Cautious Ahead of the Weekend

Overview: Investors have turned cautious ahead of the weekend.  The US dollar is firmer, stocks are struggling, bond yields are higher, and gold and oil are consolidating.  Profit-taking was seen in Asia Pacific equities, and even New Zealand, which reported its trade deficit flipped to a surplus in November, was unable to resist the profit-taking.  It and the Australian market fell by more than 1%.  Still, the MSCI Asia Pacific Index extended its advance for the seventh consecutive week.  European stocks are slightly higher, as it tries to extend the gains for a fifth session, during which time it has gained almost two percent.  US shares are little changed.  Coming into today, the Russell 2000 continues to lead the other benchmarks with around a 3.5% gain on the week.   Profit-taking is seeing benchmark yields rise mostly 2-4 bp in Europe, though UK Gilts are a notable exception, with the yield 1-2 bp lower.  The US 10-year is just below 0.94%.  The dollar is paring this week's losses.  Sterling is the heaviest of majors as UK-EU talks carry into the weekend.  The JP Morgan Emerging Market Currency Index may snap a three-day rally today, but barring an unlikely dramatic move, it is closing in on its seventh consecutive weekly advance.  Gold's recovery from the low near $1765 on November 30 reached almost $1900 yesterday but is stalling ahead of the weekend.  It is consolidating around $1880.  Crude oil is also consolidating, with the January WTI contract hovering a little above $48 a barrel.   It, too, is up for the seventh week in a row. 

Asia Pacific

There are two developments in Japan today to note.  First, deflationary pressures intensified.  The November CPI was the weakest in a decade.  The headline and core rates fell to minus 0.9%.  Energy was an important drag (0.6%) as electricity prices fell by 7.3%. Excluding fresh food and energy, the CPI was minus 0.3%. Note that the government suspended its Go-To-Travel initiative that offered discounts for domestic tourism, which had weighed on prices, due to the pick-up of the virus.  Second, and despite the deflation reading, the Bank of Japan left policy unchanged while extended its emergency lending program from March 2021 until September. The facility offers loans for zero interest rates with no collateral.  The BOJ said it will review its easing policy to make it more sustainable.  We do not see the BOJ's purchases of $6 bln from the MOF by the end of March as being untoward.  It seems prudent to have more dollars to lend to its banks if needed, as was the case in April and May when it depended on swap lines with the Fed.  It chose to buy the dollars from the MOF, which manages the more than $1 trillion in reserves.  If the BOJ had gone to the market, it would have been seen as an intervention.  

The US has signaled it will blacklist one of the most important Chinese semiconductor companies, SMIC.  Its affiliates may also be added.  Reports suggest that the Trump administration is considering adding as many as another 80 companies to its proscribed list. Beijing will respond to what it sees as a foreign attack with greater state-aid and commitment to developing and producing its own third-generation chips.  Meanwhile, China and the EU have reportedly agreed in principle to a bilateral investment treaty that will complement last year's trade agreement.  

A few hours after the US Treasury announced Taiwan was being added to its watch list for its large current surplus and growth in its reserves, the central bank left its target rate unchanged at 1.125%.  Taiwan is just emerging from deflation, and November headline inflation was positive on a year-over-year basis for the first time since January.  It is running a larger trade surplus, which drives the current account this year than last.  Through November, the monthly average is about $4.8 bln a month and $3.7 bln a month in the same 2019 period.  Taiwan argues that its trade surplus has risen as a direct result of US demand for tech products to circumvent the tariffs levied on mainland-made products.  They disagree with the US Treasury over the extent of the intervention, but the dollar value of reserves has risen by about $35 bln through last month to $513 bln.  They amount to about 4% of GDP.   The Taiwanese dollar is one of the strongest emerging market currencies this year, rising nearly 6.1% against the US dollar.  Taiwan officials seemed more irked by the citation than a prod to do more than reduce its bilateral trade surplus with the US.  

The dollar traded below JPY103 yesterday for the first time since March, and not a peep was heard from officials, who did speak up when JPY104 was busted last month.  Today the dollar has held above JPY103 and is testing the JPY103.60 area in the European morning.  A move above here would likely signal a push to JPY104.00, where an expiring option is struck for nearly $615 mln. The dollar's gain of about 0.4%, if sustained, could be the largest in nearly four weeks.   The Australian dollar reached a new high yesterday, near $0.7640.  Profit-taking in the local session pressured it to almost $0.7580 and threatening its first loss of the week. Yet, its advance is extending for the seventh consecutive week.   It is finding bids in Europe.  Initial resistance now is seen near $0.7620.  The PBOC's dollar reference rate was set in line with expectations (CNY6.5315).  The dollar has entered a consolidative phase against the yuan.  It has edged higher in seven of the past nine sessions.  The dollar is also moving sideways against the offshore yuan, and the CNH6.50 is becoming psychologically important.  

