Dollar Softens as Corrective Forces Grip Global Markets

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  • Corrective pressures are gripping the major capital markets today
  • UK CPI was lower than expected CPI; China’s was higher than expected
  • Eurozone GDP estimates missed expectations
  • Fed Chair Yellen kicks off her semi-annual testimony before Congress today
  • The CEE countries reported Q4 GDP data; Chile central bank is expected to keep rates steady at 3.25%

The dollar is mostly softer against the majors. The Aussie and the yen are outperforming, while sterling and the Swiss franc are underperforming. EM currencies are mostly firmer. ZAR and KRW are outperforming, while IDR and BRL are underperforming. MSCI Asia Pacific was down 0.2%, with the Nikkei falling 1.1%. MSCI EM is up 0.1%, with China shares flat. Euro Stoxx 600 is down 0.2% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is flat at 2.44%. Commodity prices are mostly higher, with WTI oil up nearly 1%, copper up 0.5%, and gold up 0.3%.

Corrective pressures are gripping the major capital markets today. The Dollar Index’s ten-day advancing streak is being threatened by the position adjustment ahead of Yellen’s testimony later today.

Despite record high closes in the main US equity markets yesterday, Asia could not follow suit. It tried to initially, and recorded new highs since July 2015, but sellers emerged and the MSCI Asia Pacific Index closed marginally lower on the lows of the day. European bourses are mixed in morning turnover, but the Dow Jones Stoxx 600 may snap a five-day advance. The US S&P 500’s five-day streak is also on the line.

The US Treasury market is flat, while European benchmark 10-year yields are mostly lower. Premiums over Germany continue to ease after the recent blow out. The French 10-year premium over Germany is slipping. Recall that the spread peaked at the start of last week near 76 bp. It is now at 68 bp. This is still elevated, but without the earlier momentum. At the same time, the US 2-year premium over Germany, which often tracks the euro-dollar exchange rate, is edging above 200 bp for the first time this year. It peaked at the end of last year near 206 bp, which was the widest since 2000.

There has been a flurry of economic news. The report that appears to have had the largest impact was UK inflation. Headline CPI fell 0.5% as the median anticipated, but this did not lift the year-over-year pace as much as expected. The 1.8% year-over-year increase just missed the median by 0.1%, though it is still 0.2% higher than December. The core rate had been expected to tick higher, but it remained unchanged at 1.6%.

Recall that the UK’s core CPI rose 1.4% in 2015. The headline rate was 0.2% in 2015 and 1.6% last year.   The different performances of the two suggest that most the inflation the UK is experiencing is the result of higher energy (and food prices). While this force may ease later in the year, the impact of the past decline in sterling is expected to filter through.

Sterling shed a cent on the news. It is the only major currency not to be stronger against the dollar today. In part, what seems to be an exaggerated response to the inflation figures may be a reflection of its recent strong gains on the crosses. The euro was fraying with a neckline of a topping pattern near GBP0.8470. Sterling rallied from near JPY138.55 to JPY142.60 over the past week.

China also reported January inflation figures. Both CPI and PPI were stronger than expected. The 2.5% rise in CPI follows a 2.1% pace in December. It matches the highs since November 2013. The median guesstimate was for a 2.4% gain. We had suggested upsides risks due to the Lunar New Year. Producer prices jumped 6.9% from 5.5% in December. This is the strongest past since 2011. The median guesstimate was 6.3%. This probably has less to do with the Lunar New Year and more to do with the strong rally in commodities. Raw materials rose 12.9% and mining 3.1%.

With signs the economy has stabilized, officials may turn their attention to rising inflation and accelerating credit growth. New yuan loans were less than expected at CNY2.03 trillion (Bloomberg median was for CNY2.44 trillion), though it is still nearly double December’s CNY1.04 trillion. This means that the surge in aggregate financing of CNY3.74 trillion (median was CNY3.0 trillion after December’s CNY1.63 trillion) reflects a resurgence of shadow banking. Among shadow banking instruments, banker acceptances jumped four-fold.

