Tight Ranges, Loose Lips

The US dollar has been confined to narrow ranges against the major currencies.  The euro, yen, and sterling have traded well within yesterday's ranges.  The dollar-bloc was a bit heavier, but Canadian dollar has fully recovery and the Aussie, nearly so, after disappointing, but dated, Q4 construction figures (-1.0% vs +0.7% consensus). 

One of the dominate issues, the weakness of the Chinese yuan, continues, albeit at a somewhat slower pace.  The yuan has weakened now for seven consecutive session.   It was the fifth consecutive session that the PBOC set the dollar's reference rate (fix) higher.   Key money market rates (7-day repo rate) 12 bp to just below 3.10%, to its lowest level since last May.    

There is some speculation that the PBOC is buying dollars and selling yuan.  Yesterday, PBOC figures released suggested that Chinese banks bought a record $73 bln of foreign currency in the onshore market in January reflecting clients' demand for yuan.  This represented a marked acceleration for even the heady pace seen in H2 13 (when PBOC reserves jumped by nearly $500 bln).  The Wall Street Journal reports that some of this money was invested in "target redemption forwards", which in essence reward, as in pay out month,  for yuan appreciation, but punish severely for yuan weakness.    The proximate key level to begin triggering some of these losses may be around CNY6.15 (CNY6.120-CNY6.134 today). 

The decline in money market rates and the first decline in 10-year yields in six sessions helped calm nerves and the Shanghai Composite rose 0.35% (though financials slipped), snapping a four day decline.  The PBOC helped by playing down the significance of the price action, suggesting it was primarily a reflection of market forces and it should not be over interpreted.  

It appears that the most common interpretation of the CNY developments is that the PBOC is introducing two-way risk as a prelude to widening the 1% band against the dollar.  While this is possible, we note that in past two times the band was widened, it was not proceeded by such a tactic.  As we have seen with money market squeezes, Chinese officials seem more interested in teach lessons than changing policy.  

In Europe, where new economic developments are light, official statements loom large.  First, the German  Constitutional Court ruled, in a 5-3 vote,  that the 3% threshold for German parties to enter the EU parliament (election in May) is unconstitutional.   Previously, it had ruled that a 5% threshold was unconstitutional and the Bundestag lowered it to 3%. 

Today's decision increases the likelihood that the AfD and may be even the Pirate Party, is represented in the EU parliament.  If anything, we suspect, it is more likely to take votes away from the CDU than the SPD.    

We note that a threshold for representation in the German parliament is constitutional because it has been argued, it is necessary for the functioning of parliament.  When the Bundestag lowered the threshold it justified it move in similar terms:  otherwise, parliament is fragmented.  The German Constitutional Court  ruling today, in the context of the recent doubts raised over OMT (before seeking a preliminary judgment from the European Court of Justice),  cast in particularly anti-Europe light. 

The second European official comment to note is ECB's Nowotny from Austria. As speculation mounts ahead of next week's ECB meeting, talk of a rate cut has increased, even if not seen in the euro itself.  There is some speculation that   the ECB, which says it is technically prepared and all options are on the table, will cut the deposit rate, which is now at zero.  Nowotny's comment, which we suspect are representative of broader opinion among the central bankers, showed a reluctance to push the deposit rate negative.  He cited psychological reasons. 

We argue that a small 10-15 bp cut in the refi rate is symbolic and that a cut in the 75 bp lending rate would be more effective in capping EONIA and reducing its volatility.    We have long favored measured that boost the securitzation market to encourage lending to SME and households.  The negative deposit rate and QE itself, we continue to regard as extreme measures that have a high hurdle for that is not being met.  

The euro remains in narrow ranges and even news that the second German bond auction in two weeks saw weak demand, forcing the BBK to retain a higher percentage.  Today it was a 30-yar bond and the BBK retained 18.7%, the highest since July 2012.  Total bids for 2.794 bln euros while Germany wanted to raise 3 bln euros.  It was the first uncovered 30-year bund auction since April 2012 and was sloppy in the sense of a large tail (about three times larger than recent average). 

We note that 3-month implied euro vol  is just below 6.50%, which is a little above multi-year low set last week below 6.4%.  One week implied vol is near 5.7%, which is still one percentage point above 6-year lows seen in late December 2013. 

The North American calendar is light.  The main US economic report is January new home sales.  The market is looking for a 3.4% decline on top of the 7.0% fall in December and 3.9% decline in November.  It corrects from the nearly 15% rise in October.  Most of the US data continues to be reported worse than expectations, which means that economists have not sufficiently appreciating the slowdown (whatever the causes).  When this reverses, it will be an important signal to investors. 

Two Fed presidents speak.  Rosengren is a non-voting dove and Pianalt is a voting member of the FOMC.  She is also seen more allied with the dovish wing, which at present wants to continue with the measured tapering. 

Late today, Brazil's central bank is expected to hike the overnight rate (Selic) 25 bp to 10.75%.