Anxiety? What Anxiety?

The US dollar is finishing the week on a mixed note in choppy activity in narrow ranges.  It is an apt way to finish this week, which has been largely directionless as investors wait for fresh incentives, and are especially looking toward Trump's speech to a joint session of Congress next week.  

It is hard to find evidence this week of political angst in Europe, where the first national election is three weeks away.  The benchmark 10-year Dutch bond yield is off 11 bp this week, as is France.  The premiums over Germany have narrowed a little.  

The two-year sector is a different story.  Few can keep up with the demand for German paper.  The German two-year yield fell nine basis points and draws closer minus 1.0%.  French and Dutch yields are only 4-6 bp.  Part of Germany's outperformance, we argue, is part of the scarcity that is derived from the German fiscal position, Eurosystem purchases, and the use of German paper for collateral as well as investment.  

Still, regardless of the reason that German rates are falling, the widening discount it offers vis a vis the US, weighs on the euro.  The euro fell to one-month lows in the first half of this week but has drifted higher in the second half of the week.  It is struggling to reestablish a foothold above $1.06.  A little above there (~$1.0607) is the 61.8% retracement objective of the decline since last week's high near $1.0680.  The German discount to the US on two-year rates is at 2.13% now.  It is widened for the fifth consecutive week.  

Despite the Fed signaling a rate hike fairly soon (but not at the next meeting), the movement on the spread is coming from the German leg more than the US leg.  In fact, this is the second week that the US two-year yield is declining.  The US yield is off a single basis point this week, coming into today, while the German yield is off 10 bp.  

The tenth successive gain in the US Dow Jones Industrials yesterday, the longest streak since 1987 failed to lift global equity prices.  Like the Dow 20k level, the significance is exaggerated.  It does not really tell investors anything they did not already know.  Global equities are enjoying a strong start to the year.  The MSCI Asia Pacific Index slipped almost 0.5%, snapping a four-day advance, but extended its rally for the fifth consecutive week, reaching levels not seen since mid-2015.   MSCI Emerging market equity index also has a five-week rally in tow.  Having completed the last full week in February, the Emerging market equity index has fallen in only one week so far this year.  

Dow Jones Stoxx 600 is trading heavily for the third consecutive session, but it poised to finish higher for the third consecutive week and the fourth week in the past five. The S&P 500 is no slouch. It has gained for the past four weeks.  It has fallen in two of the year's eight weeks counting this week.  This holiday-shortened week has seen the S&P 500 chop higher and is entering today with a 0.5% gain on the week at stake.  US shares are trading lower in Europe, and the S&P 500 is expected to open with a downside bias.  

The Chinese yuan is flat this week.  After aggressive rhetoric about naming China as a currency manipulator and the feint of recognizing Taiwan, the Trump Administration has changed tactics.  It has endorsed the one-China policy, and Treasury Secretary Mnuchin indicated that no judgment would be made until the semiannual report is made in April.  Under the current criteria, by intervening to strengthen rather than weaken the yuan, China is not a currency manipulator.  There is talk of an effort to take a different approach; one that focuses on valuation rather than manipulation.  

Even on this measure, it is hard to say that the yuan is out of line.   Investors seem to recognize this, and when coupled with elevated capital controls, the downside pressure on the yuan appears to have eased.  Here the tell may not be spot so much as the 12-month forward, where the points have steadily fallen over the last four weeks, the longest decline in eight months.  Also, the 12-month implied volatility has eased to nearly 6%, the lowest since the end of 2015.  

The UK market does not seem overly impressed with the results of the two by-elections held yesterday.  As the polls warned, the government picked up a seat from the opposition party for the first time in years.  On the other hand, Labour held off a challenge by UKIP in an area in which Brexit camp easily carried the referendum.  The uphill fight for UKIP to win seats in Westminster reinforces our sense that despite the spin, the UK has not truly embraced the populist-nationalist moment as much as the hard Euro-skeptic wing of the Tories managed to oust the soft Euro-skeptic wing, with admittedly far-reaching implications.  

In the US, Trump's populism-nationalism has been retracted in several areas of foreign economic policy, but next week poses an important test.    An important issue is the border adjustment (a tax on imports and no taxes on exports).  Leave aside the fact that the WTO allows for border adjustments for taxes but not for trade and the legal challenges that most likely would ensue; it does not appear that in its present form it can be approved by a simple majority in the Senate.   Treasury Secretary Mnuchin gave the noncommittal response yesterday about it and the strong dollar policy:  There are good and less good consequences.  However, late yesterday Trump said he support some kind of border adjustment, though he and Mnuchin noted the complexity of the current approach.  

The largely inexperienced Trump team have their hands full.  There is the confirmation process for a Supreme Court justice.  There is the repealing and replacing of the national health care.  The debt ceiling and spending authorization limits are being approached and will need to be addressed. Mnuchin indicated yesterday a desire to see the tax reform before Congress' August recess.   That means that impact is more of a 2018 event and the same with the infrastructure initiative.  Politically it may be more desirable to wait for next year and deliver the Democrats (and less sympathetic Republicans) a fait accompli during the off-year election period.  Could they, would they deny Trump of success by blocking fiscal stimulus that creates jobs?  

The US reports new home sales and the University of Michigan's consumer confidence and inflation expectations survey.  Earlier this week, January existing home sales rose 3.3% (three times more than expected and the December series was to show a smaller decline of 1.6% rather than 2.8%).   New homes sales fell by an outsized 10.4% in December and are expected to have bounced back in January (median forecast is 6.4%).  

Canada reports January CPI figures today.  The headline is expected to rise 0.4% and lift the year-over-year rate to 1.6% from 1.5%.  The base effect may ease starting with the March report.  In any event, the report is most unlikely to impact expectations for next week's Bank of Canada meeting.  Bank of Canada is widely seen on hold for some time.  

Lastly, note the heavy option expiry schedule today.  In the euro, every 25 points between $1.05 and $1.0575 see chunky expirations.  At $1.05, its is nearly 800 mln euros, at $1.0525 503 mln euros, at $1.0550, 1.5 bln euros of options expire, and at $1.0575 another nearly one billion euro.  In dollar-yen there relevant expirations are JPY112.30 ($405 mln), JPY112.50 ($470 mln) and JPY112.75 ($970 mln).  




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