Separately, reports suggest the Trump Administration, where Treasury Secretary Mnuchin was confirmed yesterday, is contemplating a change in the approach to currency manipulation. It may move away from the traditional language and instead regard undervalued currencies as a subsidy. This would allow US business a quicker way to register a complaint and seek redress.

The challenge with such an approach is that by many metrics, including the IMF, the yuan is not so much undervalued. The reason that this approach has been rejected by previous administrations is that it could open the US up to retaliation during a period of easing monetary policy and a falling dollar. Some countries, like Brazil, had argued that the US unorthodox monetary policy under Bernanke was equivalent to a shot in a currency war.

In the eurozone, German, Italian and Dutch GDP estimates missed expectations by 0.1%. This resulted in the eurozone Q4 16 GDP being revised to 0.4% rather than 0.5%, and puts the year-over-year pace at 1.7% rather than 1.8%. Despite the minor disappointment, growth was fairly stable in 2016 and although it did not reach 2% it recorded year-over-year in 2015, it is still regarded as above trend. This means that the output gap continued to close, even though unemployment remains stubbornly high.

Perhaps the German news was most disturbing. Not only was Q4 growth less than initially estimated (0.4% from 0.5%), but Q3 growth was shaved from 0.2% to 0.1%. Adding insult to injury, the ZEW survey showed a deterioration of both the current assessment (76.4 from 77.3) and expectations (10.4 from 16.6). Often we find that the investor sentiment in the ZEW survey is sensitive to how the DAX performs. In the first month and a half of 2017, the DAX is the second strongest G7 equity market, up 2.5% (the S&P 500 is the best with almost a 4% gain this year).

This brings us to Fed’s Chair Yellen. Fed Chair Yellen kicks off her semi-annual testimony before Congress today at 10 AM ET before the Senate. Tomorrow, she appears before the House. Given the close proximity of this month’s FOMC meeting, it’s hard to imagine that there has been much of a shift in her thinking. She is unlikely to pre-commit the central bank to raising rates at any meeting, but will likely reiterate that the commitment to gradually normalizing monetary policy.

There are three main issues she will likely address. First is the economic assessment. Little has changed since the FOMC statement. Second, she will likely be asked about the Fed’s balance sheet. The official position, as has repeatedly been expressed in FOMC statements, is that when the normalization process is well underway, the balance sheet will be addressed. Yellen will be reluctant to commit to any fixed time frame, maximizing the Fed’s flexibility. Third, Yellen may be queried about the impact of fiscal policy on monetary policy. However, while there is little doubt that Fed officials are monitoring the progress of the tax proposals in the negotiating process, it still does not reach the threshold of a policy variable yet.

During the North American session, the US reports January PPI. Given the upside surprise in January import prices reported last week, we see upside risks here. Tomorrow, January CPI will be reported. Elsewhere, the Fed’s Lacker, Kaplan, and Lockhart all speak today as well.

The CEE countries reported Q4 GDP data. Czech GDP rose 1.7% y/y vs. 2.3% expected, Hungary rose 1.6% y/y vs. 2.0% expected, Poland rose 2.7% y/y vs. 2.5% expected, and Romania rose 4.7% y/y vs. 4.3% expected. Much of the region is facing growing price pressures, and will find it harder and harder to remain so dovish. Hungary January CPI rose 2.3% y/y vs. 2.2% expected, and comes a day after Poland CPI rose a higher than expected 1.8% y/y.

Poland’s central bank isn’t facing as much of a quandary as Czech and Hungary are. It may actually contemplate a rate hike this year. The latter two are seeing slower growth at the same time price pressures are picking up. Rather than becoming hawkish, we think they will simply become less dovish. Czech National Bank will likely end the koruna cap around mid-year, but is a long way from hiking rates. Likewise, Hungary may stop expanding unconventional measures, but rate hikes are likely a 2018 story.

Chile central bank is expected to keep rates steady at 3.25%. Because CPI inflation accelerated to 2.8% y/y in January, we lean toward no cut. It will be a close call and analysts polled by Bloomberg are almost evenly split. If the bank doesn’t cut this week, then it will likely do so at the next policy meeting March 16.