Fed Unleashes Animal Spirits

Overview:  The Fed's hawkish pivot came a few weeks before yesterday's FOMC meeting, which confirmed more or less what the market had already largely anticipated. Buy the (dollar) on rumors (of tapering and more aggressive stance on rates) and sell the fact unfolded, and unleashed the risk-appetites which rippled through the capital markets. US stocks rallied yesterday, and the futures point to a gap higher opening today. Large Asia Pacific bourses, led by a 2% rally in the Nikkie advance. Australia, despite strong jobs growth, as did New Zealand, while India struggled. Still, the MSCI Asia Pacific Index snapped a four-day slide. Europe's Stoxx 600 gapped higher. The bond market remains subdued. The US 10-year yield is hovering around 1.44%, while European yields are slightly firmer ahead of the ECB meeting. The dollar is on the defensive. The risk-on is reflected by the dollar bloc's relative strength and the Norwegian krone. The latter is drawing some support from the 25 bp hike by the Norges Bank. The yen is the laggard, and the dollar has held above JPY114.00. The euro has approached the week's high (~$1.1325). Most emerging market currencies are firmer, though Deputy Ministers in Treasury and Finance dismissals have seen the Turkish lira shed another 2% ahead of the central bank announcement. Gold recovered after approaching $1755 yesterday but appears to be stalling near $1787 today. January WTI is firm but in a narrow range, mostly between $71.40 and $71.95. US natural gas is rising for a second session though it remains below $4. Europe's natural gas benchmark is retracing yesterday's loss. It is up nearly 22% this week alone. Iron ore is higher by around 4.2%, enough to recoup the past two day's losses plus some. Tomorrow it will close out its fifth week of gains. Copper prices slid 1.75% yesterday, culminating a five-day drop. Today it is up nearly 2%.

Asia Pacific

Three developments in Japan to note. First, the November trade balance deteriorated as the seasonal pattern dictates. The deficit widened more than expected (to JPY955 bln from 68.5 bln). Exports, up 20.5% year-over-year, were softer than economists projected, while imports soared 43.8%, surpassing the forecast for a 40% gain. Despite the yen being the weakest major currency this year, Japan is running a deficit three times larger than last year and about half as large as 2019. Second, as the Tankan survey suggested, while the economy enjoys some momentum, there are doubts whether any fundamental corner has been turned. The preliminary December PMI showed a moderation in activity. The manufacturing PMI slipped to 54.2 from 54.5, and the services PMI eased to 51.1 from 53.0. This pushed the composite to 51.8 from 53.3. Third, foreign investors bought Japanese bonds in size (~JPY1.16 trillion) for the second consecutive week. And in the two-week period purchased the most in five months. This seems like year-end activity and may be part of unwinding structures that may have been behind the rise in repo rates earlier this week. 

Australia reported a dramatic improvement in the labor market last month. Recall that Australia had lost about 360k jobs in the previous four months as the social restrictions and lockdowns were disruptive, and that was before the emergence of omicron. It reported that 366k jobs were filled in November, well above the 200k median expectation in Bloomberg's survey. This included what appears to be a monthly record of full-time placements of 128k. The unemployment rate fell to 4.6% from 5.2%, and the participation rate jumped to 66.1% from 64.6% (the highest since June). Less inspiring was the flash PMI, which showed moderating activity. The composite slipped to 55.1 from 55.7.  

A large option ($2.9 bln) struck at JPY114.25-JPY114.30 appears to be slowing the dollar's ascent. It expires today. The five-day moving average is poised to cross above the 20-day moving average tomorrow or early next week. The greenback has held above JPY114.00  for the first day since November 25, when it had held above JPY115.00. That said, without more help from US Treasuries, it may struggle to sustain the momentum. The Australian dollar is building on yesterday's recovery. It is testing the $0.7200 area. The (38.2%) retracement of the Aussie's slide since the end of October is found slightly below $0.7210. The next retracement (50%) target is near $0.7275. Here, the five-day moving average has crossed above the 20-day moving average for the first time since early November.   The Chinese yuan edged slightly lower today. The dollar stayed on the CNY6.36 handle for the third consecutive session. The PBOC set the dollar's reference rate at CNY6.3637, slightly firmer than the CNY6.3627 median projection in Bloomberg's survey. Note that the implied volatility for the offshore yuan has been easing since the reserve requirements were raised for foreign exchange holdings. It is around 3.3% today, the lowest since early November. 

Europe

Wouldn't the ECB like t0 pull off what the Fed just did? Its hawkish pivot was declared, and the two-year yield finished essentially flat on the day? The ECB has a tighter line to walk than the Fed. Its balance sheet was expanding before Covid, and it will continue to do so after the emergency program formally ends in March. ECB President Lagarde is likely to confirm that. The issue about what happens after may not be decided until next year. Given the uncertainties around the delta and now omicron variant, it may be the prudent course. At the same time, the new staff forecasts will be presented and extended for the first time to 2024. If there is a single macro driver at the moment to track to help understand the euro's direction it may be the two-year interest rate differential. It reached the highs for the year on December 7 at 140 bp. It may be an early signal corrective/consolidative phase if the stalled momentum is not reignited. 

