Dollar and Bonds Stabilize; Equities not Yet

The US dollar is paring yesterday's gains, and the 10-year Treasury yield has slipped back below the 2.70% level after pushing 2.73% briefly.  European bonds have also eased, with yields one-two basis points lower.   It is thus far a mild Turn Around Tuesday but suggests that the market psychology that has driven the dollar lower and yields higher persistently since mid-December have not been broken.  

One implication is that since these markets do not act in a vacuum is that equities will likely also recover, though it is not evident yet.  The MSCI Asia Pacific Index pulled back by a little more than 1% for the largest loss since early December.  No regional market was unscathed, though the regional leader has been Korea's KOSDAQ and it was down marginally (almost 0.7%), leaving it up 15.3% so far this month.   The Hong Kong Enterprise Index that tracks China's  H-shares fell nearly 2% to bring this month's gain to a still-amazing 14.4%.  

In Europe, the Dow Jones Stoxx 600 gapped lower.  It is trying to fill that gap in the early turnover, but all the main bourses are still lower on the day, and the S&P 500 is trading about 0.25% lower.  

The news stream is picking up.  Japan reported employment and consumption, while the focus in Europe is on Q4 GDP, but also Germany's preliminary inflation reports ahead of tomorrow's advance estimate for EMU.   In the US, the focus is on President Trump's first State of the Union speech.  

Japanese unemployment unexpectedly ticked up to 2.8% from 2.7%, but it appears to have been driven by people leaving jobs, which is also in this context, a sign of the tightness of the labor market.  Jobs-to-applicants rose to a new high of 1.59 from 1.56.  On the other hand, overall household spending was poor.  In December, it stood at -0.1% year-over-year.  The median in the Bloomberg survey was for a 1.3% rise after 1.8% in November.  Retail sales held up better, rising 0.9% rather than fall by 0.4% as the median had forecast. 

In the eurozone, Q4 GDP was in line with expectations.  It rose 0.6% for a 2.7% year-over-year rise.  The asymmetrical risk we thought was on the upside, but this impulse was picked up in Q3, with an upward revision to 0.7% from 0.6%.   German states reported January CPI figures and the national one will be reported shortly.   German inflation typically falls in January.  A 0.7% decline is needed to keep the year-over-year pace steady at 1.6%.  The risk may be on the downside after the states' reports. 

The shape of the dollar's pullback will give a better indication of whether or not the long overdue technical correction is at hand.  A move above $1.2440-$1.2460 might see the euro rechallenge its recent highs above $1.25 and probe into the band of technical objectives that extends from around $1.26 to $1.28.  Sterling needs to overcome the $1.4120-$1.4160 area to reignite the move higher.  Most observers cannot feign surprise that new official studies suggest that under numerous scenarios, after Brexit the UK will be poorer.  A break of the JPY108.00-JPY108.30 would be understood as extending the greenback's slide.  The key level in the Dollar Index is a little below 89.00.

Three key events still lie ahead.  First is the preliminary EMU CPI.   It will be reported tomorrow.  Any disappointment will likely weigh on the euro, while an upside surprise, especially in the core rate, will send the single currency higher.

Second is the Yellen's last FOMC meeting.  A hawkish hold is the most likely scenario.  It seems politically naive to suggest Yellen may unveil a new initiative, such as a rate hike or announcing a press conference after every meeting (like we have been urging).  Institutionally, it is better that the new chair announces whatever changes there are going forward.  

The third is the US economic data--auto sales and the employment report.  Both are showing late cycle symptoms.  Though occasionally masked by short-term volatility, the 12-month moving averages are gradually turning lower. 

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