Hope for De-Escalation of Tensions Continues

Overview: Hope that the geopolitical tensions in Eastern Europe are de-escalating is underpinning risk appetites.  The large bourses in the Asia Pacific region but China were all up more than 1% and Europe's Stoxx 600 gapped higher, but has come back to close the gap, with communications and financial sectors the largest drags.  US futures have softened over the past couple of hours.  The 10-year Treasury yield is hovering around 2.04%, while European yields are a little softer.  In the foreign exchange market, the risk-on means the dollar, yen, and Swiss franc are underperforming, while the Canadian and Australian dollars are leading the advance.  Most emerging market currencies are firmer, and the JP Morgan Emerging Market Currency Index is edging higher for the third consecutive session.  Gold and oil are stabilizing after yesterday's downside reversals.  After dipping below $1845 yesterday, the yellow metal is approaching $1860.  March WTI is recovering from yesterday's $90.65 low to resurface above $93.00.  API estimated that US crude inventories fell by 1.1 mln barrels and the drawdown at Cushing was more than twice as much.   US natural gas prices are higher for a third session and around 13% for the week.  Europe's benchmark has steadied after collapsing 16% yesterday.  Iron ore bounced almost 3.5% to snap an 11% slide over the past three sessions, while copper is edging higher.  

Asia Pacific

While many countries are combatting price pressures, China is moving in the opposite direction.  Falling food prices helped the January CPI slow to 0.9% year-over-year from 1.5%.  Pork prices fell by more than 40% year-over-year and fresh vegetable prices dropped 4.1%.   Excluding food and energy prices, the core CPI was unchanged at 1.2% year-over-year.  Falling coal, steel, and other industrial goods prices say the PPI eased from 10.3% at the end of last year to 9.1% in January.  Both the price gauges were lower than expected and underscore the scope for further official support.  Many expect rate cuts and a reduction in required reserves to be delivered with Q2 a favorite timeframe.  

The Bank of Japan conducted its normally scheduled bond buying operation today. The offer-to-cover rose to over 5x, the highest since last October, reflecting the greater willingness to sell the bonds to the BOJ.  There may have been some extra interest to sell 20-year bonds ahead of tomorrow's auction.  BOJ Governor Kuroda was clear.  The offer to buy unlimited amounts of 10-year bonds to defend the yield-curve-control cap of 0.25% can be made again.  The BOJ has no intention to abandon it or widen the band for the 10-year yield.  The IMF has previously suggested targeting a short-term rate, but Kuroda showed no interest.  While a strong reception at tomorrow's auction may buy some time, the pressures emanating from the rise in global rates suggests a running battle with the BOJ will continue.  

The US dollar has been confined to about a 20-pip range above JPY115.60.  It is too narrow of a range to persist.  The upside looks blocked around JPY116.00 and is reinforced by the expiration of a nearly $1 bln option there today.  On the downside, the JPY115.30-JPY115.40 may limit a pullback.  The Australian dollar tested the $0.7185 area, the high before the weekend and US warning that a Russian invasion of Ukraine could happen any day.   This area corresponds to the (61.8%) retracement objective of the slide from last week's high set near $0.7250.  It appears to have stalled there and a test of nearby support in the $0.7140-$0.7150 area appears likely ahead of the jobs report first things tomorrow in Australia. The US dollar fell by a little more than 0.25% against the Chinese yuan yesterday, the most in two months, and slipped a little further today.  The market may have been encouraged by the PBOC's dollar reference rate, which for the second consecutive session was slightly below market expectations (of the median forecast in the Bloomberg survey).  Today's reference rate was set at CNY6.3463 vs. expectations for CNY6.3465. 


Understandably, the focus is on geopolitics and monetary policy, but the eurozone trade balance is at an important junction.  Yesterday, the EMU reported its largest monthly trade deficit (9.7 bln euros) in 19-years, mostly due to the surge in the cost of energy.  For last year as a whole, it recorded an average monthly surplus of about 10.2 bln euros, down from 18.7 bln in 2020 and 16.5 bln average in 2019. Last year's average was the smallest since 2012.  

After the four largest EMU members report larger than expected declines in December industrial output, the median forecast in Bloomberg's survey for a 0.3% increase seemed wide of the mark.  Consider that German output fell by 0.3% (median forecast 0.5%), French output fell by 0.2% (median forecast 0.5%), and Italy's fall by 1.0%, which was only slightly more than expected. Spain was the biggest disappointment. It collapsed by 2.6% while the median forecasted a 0.5% decline.  Nevertheless, the Eurostat reported a 1.2% jump in December industrial output and appears to use different national figures.  

