euro’s upside correction may be in its final stages, it does look poised to push higher first. A retest of yesterday’s high near $1.0775 seems likely. The next technical objectives are in the $1.0820-$1.0850 area. Support is seen near $1.07.

The US and Canada’s economic calendars are light, offering little distraction from political events. Although it may not be a market-mover, global investors will be watching for the Italian court ruling on Italy’s political reform (lower chamber only), and are sensitive to the implications for the timing of the election. The 5-Star Movement is running neck-to-neck with the PD, even though problems in the local government in Rome, which it leads, raise questions of whether it has succeeded becoming a governing power rather than simply an opposition force.

Korea Q4 GDP grew 2.3% y/y vs. 2.2% expected and 2.6% in Q3. This was the slowest rate since Q2 2015. BOK board member Cho recently said the bank has room to cut rates further if the economic outlook deteriorates. Next policy meeting is February 23, but we think that the decision then will really depend on how the Q1 data come in. Consumer confidence has been falling due to the ongoing presidential impeachment trial, and so further slowing appears likely in H1 2017.