Markets Calm; Waiting For...?

The global capital markets are quiet today, as investors await fresh impetus which could come in the form of tomorrow's US national employment figures.  There is also next week's ECB meeting that looms large for investors.  

The euro is trading quietly.  In fact, through the European morning, the euro has been confined to a little more than a third of a cent above $1.0850.   It has not been above $1.09 since Monday, and despite contrasting economic signals, and the anticipation of more easing by the ECB, the single currency has not been pushed through $1.08.  

The dollar is straddling the JPY114.00 range, inside yesterday’s range. With a little more effort to test the nearby cap in the JPY114.55-JPY114.85 range, the five-day moving average could cross above the 20-day average for the first time since early February.  

Sterling extended yesterday's recovery to poke briefly through $1.4100 and reached its highest level since February 23.  The $1.4125 area corresponds to a retracement objective since EU Summit that struck the agreement with Prime Minister Cameron, which was shortly followed by London Mayor Johnson's decision to campaign for Brexit.   

Although sterling's advance is mostly about market positioning and the unwinding of some momentum trades, including on the crosses, macro considerations have stalled its recovery. The service sector PMI today completed the trifecta of disappointing reports. All three--manufacturing, construction, and services--all came in below expectations.  The service PMI was expected to soften a little from the January 55.6 reading.  It actually fell to 52.7, the lowest in about three years.   

The surveys warn that the UK economy may be losing some momentum prior to whatever disruptions the Brexit uncertainty generates.   However, positioning is still key and sterling may prove resilient to the disappointing economic news after the knee-jerk reaction as it has done in recent days.  

In contrast, the eurozone service PMI was better than expected.  Recall that flash reading was 53.0.  This has been improved to 53.3 but is still down from the 53.6 reading in January and the 54.2 December results.  Germany saw its flash revised upwards (55.3 vs. 55.1) while France was revised down (49.2 vs. 49.8).  Both Italy and Spain came in a little better than expected.  The composite PMI was lifted to 53.3 from 53.0 in the flash report; it is still the lowest reading since January 2015.  The euro was not impacted by the service PMI reports.  

Given how the year began, with steep stock market losses, new lows in oil, and uncertainty but weak impulses from China, it is hardly a surprise that sentiment measures, in general, were undermined.  Investors need to be sensitive to the potential that the survey are weaker than the actual macro data.  The hypothesis then would be that sentiment can recover provided the markets continue to stabilize.  Another way to think about it is that if the tightening of financial conditions are relaxed, the real economic impact could be modest.  

Meanwhile, the Australian dollar continues to outperform.  Helped by a smaller January trade deficit (A$2.94 bln vs. A$3.2 bln consensus) and a rise in the service PMI (51.8 vs. 48.4) helped lift the Australian dollar above $0.7300 to its best level of the year. Rising commodity prices, including iron ore, may have also help underpin the Aussie. The highs from last September and December in the $0.7380 area is the next major technical area of significance.   

What is also impressive about the string of favorable Australian data and the gains in the Aussie is that they are coming despite continued weakness in the China's PMIs this week.  Earlier today the Caixin service PMI was reported at 51.2 from 52.4.  Recall the government's measure eased to 52.7 from 53.5.  The results raise concern that the weakness in the manufacturing sector may be now serving as a drag on the service sector.  

Previously, the resilience of the service sector had been seen as a function of the transition in China away from manufacturing and toward services.  As we noted previously, falling producer prices may have exaggerated the transition away from manufacturing.  Chinese stocks were narrowly mixed while the yuan strengthened slightly.  

Oil prices remain firm near eight-week highs.  The market appears to be putting more emphasis on US output than inventory accumulation.  While Saudi Arabia, Russia, and a few others have agreed to freeze output at the elevated January levels, US output has fallen.  With yesterday's government report, the cut in output has extended for the sixth week and now is at its lowest level since November 2014.  

At the same time, the government reported that inventories rose by a dramatic 10.4 mln barrels.  This is more than a day's output (roughly 9.08 mln barrels a day).  Inventories in Cushing rose for the fifth week and are at new record highs.

One of the consequences of the recovery in oil prices is rising 10-year break-even measure of inflation expectations.  The difference between the 10-year conventional yield and the inflation-linked securities is thought of a handy metric of inflation expectations, even though it is among the worst forecasting tools for CPI that the San Fransico Fed looked at within 48 hours of the September 2015 FOMC statement that explicitly cited market-based measures of inflation expectations. 

Recall the 10-year breakeven had dipped below 1.20% on February 10.   The 10-year break-even has risen nine consecutive sessions coming into today.  Pushing through 1.52%, it is at its highest level since January 11.  If it continues to recover, look for the Federal Reserve to recognize this in its statement in a couple of weeks. 

Although several US economic reports are on tap for today, barring a significant surprise, they might not offer much new news, and the market’s focus in on tomorrow employment data.  Among the reports, which include weekly jobless claims, factory orders, and the final January durable goods orders, Markit’s final service and composite report, and the ISM non-manufacturing, the ISM may have the greatest potential to impact activity. 

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