UK January inflation gauges were slightly firmer than expected.  CPIH, which includes owner equivalent housing costs edged up to 4.9% from a year ago.  It was at 4.8% in December.  The month-over-month decline in CPI of 0.1% was slightly less than expected. The core measure rose 4.4% after a 4.2% pace at the end of last year.  Output producer prices accelerated to 9.9% from 9.3%, dashing forecasts of a decline (to 9.1%).  Input prices rose 13.6% from a year ago. This has also been a quickening if not for the upward revision of the December series to 13.8% from 13.5%.  Today's inflation report will not change many minds about the outlook for next month's meeting. The swaps market continues to show a better than even chance of a 50 bp rate hike on March 17.  

The euro extended its recovery to $1.1395 in late Asian turnover today.  Recall that the geopolitics and widening rate differential had pushed it to about $1.1280 at the start of the week.  The upside looks blocked at $1.1400 by a one-billion-euro option that expires today and another a little larger at $1.1425.  Initial support is seen in the $1.1340-$1.1350 area.  Below there, support may be near $1.1320.  Sterling remains mired in a $1.35-$1.36 range.  It briefly slipped to below $1.3490 on an intrasession basis yesterday but quickly rebounded.  It has not settled outside this range this month.  


After the recent price data, the US economic news turns to the real sector today with consumption and production news.  Helped by a jump in prices and auto sales, retail sales are expected to have recouped December's 1.9% drop.  Auto and gasoline likely accounted for around half the projected increase.  The core measure, which excludes autos, gasoline, building materials, and food services are expected to have risen by 1.4%, the median forecast in Bloomberg's survey.  After dropping 3.1% in December, it may be a little disappointing. Next week, the more comprehensive consumption expenditures will be reported.  Like the headline retail sales, the PCE is expected to fully recover the 0.6% decline at the end of last year. 

Industrial output is expected to have risen by 0.5% last month.  It fell by 0.1% in December.  However, parts of manufacturing remain disrupted and factory output is forecast to have risen by 0.2% after falling by 0.3%.  Perhaps, an under-appreciated component in industrial output is the surge in shale output from the Permian Basin.  It hit a new record high for the third consecutive month and was above 5 mln barrels a day for the first time since 2007 when the time series began.  America's seven major shale areas are ramping up output and is expected to reach 8.7 mln barrels a day next month.  That said, there are two medium-term challenges that ought to be monitored.  First, output per well is falling.  It is now back to August 2020 levels.  This means more wells are needed for the same level of output.  Second, the inventory left in the ground as in drilled but not completed wells has been trending lower and is now the lowest since 2014. 

Late in the session, the FOMC minutes from last month's meeting will be released. Recall the statement was not as hawkish as Chair Powell comments.  Powell sought maximum flexibility and the market, with the help of some Fed officials (see Bullard) and the jump in CPI, read into that flexibility a sign of more aggressive monetary policy.  On the eve of Powell's press conference, the Fed funds futures had discounted around a 50% chance of a March hike and almost four hikes this year.  Now the Fed funds market is discounting almost a 2/3 probability of a 50 bp hike in March and is divided between six and seven hikes this year.  The swaps market is pricing in two hikes next year and a cut in 2024.  

Canada reports January CPI figures.  It appears that after the US reported a stronger than expected increase, some economists tweaked their Canadian forecasts higher.  In January 2021, Canada's CPI rose by 0.6%.  The median forecast (Bloomberg survey) now looks for a 0.6% increase last month.  This will keep the year-over-year rate steady at 4.8%.  The underlying measures may also be broadly stable.  Note that last February through May, Canada's CPI rose by 0.5% each month.  Still, it may not impact expectations for monetary policy.  The swaps market has nearly 175 bp of tightening priced in for this year--seven hikes. The market sees a terminal rate of about 2.5%, which Bank of Canada Governor Macklem says may be higher.  

The upper end of the US dollar's range against the Canadian dollar held earlier this week near CAD1.28. The greenback is being pushed lower now and is back near the pre-weekend/pre-US warning low (~CAD1.2670).  The lower end of the range is around CAD1.2650-CAD1.2660.  Last week, there was an intrasession spike to almost CAD1.2635. However, the intrasession momentum indicators are stretched, warning of the risk that the greenback bounces in early North American turnover.  The CAD1.2700-CAD1.2720 may serve as a nearby cap.  The US dollar remains soft against the Mexican peso.  The deputy governor of the central bank made it seem as if the Fed delivers a 50 bp hike by mid-March, it would be matched by Banxico at its meeting on March 24. The greenback has been testing the 200-day moving average, which comes in today near MXN20.34.  Yesterday's bounce off it has been particularly shallow, suggesting that the bids are being absorbed. A break would target this year's low around MXN20.28. Below there, the greenback could fall toward MXN20.10-MXN20.15.  


Hope for De-Escalation of Tensions Continues Hope for De-Escalation of Tensions Continues  Reviewed by Marc Chandler on February 16, 2022 Rating: 5
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