Dollar Firmer But Mostly Sidelined As Equity Charge Continues

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  • The main economic news has been the UK’s first estimate of Q4 GDP
  • The US has a full slate of economic data, including December trade and wholesale/retail inventories
  • US breakevens (difference between the conventional bond and TIPS yields) are rising
  • Press reports suggest China’s central bank has ordered banks to limit new loans in Q1
  • Philippines Q4 GDP grew 6.6% y/y, as expected

The dollar is broadly stronger against the majors. The Swiss franc and Swedish krona are outperforming, while the yen and the Antipodeans are underperforming. EM currencies are mostly softer. MXN and KRW are outperforming, while RUB and SGD are underperforming. MSCI Asia Pacific was up 0.8%, with the Nikkei rising 1.8%. MSCI EM is up 0.7%, with China markets up 0.4%. Euro Stoxx 600 is up 0.5% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is up 3 bp at 2.54%. Commodity prices are mixed, with WTI oil up 0.2%, copper up 0.2%, and gold down 0.7%.

The US dollar is mostly firmer against the major currencies but is confined to narrow ranges. Indeed, these are well-worn ranges, but the focus has shifted to the strong advance in equities. Yesterday, the Dow Jones Industrials finally rose through the psychologically-important 20k level, and the S&P 500 gapped higher to new record levels.

The Nikkei and Topix gapped higher too, helping lead the MSCI Asia Pacific Index to a 1% gain and the third rise this week. It is at levels not seen since Q3 15. Note that Australian and Indian markets were closed for local holidays.

European equities are following suit. The Dow Jones Stoxx 600 is up about 0.5% near midday in London, led by financials and health care. This is the second consecutive session that it has gapped higher. Note that the beleaguered Italian banks are extending yesterday’s 3.4% advance with another 1.3% gain today. Barring a reversal ahead of the weekend, it will be the second consecutive weekly advance and seven of the past nine weeks. The FTSE Italian bank index has risen almost 60% since last July. However, the index peaked in July 2015 near 18,555. By last July, it had fallen to 6420. It is now near 10,100.

Equities are rising as bonds sell off. Unlike the last leg-up for yields, they are not being driven by US Treasuries. While the US 10-year yield is at new highs for the year (~2.54%), it is still about 10 bp below the peak recorded the day after the Fed hiked rates in December. On the other hand, we note that the 50 bp yield on the 10-year Bund is the highest since last January. The French 10-year yield is pushing above 1.0% for the first time since Q4 15. Over the past five sessions, the US 10-yield has risen almost eight bp, while the same yield in Germany is up 11 bp, 16 bp in France, and 20 bp in Italy.

Japan’s 10-year yield is up 1.5 bp over the past week to yield eight basis points. The failure of the dollar to perform better against the yen as US yields and equities rise is frustrating many short-term traders. According to MOF data, Japanese investors sold foreign bonds last week for the first time this year, breaking a three-week buying spree.

That said, the dollar may be carving out a double bottom against the yen after the penetration of last week’s low did not generate much follow through selling. A move above the JPY114.50 would boost the chances that the dollar’s low is in place. The market needs confirmation that we have seen a double bottom, but a move above last week’s high near JPY115.60 is needed. The measuring objective of the double bottom is back toward the JPY118.50 seen at the start of the year.

The main economic news has been the UK’s first estimate of Q4 GDP. It came in at 0.6%, a touch above consensus, leaving the year-over-year pace unchanged at 2.2%. This estimate is based on a little less than half of the data that will eventually be in the final estimate. Still, the pattern is clear. Growth was narrowly based on services, while industrial production and construction were flat. Within industrial production, though, manufacturing did increase (~0.7%).

The UK expanded by 2% in 2016, after 2.2% growth in 2015. Some economists expected an immediate hit to the economy by the Brexit decision, but this did not materialize. Many still expect the UK economy to weaken as a result. The median forecast for this year from the Bloomberg survey is 1.2%.

Sterling reached almost $1.2675, the best level since the Fed hiked last month, before finding sellers who knocked it back down. Although we have suggested that a few chart patterns and retracements converge near $1.28, we do think this is a counter-trend/correction and want to be on-guard for a failure. To be anything significant from a technical point of view, sterling would need to be sold through $1.2500-$1.2520.

For its part, the euro is in the range that it has been in all week. For the fourth session, the euro has been stymied near $1.0770. We continue to believe the euro’s correction from below $1.04 is nearly over. Although US rates have risen, German rates have risen more. Consider that the two-year differential peaked at the end of last year near 2.06% and now is near 1.88%. The US premium on 10-year money peaked on December 16 just below 3.40% and is now near 3.15%. We see a break of the $1.0680-$1.0700 area as being supportive of our view, and a close below $1.0660 would suggest a top may be in place.

The US has a full slate of economic data, including December merchandise trade and wholesale and retail inventories. These will allow economists to tweak Q4 16 estimates ahead of tomorrow’s official report. Before today’s data, the Atlanta Fed’s GDP tracker estimates a 2.8% pace in Q4, down from 3.5% in Q3. The median from the Bloomberg survey is 2.2% matches the NY Fed’s GDP tracker estimate of 2.1%.

There is also January data today in the form of Markit service and composite PMI, the Kansas City Fed manufacturing survey, and the weekly initial jobless claims. Recall that last week’s jobless claims report, which covered the same week as the non-farm payroll survey, showed a fall to 234k, which is 1k above the low point in the cycle recorded the week of the US election. The four-week moving average, however, fell to the new cyclical low of 247, which is where the report is expected to show this time. Last week’s report may have been depressed by the US holiday.

Lastly, we note that the US breakevens (difference between the conventional bond and TIPS yields) are rising. The 10-year breakeven is elevated at 2.07%. The peak since September 2014, was recorded a week ago at 2.09%. However, yesterday was the first time since 2014 that the five-year breakeven also poked through 2.0%. We hear more clients talking about this and the possibility that the Fed may be slipping behind the curve. Bloomberg calculations suggest a little more than a one-in-three chance of a hike in March has been discounted by the Fed funds futures. The CME’s calculation sees a one-in-four chance is discounted.

Press reports suggest China’s central bank has ordered banks to limit new loans in Q1. The PBOC reportedly emphasized its concern about mortgage lending. Reports also suggest that it may make some lenders pay more for deposit insurance. While the mainland economy has stabilized, we too have expressed concern that this is being driven by a return to the debt-dependent growth model. If reports are true, then we would expect the economy to slow as we move through 2017. For now, China is not one of the major market drivers but this news would clearly be negative for risk and EM.

Philippines Q4 GDP grew 6.6% y/y, as expected but down from 7.1% in Q3. This was the slowest rate since Q4 2015, yet price pressures are rising. CPI rose 2.6% y/y in December, the highest since December 2014 but still within the 2-4% target range. Low base effects should push the rate above the 3% target this year, which will keep the central bank in a hawkish mode.

The Mexican peso continues to outperform. USD/MXN took another leg lower yesterday after President Trump seemed to take a more conciliatory approach with Mexico. Yet Trump also moved ahead with an executive order to build the controversial border wall. Reports suggest Mexican President Pena Nieto may cancel a planned trip to the US to meet Trump next week, which would signal a marked deterioration in relations.

Later today, Mexico reports December trade. November was a good print, with exports up 11.1% y/y and imports up 5.1% y/y. Petroleum exports have risen y/y for three straight months, while non-petroleum exports have risen y/y in three of the past four months.