Dollar Consolidates Losses, Peso Firms while Yuan Reverses

The US dollar is consolidating yesterday's losses against the major currencies, giving it an apparently firmer tone today ahead of the monthly employment report.   Even though the Turkish lira continues to be sold to new record lows, the focus in the emerging markets in recent days has been the Mexican peso and Chinese yuan.  

Mexico's central bank is believed to have intervened in the Asian session for the first time.  This is helping the peso stabilize now.  Still, its 0.4% gain against the dollar (~MXN21.33), only manages to pare this week's loss to 2.9%.  The major trigger this week has been tweeted by the US President-elect objecting to investment in Mexico by the auto industry.    Since NAFTA and the loss Canada's preferential treatment, as well as Mexico's trade agreement with the EU, auto production is organized on a continental basis and Mexico now accounts for roughly 40% of the auto jobs in North America.  

Last February, when Mexico last intervened, the central bank also raised interest rates 50 bp between meetings.  Energy tax increases went into effect at the start of the year.  This coupled with the drop in the peso will likely boost price pressures.  The risk of a rate hike before the February 9 meeting rises if the intervention.  

Next week Mexico reports December CPI.  The year-over-year rate is expected to rise to 3.4% (from 3.3%).  It would be the highest since late-2014.  However, raising rates to defend a currency is a limited strategy especially when the domestic economy is already struggling.  Next week, Mexico also reports December industrial production.  It was off.14% in year-over-year in November.    Another course open to it is to change the intervention tactics and take a page from Brazil's playbook and use swaps, which do not have a direct claim on reserves.  

China does not have the same limitation in this regard as Mexico.  It is not that its reserves are a multiple of Mexico's.  Instead, it is that Chinese can squeeze offshore yuan deposit rates sharply higher, to instill in speculators that the yuan is not a one-way market while having little impact on the onshore interest rates.  In any event, after the biggest two-day rally on record, the offshore yuan (CNH) fell 0.7% today, and the onshore yuan (CNY) slipped 0.6%.   On the week, CNH is up 2%, while CNY is up a little less than 0.4%.   Yesterday's gap created by the sharply lower dollar opening has been filled.  

Chinese shares are eased to pare this week's gains; the Shanghai Composite gained almost 1.9%.  Most Asian equity markets, save China, Japan and India posted small gains, but the MSCI Asia Pacific Index lost 0.2% after a two-day 3% rally.   European shares are also seeing this week's gains pared.   The Dow Jones Stoxx 600 is off 0.25% near midday in London.  Some markets are closed or thinly traded due to the holiday.  Most sectors are seeing profit-taking, though the real estate sector is bucking the trend.  

The FTSE 100 is at risk of snapping eight-day advance.    Real estate, information technology, and financials are leading the advance, while utilities, consumer discretionary and energy are among the largest drags.    Whether it manages to extend the winning streak or not may prove to be a function now of the market's reaction to the US jobs data.

The US Treasury market is also stabilizing after yesterday's rally that saw the 10-year yield fall nine basis points, the most since late June, following the UK's referendum and a little below the level that prevailed before the FOMC decision last month to hike its Fed funds target range.  JGBs were unchanged, while European bond yields are mostly firmer.  We note that DBRS is the only rating agency recognized by the ECB that accepts that Portugal is an investment grade credit.  It has suggested that rising yields are credit negative and the 4% yield threshold is seen as important.  The 10-year Portuguese benchmark pushed above there yesterday, it is slightly below there now, while the generic yield is still a couple of basis point north of it.  

There are a few economic reports released today to note.  The first was Japan's real cash earnings.  In November, they were 0.2% lower on a year-over-year basis.  This is a poor reading.  It is is the first negative reading for 2016.  The central bank is pushing for inflation, but without employers raising wages to compensate this is the result.  It could impact consumption and/or see a draw down in savings.  

Germany reported disappointing November retail sales and factory orders.  The 1.8% decline in November retail sales was twice the decline the Bloomberg median forecast.  It gives back more of the  2.5% rise in October than expected.  Still, the 3.2% year-over-year pace is respectable.  Factory orders fell 2.5% in November, which is a little more than expected and follows a 5% rise in October. Germany reports industrial output figures next week, today's data suggests small risks to the downside.  

The US and Canada report December jobs data and November trade figures.  The main focus is on the US employment.  We see downside risks, especially following the ADP, service ISM, Challenger figures and the trend in jobless claims.  The decline in jobless claims reported yesterday were likely skewed by the holiday and are well past the survey week for the non-farm payroll.   A disappointing headline non-farm payroll figure and a tick up in the unemployment rate that many expect could be blunted by a stronger than expected rise in hourly earnings.     Although it may be choppy,  we see the technical evidence aligned for additional corrective pressure on the dollar. 

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