 Europe

Creeping, even if guarded, optimism that a new trade deal with the EU helped sterling rise for four consecutive sessions through yesterday.  Even with the modest pullback now, it has the makings of the best weekly performance of sterling since the end of July.   Some, but not all, of sterling gains are a function of the dollar's broad weakness, but it also nearly 1.1% higher against the euro. Like the Federal Reserve a day earlier, the Bank of England seemed more upbeat about next year, especially if a trade deal is in place.  The BOE left its policy-settings unchanged but left no doubt that it would ease policy if the end of the standstill agreement disrupts the economy.  We suspect this would be an increase in Gilt purchases, now running about GBP4.4 bln a week.  A rate cut is possible (the current bank rate is at 10 bp), but officials do not seem prepared to move it below zero.  

Following a call with UK Prime Minister Johnson, EC President von der Leyen said that while "substantial progress" has been achieved, "big differences remain: and a key area of fisheries remains unresolved.  Many observers shake their heads at the idea that the industry that accounts for less than 0.15% of the UK's GDP has proved so contentious.  This is a red herring.  It is like asking how important the heart is when it accounts for less than 0.5% of our weight.  For his part, Johnson said that talks with the EU were in a serious moment, and if the EU did not change its position, there might not be an agreement.   Note that UK business group CBI is asking for a grace period, seeking the EU to delay customs checks and paperwork because there is little time to prepare.  

There are two data points to note.  First, the UK November retail sales fell, but the decline was not as steep as economists expected.  Retail fell by 3.8% in November and by 2.6% when petrol is excluded.  The median forecast in the Bloomberg survey expected at least a 4% decline.   The social restrictions took a toll.  Second, the Germany IFO survey for December beat expectations.  The assessment of current conditions edged higher to 91.3 from 90, and the expectations component rose to 92.8 from a revised 91.8. The overall business climate measure rose to 91.3 from 90.0, which is the best since March.  

The euro is consolidating just below the highs seen yesterday, a little shy of $1.2275.  Today's low is roughly $1.2240.  The euro four-day advance is threatened by the consolidation, but the profit-taking is light. The euro is up almost 1.2% for the week, around $1.2255.  A large option for 2.2 bln euros at $1.2250 is expiring today but appears to have been neutralized.  For the first time this week, sterling has taken out the previous session's low.  The bout of profit-taking ahead of the weekend is not surprising given the uncertainty that hangs over the UK-EU talks.  Recall it finished last week near $1.3225 and straddled the $1.3500 area in the European morning.  Initial resistance may now be seen around $1.3550, with stronger support about a cent lower.  

America

Yesterday's unexpected rise in weekly jobless claims and the disappointing December Philadelphia Fed survey cap a string of poor data.  It began with the miss on the November jobs report. This week included a weaker than expected December Empire manufacturing survey, a big miss on retail sales (-1.1% vs. -0.3% median forecast in the Bloomberg survey), and a softer preliminary December PMI.  Housing remains a strong sector, helped by low-interest rates, and manufacturing is robust. The average rate on a 30-year fixed-rate mortgage is at a record low, 2.67%.  A year ago was more than 100 bp higher.  Output rose by 0.8%, twice what was expected after a revised 1.1% rise in October (initially 1.0%).   Even the Fed's Powell seemed cautiously optimistic after the first part of next year.  The Fed's newest forecasts revised higher growth in 2021 and 2022.  

Meanwhile, the US spending authorization expires at midnight today, and efforts to attach a stimulus bill to the new omnibus appropriations bill is not quite ready.  The choice seems to be between another short stop-gap bill or face a partial government shutdown over the weekend, which could be waived.  However, if it is waived, a deal needs to be delivered early next week.   Separately, although the defense bill was based with overwhelming support in both chambers, Trump is threatening to veto it and has until roughly Christmas Eve to do so.  Several Republican Senators will not override the presidential veto.   The dispute has little to do with defense and involves social media companies' liability for the content provided by users.  The drama is not over.  

Mexico's central bank left the target rate steady at 4.25% for the second consecutive meeting.  It turns out the vote was closer than expected.  There were two dissents in favor of an immediate rate cut, which means that the governor called the five-person board.  The majority wanted to see confirmation that inflation was moderating. At the same time, the recent decline may be simply the result of the discounts associated with the Buen Fin shopping celebration akin to Black Friday.  A new unknown will be added to the mix at the next meeting (February 11).  The Treasurer in the Finance Minister, Galia Borja, will replace a hawk Jaiveir Guzman who is retiring.   She will be the new deputy governor.  Given her nomination by President AMLO and her role at the Finance Ministry, she is thought to be a dove.   

Canada reports October retail sales today.  Only a small gain is expected after the 1.1% rise in September.  It is unlikely to push the Canadian dollar out of its consolidative range seen this week.  The US dollar was found to support a little below CAD1.27 and encountered offers in front of CAD1.28.  The greenback settled near CAD1.2770 last week, which was the four successive weekly advance.  The streak is at risk.  After testing the MXN20.25 area at the start of the week, the US dollar fell a little below MXN19.74 yesterday.  The greenback is firmer and initial resistance today may be around MXN20.00.  Since the end of July, the dollar has risen against the peso in only four weeks.  Trading around MXN19.88 leaves the greenback about 1.25% lower on the week.  

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