A Bloody Friday

The recovery of US shares and oil yesterday provided short-lived.  Asian shares were dragged lower with the help of Chinese equities.  The 3.5% fall in the Shanghai Composite today brings the year-to-date decline to a little more than 18%. Taiwan, which goes to the polls this weekend ( the opposition that has been critical of the government's pro-China policy is ahead) bucked the trend to post minor gains.

European shares are also moving lower, with the Dow Jones Stoxx 600 off more than 1.7% near midday in London.  The energy sector is leading the way with losses more than 2% today.  With US production still higher than anticipated, and Iranian oil to hit the market as early as next week, oil has been drilled back below $30, reflecting a nearly 3.5% decline on the day.

The US dollar itself is mixed.  It stands at the fulcrum.  The dollar-bloc currencies, sterling, and the Scandis are lower while the euro, yen and Swiss franc are firmer on the day.  Of note the, Australian dollar is the weakest of the majors, off 1.5% to new multi-year lows.  The Canadian dollar is off 1%, as the greenback pushes through the CAD1.45 level for the first time since 2003.   Sterling is also at new multi-year lows, slipping below $1.4335.

The euro had flirted with the lower end of its $1.08-$1.10 trading range that has largely bounded activity since the ECB meeting in early December and has recovered to the middle of the range.  The gains in the euro when share prices suffer sharp losses seems to reflect the unwinding of the use of the euro as a funding currency and short euro hedges.

For the third consecutive session, the dollar encountered sellers in near JPY118.30.  The broad risk-off, with weakness in equities and the lower US yields, kept greenback on the defensive.  The selling pressure eased near JPY117.25.  A break would signal a retest on the recent low near JPY116.70.

It is the one-year anniversary of the Swiss National Bank's decision to lift the franc's cap.  The dollar is trading with a softer bias, but above CHF1.0.  The euro had been near CHF1.20 a year ago. It fell to nearly CHF0.85.  The recovery high was seen last September near CHF1.1050.  It is now near CHF1.0950.

Despite the dramatic market moves, there does not appear to be fresh catalyst.  Given the price action since the start of the year, what stands out is not so much today's directional moves, but yesterday's brief reprieve that appears to be a bit of a bull trap.  Moreover, given the importance of developments in China and the oil market, it seems unreasonable to expect a recovery in North America today as there was yesterday.

Indeed, the risk is that US economic data disappoints.  There are two real sector reports that are the most important, namely retail sales and industrial production.  Headline retail sales will likely be weighed down by falling gasoline prices and small decline in auto sales on a sequential basis.  In addition, the unseasonably warm weather in much of the country likely dampened the usual winter clothing purchases.  The GDP component, which excludes autos, gasoline and building materials, likely did better, but there is downside risks to the consensus 0.3% forecast after a 0.6% rise in November.

Industrial production may also disappoint as the energy sector, and weaker utility demand takes a toll.  The consensus forecast a 0.2% decline in December output.  Coming into December industrial production fell every month last year but July and August. 

Manufacturing has held up a bit better.  It is expected to be flat in December as it was in November.   Manufacturing output fell in five of the first 11 months of 2015 and was unchanged in two months.  The divergence between the industrial and service sectors persists.  

The US also reports producer prices and the Empire State manufacturing survey. Although the latter is among the first reads for January, both reports will be overshadowed by the retail sales report. 

Three Fed officials speak today, Dudley, Williams, and Kaplan.  Dudley is the first among equals.  His observation in late-August that a rate hike was less compelling offered a good tell that the Fed was not going to raise rates in September.  The reasons the Fed gave for not hiking in September are becoming more relevant again, even though last week the US reported the largest monthly rise in jobs for the entire year. 

The markets are unsettled, to say the least, and US market-based measures of inflation expectations are falling. The 10-year breakeven (the difference between the conventional yield and the yield of an inflation-linked note) is more than 10 lower than it was at the September FOMC meeting.  Growth in the US economy appears to be tracking something less than 1% at an annualized pace in Q4, according to the Atlanta Fed.   The January FOMC meeting is not seen as live, but market participants cannot be confident of a March hike either. 

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