Week Closing on a Disappointing Note

Overview:  A string of disappointing economic is spurring risk-off sentiment today.  Global shares prices are being punished and core bonds are being snapped up.  The US dollar is trading higher against most major and emerging market currencies.  The MSCI Asia Pacific Index was flat on the week coming into today's session.  Many of the large markets were off 1.5-2.0% today, and the benchmark is off for the eighth week in the past ten.  European shares are getting knocked back.  The Dow Jones Stoxx 600 had been up about 1.2% this week but has given it all back and a little bit more.   US shares trading lower in Europe, and the S&P 500 is off around 1%.  Core bond yields are a two-three basis points lower, while the US 10-year yield is off four basis points near 2.88%.   Near 97.55, the Dollar Index is up a little more than 1% on the week, which, if sustained, would be the largest gain in four months.  

Asia Pacific

Business sentiment was little changed in Japan, but the Q1 19 outlook weakened slightly, according to the latest quarterly Tankan survey.  Capex plans, though, were stronger, as large businesses anticipate a 14.3% increase up from 13.4%.  Many had expected a decline.  Although the large manufacturers revised higher their dollar forecasts for this fiscal year, they bearish.  The exchange rate is expected to average about JPY109.40 this fiscal year, up from JPY107.40 forecast in September.  Thus far in the fiscal year, the dollar has averaged nearly JPY111.15.  The indicative forward for the end of Q1 19 is about JPY112.40.   After the data, the BOJ announced it would reduce the 5-10 year JGBs that it will be next month, the first reduction of this maturity bucket since mid-year.  

China reported disappointing retail sales and industrial output figures today.  It suggests that the world's second-largest economy is weaker than economists appreciated.  Retail sales slowed to 8.1% fro 8.6%, which appears to be the weakest pace since 2003.  Industrial output slowed to 5.4% from 5.9%.  This matches the slowest since 2002.  It is possible that the stimulative measures are not working, which many are suggesting.  Yet it seems more likely that it is too soon to make such a judgment.  

Australia's preliminary December PMI warns of a poor momentum going into the New Year.  Declines in both manufacturing and services drove the composite to 52.4 from 53.9.  It has averaged 53.6 in Q4 and 53.6 for the entire year.  Last year it averaged 55.6. The RBA is expected to remain on hold into 2020, but the risk of a cut seems higher than appreciated, especially if trade tensions escalate next year and China's slowdown deepens.   

There is little enthusiasm for the yen despite the heavy equity tone and lower yields.  The greenback is in about a quarter yen range today, straddling JPY113.50, where there is a $610 mln option struck that is expiring today.  There are $1.4 bln in an option at JPY113.75 and $460 mln at JPY114.00 that also expire today.  The risk is on the downside, and initial support is seen around JPY113.00.  The Australian dollar is at its lowest level since the start of November as it approaches $0.7155.  The intraday technical indicators warn against chasing it lower. Some corrective upticks can carry it back to the $0.7180-$0.7200 area.  

Europe

True to form, the euro weakened in response to Draghi's comments.  The market took his warning that risks were moving to the downside as a reason to sell the single currency back toward the lower end of its recent range after initially pushing it to almost $1.1400. Draghi acknowledged that inflation was also likely to work its way lower in the months.  The forward guidance indicated that the reinvestment of maturing proceeds would continue until well past the end of QE was modified to well past the first rate hike.  This seems mostly technical, and reinvestment phase was expected to last at least a couple of years.  The revisions to growth and inflation forecast were minor.  Given the magnitude of the misses, changing a forecast by 0.1 of a percent gives the illusion of greater precision than is justified. The introduction of the 2021 forecast for the first time at 1.5% GDP and 1.8% CPI should be understood as medium-term trend growth and stable prices.

