Markets Trying to Stabilize Ahead of Weekend

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  • A fragile stability has enveloped the markets after US equities markets stabilized yesterday and the dollar recovered from earlier losses 
  • The US economic calendar is clear 
  • Canada reports April CPI and March retail sales 
  • Further BRL losses likely as Temer digs in; Colombia reports Q1 GDP  

The dollar is mostly softer against the majors as the weekend approaches. Nokkie and sterling are outperforming, while Kiwi and yen are underperforming. EM currencies are broadly firmer. RUB and ZAR are outperforming, while KRW and PHP are underperforming. MSCI Asia Pacific was up 0.2%, with the Nikkei rising 0.2%. MSCI EM is up 0.3%, with Chinese markets rising 0.2%. Euro Stoxx 600 is up 0.6% near midday, while S&P futures are pointing to a higher open. The 10-year US yield is up 1 bp at 2.24%. Commodity prices are mostly higher, with oil up 1.1%, copper down 0.6%, and gold up 0.4%.

Judging from investors’ reactions, the only thing worse that than the low volatility environment is when volatility spikes higher, as it did yesterday. Higher volatility is associated with weakening equity markets, falling interest rates, pressure on emerging markets, a strengthening yen and, sometimes, as was the case yesterday, heavier gold prices.

A fragile stability has enveloped the markets after US equities markets stabilized yesterday and the dollar recovered from earlier losses. Those dollar gains have been pared and sterling recovered from what many are calling a mini-flash crash, during which sterling fell nearly 3/4 of a cent in a matter of minutes with no apparent trigger. A combination of algorithmic trading, market fragmentation, and less liquid conditions often in the US afternoon are seen as the main culprits.

The recovery on Wall Street helped Asian and European markets steady today. The MSCI Asia Pacific Index eked out a small 0.15% gain, cutting this week’s loss in half. We note that the South Korea’s KOSPI managed to post a small gain today and for the week, while the Korean won weakened (0.2% on the day to be the weakest of the Asian currency complex) but is essentially flat on the week. Tensions on the peninsula remain elevated. The US has reportedly sent another aircraft carrier into the region. Separately, China intercepted a US aircraft over the East China Sea.

European shares are doing better. The Dow Jones Stoxx 600 is nearly up 0.5% in late morning turnover, leaving it off 1.2% for the week and snapping a three-week advance. Materials and energy are the leading the market higher. Real estate and consumer discretionary are lagging, but all sectors are higher.

Emerging markets are doing better today as well. The MSCI Emerging equity market index ended a seven-day advance Wednesday and fell 2% yesterday. Ahead of the Latam open, it is up about 0.4% today. Its four-week rally is at risk. Mexico surprised many yesterday with its sixth consecutive rate overnight rate hike (to 6.75% from 6.50%). The peso had largely recovered from its mostly Brazil-induced slide before the central bank met and it has continued to edge higher today.

Brazil’s situation does not appear to have stabilized much. The country’s ETF that trades in Japan fell another 6.5% earlier today. Of the two men who led the impeachment of the former president on corruption charges, one is in jail and the other is president and allegedly is recorded supporting payoffs to the one in jail. The other more liquid and accessible emerging market currencies like the South African rand and the Turkish lira are also recovering from yesterday’s slide.

Also, earlier today S&P lifted its rating on Indonesia one step to BBB-, which brings it back into investment grade status. This brings S&P into line with the other two leading rating agencies. However, it has a stable outlook, while Moody’s and Fitch have positive outlooks. The currency gained a little ground while the stock market surged to a new record high, and gained 2.5% on the day.

While markets are calmer than yesterday, nothing has been resolved. US political risks remain. Yet impeachment talk is not only unfounded but not politically realistic, even if some Democrats are pushing it. First, Trump’s support among Republicans remains high, according to recent polls. Second, the Republicans have a 45-seat majority in the House of Representatives, where a vote to impeach requires a simple majority. In the Senate, where the Republicans have 52 seats, only 35 votes would be necessary to block a conviction.

The more realistic threat is that the investigation into links with Russia distracts from the economic agenda, especially given the inexperienced team in the executive branch in terms of shepherding legislation through Congress. Investors are probably best served by monitoring progress on the economic agenda.

There are three developments to note. First, with Lighthizer being confirmed as Trade Representative, the 90-day notice to renegotiate NAFTA formally was given. Ideas that a new agreement can be wrapped up by the end of the year seems unrealistically ambitious. Second, Treasury Secretary Mnuchin affirmed that an ultra-long bond (50-year or more) is being contemplated, despite a cool reception by primary dealers. Third, Speaker of the House Ryan indicated that he still favors the border adjustment tax, even though the White House has indicated that its current form is not acceptable.

The euro has returned to approach yesterday’s highs. The price action reaffirms the importance of support we noted yesterday in the $1.1080-$1.1100 area. The intraday technicals are getting stretched, and barring new developments, not much more than a marginal new high seems likely. The JPY111.75-JPY112.00 may be sufficient to cap a stronger dollar recovery against the yen as the US 10-year struggles to push above 2.25%, as it nurses a nine basis point decline on the week.

Sterling has edged back above $1.30. The $1.3055 retracement objective held yesterday and may be tested again today. Intraday technicals warn against a significant break above there before the weekend. The Australian dollar may have peaked after it made a marginal new high for the week near $0.7470. Support is seen by $0.7430.

The US economic calendar is clear. President Trump’s first trip abroad is about to begin. Saudi Arabia is the first stop. Canada reports April CPI and March retail sales. The pace of inflation may tick up a little but remains subdued. Retail sales are expected to increase 0.3% after a 0.6% fall in February. The Bank of Canada meets next week, and there is little doubt that policy will remain steady.

The US dollar is at new lows for the week and month against the Canadian dollar. It has been flirting with the CAD1.3575 retracement target for several days. A convincing break targets CAD1.3510 initially and then CAD1.3440. However, the intraday technicals warn that even a slight disappointment with the data could see the greenback bounce back.

It was a tale of two currencies. MXN recovered most of its losses yesterday ahead of the Banxico decision, then gained some more after the bank hiked 25 bp to 6.75%. The peso’s recovery was remarkable. On the other hand, BRL ended near its worst levels of the day despite BCB auctioning FX swaps throughout the day, as Temer appears to be digging his heels in for a messy fight.

Further losses are likely, as USD/BRL has only retraced about a third of the 2016-2017 drop. Major retracement objectives for that big move come in near 3.4730 (38%), 3.6065 (50%), and 3.74 (62%). Markets were too pessimistic when BRL was at 4.25 and too optimistic when it was at 3.05. Fair value lies somewhere in between, perhaps in the 3.60-3.65 area.

Colombia reports Q1 GDP, which is expected to grow 1.1% y/y vs. 1.6% in Q4. CPI rose 4.7% y/y in April, above the 2-4% target. However, the weak economy has led the central bank to accelerate its easing cycle with a 50 bp cut in April. The next policy meeting is May 26, and another 50 bp cut seems likely.