Overview: The more hawkish turn by the Federal
Reserve continues to ripple through the capital markets. Equity markets
are struggling to stabilize. Apple's earnings help its shares and
ecosystem stabilize. The MSCI Asia Pacific Index pared with this week's losses were helped by 2%+ gains in the Nikkei and Australia. Strong industrial production
figures helped Korea's Kospi. It pared its weekly loss to 6%, the most in
the region. All the sectors are trading lower in Europe's Stoxx 600 today
as the finishing touches are put on the fourth consecutive weekly
decline. It is off around 1.5% near midday. US futures are narrowly mixed, with the NASDAQ faring
best. Benchmark 10-year yields are firm in Europe and the US.
European yields are 2-4 bp higher, and we note that for the week, the Italian
premium over Germany narrowed and is virtually unchanged with the basis point widening today. The US 10-year
yield is 1.83%-1.84% The 10-year JGB yield rose to 0.165%, testing the
last couple years' high. It has not been above 0.20% since 2016.
Foreign investors sold the most Japanese bonds last week since last
September. The Scandis and dollar bloc are bearing the brunt of the
greenback's broad strength today. The dollar's weekly gain ranges from
around 1% against Norway to 2.7% against Sweden. Most emerging market
currencies are lower too. Of note, today India, Russia and China are
seeing small gains against the dollar. The JP Morgan Emerging Market
Currency Index is snapping a three-week advance. Rising yields are sapping
the appeal of gold. It tested $1850 earlier this week and is now near $1786. It looks set to test the month's low a little below
$1783. March WTI is quiet as it puts the finishing touches on its sixth
consecutive weekly advance. US natural gas went on a wild ride
yesterday. A powerful short squeeze saw the expiring February contract
rise by over 70% yesterday. The generic contract was up almost
46.5%, while it is off almost 30% today. Net-net, it is up around 11% for the
week. Europe's benchmark is 2.5% higher on the day, which brings the weekly
gain to about 17.5%. Iron ore prices were virtually flat on the week
before today's 6% advance. Copper prices are heavy and now breaking below
the 200-day moving average ($438).
Asia Pacific
Mainland Chinese markets
will be closed next week for the Lunar New Year celebration. Over the weekend, the January PMI and
Caixin manufacturing PMI will be reported, and are expected to have
softened. The lockdowns are taking a toll. Recall that China
reported stronger than expected growth in Q4 21 (1.6% vs. 1.2% expected and
0.2% in Q3). Still, it is clear that officials are pushing different
levers to induce stronger growth. Separately, China approved AMD's $35
bln acquisition of Xilinx. It won regulatory approval in the US and
Europe. China has rejected the last big chip merger a few years
ago.
Tokyo's January CPI was a
little disappointing.
The headline pace slowed to 0.5% from 0.8% year-over-year. The core
measure, which excludes fresh food, slowed to 0.2% from 0.5% year. The
deflationary thrust can be seen when fresh food and energy are excluded. This
measure stands at -0.7%, matching last year's low point, which was the lowest
since 2013. One key development will come in the next few months when last
year's cut in mobile phone fees drop out of the 12-month comparison.
Rising US yields have
eclipsed equities and is driving the dollar higher against the yen. Today is the fourth advance of the
week. Up until this week, the dollar had only risen against the yen four
times this month. The greenback finished last week slightly below
JPY113.70 and is knocking on the JPY115.70 area now. Some demand may be
linked to the $1.6 bln option at JPY115.50 that expires today. The
five-year high was set on January 4 near JPY116.35. The
Australian dollar is breaking below key support near $0.7000. It has scraped
it before, but it has held on a closing basis since July 2020. A
convincing break could signal a medium-term move toward $0.6750, from a
technical perspective. We have seen a few false breaks this year already.
Caution is advised ahead of next week's RBA meeting, which is expected to shift
toward a less dovish bias. The intraday momentum indicators are
stretched. After surging (relative concept) against the Chinese
yuan yesterday, the greenback consolidated at slightly lower levels today.
Hopes of a cut in reserve requirements ahead of the Lunar holiday were
unfilled. Continued currency strength and soft incoming data may still
get the PBOC to move. The IMF is encouraging more fiscal support.
The dollar's reference rate was set at CNY6.3746. The market (Bloomberg
survey median) was for CNY6.3738.
Europe
The divergence between the
Fed and the ECB will be driven home next week and that is one of the reasons
why we are not particularly sympathetic to ideas that this is a false break like
the upside move was earlier this month. Consider that European businesses have a
practice of cutting prices in January. This pattern was broken for the
first time in more than a decade last year. However, it appears to be
back in play this year. A day before the ECB meets next week, the
preliminary estimate of January CPI is expected to fall by around 0.8% on the
month. This would bring the year-over-year rate down toward 4.3% from
5.0%. The core rate may ease below 2% from 2.6% at the end of last
year. This will allow President Lagarde to resist the pull of the
hawks.
Italy's presidential contest
extends to the fifth round today. We suspect that the longer it goes the less likely it is
given to Draghi. There does seem to be a reasonable recognition that if
Draghi were to become president, the risk of political instability could
return. Of course, a compromise candidate, including having the current
president begin another term, could simply extend the calm a year or so until
next year's parliamentary elections move into the fore. Without a
political party, Draghi is unlikely to serve as PM again.