The flash eurozone December PMI was dismal.  It is not simply that expectations were not met, but the French composite PMI fell below the 50 boom/bust level since June 2016.  The Yellow Vest demonstration may have exacerbated the economic challenge, and the action is expected to continue this weekend, though, after the Strausbourg attack, the government may try to ban the protests.  The French manufacturing and service PMIs fell below 50 and the composite dropped to 49.3 from 54.2.  German reports softened.  The manufacturing PMI slipped to 51.5 from 51.8.  German services slowed to 525 from 53.3.  The composite eased to 52.2 from 52.3. The flash composite reading for EMU fell from 52.7 to 51.3, the lowest in four years. 

The euro has been sold to new lows for the month.  It is trading below $1.13 for the first time since November 28, when $1.1265 area was approached.  The intraday technicals suggest the downside momentum may have been exhausted in the European morning, or nearly so.  However, there is a 1.1 bln euro option at $1.1300 that is expiring for which there may be a battle over.  Above there, resistance is seen in the $1.1320 area.  Of the past 12 weeks, including this one, the euro has fallen in nine.   

Net-net little seems to have changed on Brexit this week, except that the failed attempt to oust May protects here from another attempt until the end of next year.  The Prime Minister still has an agreement that the EC is reluctant to change that will not be accepted by Parliament.  Preparations for no-agreement have to be stepped up.  Sterling had recovered about 1.25% against the dollar over the past two sessions, but what appeared to be mostly short-covering has ended, and new sellers have emerged.  Initial support is near $1.2555, but if broken, there is little in the way of the week's low near $1.2480. The $1.2630 area may offer reasonable cap today, ahead of the large GBP1.2 bln $1.2650 expiring options. Unless there is a dramatic reversal, this will be the fifth consecutive week that sterling has depreciated against the dollar.   

North America

There is a deluge of data today, and the data will likely underscore the resilience of the US economy.  The most important reports are the November retail sales and manufacturing output.  The GDP components in the retail sales report have averaged 0.3% through October compared with 0.4% for the first ten months of 2017.  Next week's personal consumption report likely see some payback for the outsized 0.6% increase in October, the biggest since March.  However, the take away is that the labor remains strong which is helping fuel consumption even if wealth effect from the stock market has wobbled.  Manufacturing output has averaged a 0.3% gain over the past three months, accelerating a little from the 0.2% average this year and 0.1% average in the same year-ago period. 

The weekly jobless claims are among the most real-time reads on the economy.  While changes to the rules that govern access to these state benefits make long-term comparisons difficult.  Still, the recent rise fed into the market's pessimism and the recession-risk narrative.  The holiday period may inject extra noise into this noisy report, though the data is seasonally adjusted. The 27k decline in initial claims last week was well more than expected, and at 206k, it is not even a stone's throw from the cyclical low see in September at 202k. As we will more forcefully argue in the coming days, expectations of a dovish hike seem to risk repeating the mistake made several times this year of consistently being more dovish than the Fed.

The US dollar is firmer against the Canadian dollar and is testing the CAD1.34 area.  Barring a setback in North America today, the greenback will post its fourth consecutive weekly advance against the Canadian dollar.   Despite mentioning it before, the re-adjustment of the exchange rate has drawn little attention.  The US dollar has risen against the Canadian dollar in every week here in Q4 except one.  The Canadian dollar may suffer more as risk assets are sold, but caution is warranted.  First, the Canadian dollar often does better on the crosses when the greenback steps up.  Second, the two-year interest rate differential, which widened around 25 bp in the US favor since the end of Q3, has fallen five basis points this week and is nearly 10 bp from its pack.  Near 65 bp now has returned to the 20-day moving average.  

The Dollar Index recorded this year's high on November 12 near 97.70.  It closed above 97.50 that day but has not managed to do so again, though it has approached the area several times over the past month.  It reached almost 97.60, but the intraday technical indicators warn that the market's enthusiasm may wane in the remaining hours ahead of the weekend.   The S&P 500 is poised to gap lower at the opening.  The 2620 area may offer the first line of defense, and a close below 2600 would look be an ominous sign for the start of next week.  The inability to sustain a bounce after last week's 4.6% slide may discourage investors ahead of year-end.  

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