Dollar and Yen Post Gains to Start the Week

The US dollar is retracing part of its pre-weekend losses against the European currencies and dollar-bloc today while falling equity prices are underpinning the yen.  

Brent is nearing $40 a barrel, and WTI is pushing through $36.   Iron ore prices were limit up in China.  US 10-year Treasury yield is three bp higher to poke through 1.90% level for the first time since February 4.  European bond yields are mostly 2-3 bp lower, with notable exceptions of  Portugal and Greece.  

The US two-year premium over Germany is near 1.45%, a new cyclical high.  It is metric of the divergence we have a privileged place for in our bullish dollar outlook.  We expect that premium to trend gradually higher toward 2.0%. The US 2-year premium over Japan is also at a new cyclical high today.  The 1.10% premium has not been seen since  September 2008.  The US two-year premium over Canada is widening and at 36 bp it is the highest since February 1 and appears to be blunting some of the impacts of higher oil prices on the Canadian dollar, which is paring its pre-weekend gains.

Asian equity markets were mixed.  Tokyo, Hong Kong, Singapore and Indonesia moved lower, while the others, including China, Korea and Taiwan advanced.  The MSCI Asia-Pacific Index finished fractionally lower to snap a four-day nearly 5% advance.   European bourses are heavy, and the Dow Jones Stoxx 600 is giving back the gains registered before the weekend.  Energy and materials are the weakest sectors.   US shares are trading lower in Europe, and the S&P 500 is currently expected to open nearly 0.5% lower. 

The news stream is light.  The report that is stirring some discussion is the Chinese reserve figures.  Reserve fell $28.6 bln in February, about 3/4 of the draw down that consensus expected.  If anything, given that appreciation of the yen (7.5%) and the euro (0.4%) might have blunted some of the declines.  Separately, but related, Hong Kong's reserves rose nearly $3 bln.  

The BIS report over the weekend lent support to our argument that the capital outflows from China last year were not so much the speculative capital fleeing that many in the media played up, but rather Chinese companies paying down their dollar debt.  The BIS added to the discussion evidence that there was also a reduction in offshore RMB deposits.  

The attempt by Spanish Socialist to form a minority government with the new centrists Ciudadanos Party failed at the end of last week  While this is prolonging the political deadlock after the December elections, the Spanish bonds have only slightly under-performing Italy, while the IBEX 35 is off half as much as the FTSE-MIB 16% year-to-date decline.  New elections seem increasingly likely.  They would likely be held in June.   

Similar theme, different setting in Slovakia.  Elections over the weekend denied the government a  new majority, which it has enjoyed since 2012.  Prime Minister Fico's Smer Party won a third of the seats with about 28% of the vote.  The next three largest parties refuse to enter a coalition with Smer.  At the same time, the distrust and animosity between the opposition parties hinder their ability to form a coalition as well.  Note that Slovakia holds the rotating EU presidency in the second half of the year.  Like other countries in Central Europe, Slovakia has become more critical of the EU, especially over the refugee issue.  

The Fed's Labor Market Conditions Index, a new measure, does not draw much attention from investors, and the January consumer credit report is issued too late to impact activity.  The Fed's Brainard and Fischer speak today.  The market is comfortable with its assumption that the Fed will not hike rates next week but has begun recognizing the increased likelihood of a June move.   The Bank of Canada meets on Wednesday.  It is expected to stand pat.  Governor Poloz comments, especially about the Canadian dollar in light of its sharp appreciation since the last central bank meeting, will watched closely.   Lastly, the lack of closure of Brazil's political crisis may see the pre-weekend euphoria continue to unwind. 

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