The higher than expected CPI (4.6% on the measure that includes owner occupiers' housing costs) and the IMF's call for the BOE to be more hawkish spurred the market to raise the odds of a BOE hike from about less than 1 in 5 to more than 1 in 4. Still unlikely but less so.   October's mostly disappointing real sector data warns of a new economic soft patch. Moreover, delta covid cases were on the rise even before omicron emerged. Whatever damage to the markets' goodwill or the BOE's credibility happened last month. The market almost seems disinterested. That said, a hike now would seem like a poke at the scar damage inflicted in November. In any event, a hike appears fully discounted for February and a bit more than three hikes priced by the end of next year. 

Given the central bank meetings, the preliminary PMI readings are being overshadowed. Still, the takeaway from the eurozone is that activity slowed a bit and the German service sector was particularly weak, which likely speaks to the delta surge. The aggregate manufacturing PMI eased to 58.0 from 58.4. Germany's actually ticked up to 57.9 from 57.4. The aggregate services PMI was weaker than expected, falling to 53.3 from 55.9. The German services PMI fell below the 50 boom/bust level to 48.4, the weakest since January.   The aggregate composite was dragged lower to 53.4 from 55.4, the lowest since March. Lastly, we note that the October trade surplus of 2.4 bln euros was less than half of what economists projected and the smallest since April 2020. It was the third consecutive decline. This year's trade surplus is about 1/3 smaller than the 2019 and 2020 pace.  

The UK's preliminary PMI also looks to have been impacted by the delta surge. The manufacturing PMI eased (57.6 vs. 58.1) but was in line with expectations. However, the services PMI fell to 53.2 from 58.5, well below forecasts and the weakest since February. The composite also stands at 53.2 (down from 57.6). Tomorrow the UK reports November retail sales, and a 0.8% gain is expected. 

The euro recovered smartly yesterday after falling to almost $1.1220 to record a new low for the month. It stopped shy of $1.13 but poked above it in early Asia and reached nearly $1.1320 in the European morning. Recall this is the resistance area seen in the past 4-5 sessions. Some of the price action may have been influenced by the hedging of some large options that expire tomorrow. There are roughly 2.45 bln euro options at $1.13 that expire before the weekend. Sterling is also extending yesterday's recovery that began from around $1.3175. Today it poked above the 20-day moving (~$1.3290) average for the first time since late October. Like the euro, the momentum appeared to have stalled early in the European morning, ahead of the central bank meeting outcomes but could mark the top of what seems to have been a short-squeeze.  

America

The Fed validated market expectations. First, it doubled the pace of tapering. It will be done at the end of Q1 22.   That means it will still be buying $180 bln of Treasuries. The growth and inflation profile were upgraded, and the median Fed forecast now looks for three hikes next year. This is more or less what was expected and maybe a touch more. Hence, the implied yield of the December 2022 Fed funds futures contract rose by 5.0 bp to 74.5 bp. Powell did not refer to inflation as transitory, but he also shunned the idea that it would be persistent. He cited approvingly the Blue Chip survey anticipating inflation to be below 2.5%  by the end of next year, which aligns with the Fed officials' individual projections. It may have been among the first times that a Fed chair has drawn attention to the Summary of Economic Projections (aka dot plot), though retained the traditional caveats, including that they are subject to large swings.   Recall that President Biden is likely to make as many as three nominations to the Board of Governors in the coming days, and replacements for the Dallas and Boston regional Fed presidents are also expected to be announced shortly. That means there is potential for five dots to change in March.  

The US reports a slew of data today. It includes weekly initial jobless claims, housing starts and permits, and the Philly Fed manufacturing survey. Then comes the industrial production and manufacturing output figures, followed by the preliminary PMI, and finally the Kansas Fed manufacturing survey. The early data will be overshadowed by the ECB press conference. But, in general, the US economy appears to be accelerating after the softer growth in Q3.

Mexico's central bank meets today. Most still expect a 25 bp rate hike, which would lift the overnight target to 5.25%. Several other countries in the region are hiking more aggressively than Mexico. Nevertheless, the peso is the strongest currency in Latam this year, with its roughly 5.25% decline. For example, Brazil, which has hiked rates more aggressively, has seen the real depreciate by 8.5%. This is Banixco Governor Diaz's last meeting, but few expect a 50 bp move. Still, the swaps market has a little more than 75 bp of hikes priced over the next three months.  

The US dollar reversed lower yesterday against the Canadian dollar but only after spiking to almost CAD1.2940 to approach the year's high set on August 20 (~CAD1.2950). It settled on its lows (~CAD1.2835) and fell toward CAD1.2780. The CAD1.2775 area is the (50%) retracement of the bounce since December 8 low near CAD1.2610. Below there, the (61.8%) retracement is found closer to CAD1.2735.   The dollar is straddling the MXN21.00 area in subdued activity. The dollar came off hard yesterday from the MXN21.36 area, a nearly two-week high to finish on its lows just above MXN21.00. We suspect the greenback can recover and look for gains above MXN21.10 to signal a low is in place, barring a surprise 50 bp hike from Banxico.   

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