Euro Slips, but Markets Take Developments in Stride

Investors have mildly responded to the tragic developments in Paris.  Equities tumbled in Asia, with the MSCI Asia-Pacific Index shed more than 1%, and the euro was briefly pushed below $1.07.  The dollar fell to almost JPY122.20.   US Treasury yield slipped around 3 bp.  However, the markets have since stabilized.  

The euro remains soft, but it has held above $1.07 in the European morning.  The dollar has rebounded back to the pre-weekend high near JPY123.  US Treasuries are little changed, and European stocks are higher, with the Dow Jones Stoxx 600 up around 0.25% near midday. 

The S&P 500 closed poorly before the weekend, and this would have likely taken on toll on Asian shares in any event.  The divergence meme had left the euro vulnerable after the short-squeeze lifted it briefly above $1.08, almost retracing 38.2% of its loss since the FOMC meeting on October 28.  The US-German two-year interest rate differential firm, less than a single basis point from the multi-year high set late last week.   Several ECB officials will be speaking today, and last week's Q3 GDP estimate was somewhat disappointing, and the uptick in the preliminary CPI to 0.1% year-over-year (with the core being lifted to 1.1% from 1.0%) is hardly sufficient to move anyone's needle.  

Draghi has indicated that all options are on the table for the December 3 meeting.  This includes not only extending QE from its soft initial end date, September 2016, but also potentially a wider range of assets, and increased purchases, as well as a deposit rate cut.  A cut in the deposit rate serves two purposes.  It would likely increase the range assets that can be bought.  It acts as a stimulus in its own right.  Note that  a recent ECB survey found most banks admitted to not using QE funds for making new loans.   

Japan reported Q3 GDP contracted 0.2%.  While this was a bit more than the consensus expected, Q2 GDP was revised up to -0.2% from -0.3%.  Many are claiming this is a recession.  We point out that there is not agreed upon definition of a recession, and many have made a fetish out of the two consecutive quarter rule of thumb.  In the 19th century, the end of the business cycle was called, crisis or panic, and then the Great Depression.  Going forward politicians and economists wanted to differentiate the end of a normal end of a business cycle from the Great Depression; hence recession. 

This is not just semantics.  The point is that the negative growth in Japan does not signal the end of a business cycle.  Japan's trend growth is so low (no more than 0.5% according to the BOJ) that a small negative print is partly just noise around the trend.  Moreover, the detail suggested the inventory cycle played a significant role.  Capex was also weak.  However, private consumption increased by 0.5%, which was a tad more than expected and Q2 was revised to -0.6% from -0.7%.  In addition, the GDP deflator rose to 2.0% from 1.5%.  

Whether the contraction denotes a recession or not is important also from the kind of policy response that is likely.  By understanding the way that Japanese officials will view the data is important.  They will not view it as a recession.  The BOJ meets later this week, and Kuroda will hold his usual press conference.    The same arguments he offered for not easing last month are still applicable now.  On the other hand, the Abe government has already reportedly been working toward a supplemental budget.  

Of note, before the weekend DBRS affirmed Portugal's investment grade rating with a stable outlook.  There was some fear of a downgrade, as the other rating agencies place it below investment grade.  There has been a sigh of relief and Portugal's 10-year yield is off 6 bp, while most bond markets are in Europe are a touch heavier.  

Sterling has been weighed down by a the largest decline in Rightmove's house price index of the year (-1.3% in November month-over-month).  Some also are arguing that the attack on Paris may influence the EU referendum debate in the UK.  It is possible, of course, but many claimed that the refugee/immigration issue was going to do that previously, and it did not. 

We peg initial support for sterling in the $.15145-$1.5170 area.  It will take a break of the $1.5120 area to denote anything significant.  The euro fell to three-month lows against sterling  near GBP0.7025  but rebounded to GBP0.7080.  A move above GBP0.7100 would spur another bout of short-covering.  

Finally, we note that the PBOC fixed the dollar-yuan higher for the tenth consecutive session.  This pattern sparked speculative sales of the offshore yuan (CNH) and produced a widening of the onshore (CNY) and offshore yuan.   Late in the local session, it appeared some policy banks may have sold dollars ostensibly to break the one-way market.    The pre-weekend report indicating that the IMF staff endorses the yuan’s membership in the SDR is important but did not spark new flows into China.  

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