The launching of a police
investigation into "partygate" appears to be complicating the
internal report conducted by Susan Gray. Her "internal" report was expected this week, but
now it appears that it could be stripped of key details at the request of the
police. Press reports say that the police have requested Gray's report
include only “minimal reference" to the parties. The police
apparently have not asked Gray to limit her inquiry into other events or to
delay the report. On balance and from afar, our best guess is that
Johnson leads the Tories into the May elections before his political future is
decided.
The euro's sell-off has been
extended to almost $1.1120.
Recall that two weeks ago it was near $1.1485. There is an option for 1.2
bln euros at $1.1150 that expires today. It could come back into play as
the intraday momentum indicators are stretched and Europe has not managed to
push it below the lows seen in Asia. This week's 1.8% loss (at $1.1135)
is the largest since last June. We continue to see potential toward $1.10
and will re-evaluate if/when it is approached. Sterling is
consolidating this week's 1.25% drop (at $1.3380). The $1.3400
area, which it is hovering around, corresponds to the (61.8%) retracement
objective of the rally from the December 20 low near $1.3175 to $1.3750
(January 13). The next area of technical support is seen a little above
$1.3300. On the upside, the $1.3440 area offers initial resistance. The
BOE is expected to hike next week and signal it is prepared to let the balance
sheet begin shrinking too. This may deflect some selling pressure
away from it.
America
Fed Chair Powell repeated a
few times a mantra about how growth is robust (despite Covid-inspired
weakness in Q1), the labor market is tight, and prices are elevated. In December and again this week, he mentioned
labor costs. Many liberal and neoliberal economists see core inflation
driven by wage growth. Profits are seen as a residual after cost are
incurred. While that may be helpful for analytic purposes, it is not
clear that it is factually true. Many years ago, I was talking to
the CFO of a large auto manufacturer. I told him that I did not see consistent effort to cut labor costs. I noted that in the annual report,
the company was very proud of being able to produce a car in less than 20
man-hours. Assume labor costs and legacy costs (pensions, etc.) are $150
an hour that is $3000 of labor costs for a car that will cost me $30,000 to
$35,000. I said saving $100 or $200 in labor costs will have little meaningful
impact on the price. The CFO criticized me for thinking like an economist
instead of a businessperson. He explained that the company could not control
the price of capital or raw materials or other inputs, but labor. Getting
a $100 more from labor, doubles and sometimes more than doubles, the profit per
vehicle.
The US reports the Q4 Employment
Cost Index today.
Powell has specifically cited this time series. Although it is not
typically closely followed by market participants, it will likely draw more
attention now that market participants know that the Fed is watching it
closely. The index is a broad measure of changes in compensation
that include direct costs (ages, bonuses, in-kind benefits) and indirect costs
(social security contributions, taxes, medical and other benefits). It
jumped 1.3% in Q3 21, which is the highest since at least 2000. It can be a
volatile series. The four-quarter moving average is 0.9%, the highest
since Q4 04. A 1.2% rise is projected for Q4 (median forecast Bloomberg
survey), which would lift the four-quarter moving average above 1% for the
first time since 2001. In Q3 21, total compensation rose 3.7% year-over-year,
accelerating from 2.8% in Q2. Private sector wages and salaries
rose by 4.6%. The market is pricing in roughly a 1-in-4 chance of a 50 bp
rate hike, something the Fed has not delivered since May 2000. Labor
costs are variable and move the proverbial needle. The US also reports
personal income and spending for last month. While the deflators may draw
attention, the activity was already included in the first estimate of Q4 GDP
(6.9% annualized quarterly pace) released earlier this week. Lastly, note
that some 1700 west coast dock workers have tested positive for the virus,
which fans fears of more supply disruptions.
The Bank of Canada seemed as
hawkish as the Fed.
A March rate hike is as much of a done deal as these things get and the balance
sheet will likely be brought into play relatively quickly. Still the
Canadian dollar continues to be sold. The greenback punched above CAD1.27
yesterday and is pushing near CAD1.28 today. There is an option for
almost $500 mln at CAD1.28 that expires today. Note that the
CAD1.2770 area corresponds to the (61.8%) retracement of the US dollar's
retreat from the December 20 high (~CAD1.2965) to the January 20 low
(~CAD1.2450). Chart resistance above CAD1.2800 may be encountered around
CAD1.2815-CAD1.2835. Meanwhile, the Mexican peso is weaker for the
fifth consecutive session and eight of the last nine. It
continues to be a laggard in the region, with international asset managers
seemingly drawn to Brazil. Brazil's central bank has pre-committed to a
150 bp hike at next week's meeting. The next target for the dollar is
near MXN20.98, the halfway mark of the slide that began from MXN20.1550 late
last November. A note of caution comes from a push above the upper Bollinger Band
(~MXN20.7960). Lastly, Colombia is expected to hike its overnight lending
rate by 75 bp to 3.75% later today.
Disclaimer
Reviewed by Marc Chandler
on
January 28, 2022
Rating:
