Dollar and Yen Finish the Month on Firm Footing

The US dollar is finishing the week and month on a firm note.  It has risen against all the major and emerging market currencies, but the Japanese yen over the course of the month. On the day, this is the same pattern, but a few emerging market currencies, like the Malaysian ringgit and Taiwanese dollar are slightly firmer on month end flows.  

Emerging markets remain front and center.  EPFR is reporting that in the week through January 29, US-based emerging market equity funds saw $6.3 bln of net withdrawals., the most since August 2011.  On the month, some $12. 2 bln  has left.    Emerging market bond funds reportedly experienced $2.7 bln redemptions over the course of the week  and close to twice as much on the month. 

The Asian session was thinned by the Lunar New Year. A quiet start to the European session was interrupted by the softer than expected euro area flash January CPI figures.  The 0.7% year-over-year compares with Bloomberg consensus of 0.9% and a 0.8% pace in December.  Next week the ECB meets.  Its two pillars of monetary policy, inflation and money supply growth, have disappointed this week.   There is some speculation that the ECB can deliver a small interest rate cut next week, without setting a negative deposit rate.    German interest rates are at two month lows and this is with tensions in the euro area at a low ebb.  In fact, we note that today Cyprus is lifting the freeze on withdrawals of term deposits (almost 1 bln euros). We are less sanguine, though we do expect Draghi's comments to be even more dovish.  

Separately, Germany reported a shockingly weak retail sales figure, which admittedly is often erratic.  It fell 2.5% in the month of December.  The consensus called for a 0.2% rise.  On the other hand, household consumption in France fell 0.1% in December, which was smaller than the consensus forecast of a 0.4% decline.  

The US-German 2-year spread is at six-month highs today at a little more than 26 bp.  It is widened by a roughly a third this month.  How it has widened is also important.  It has not widened because Fed tapering is pushing up US interest rates, as many arguments that attribute the acute pressure on emerging markets over the past two weeks seem to suggest.  The US premium over Germany grew primarily because German rates have fallen more than US rates.  The US 2-year yield is off 4 bp this month, while Germany's is off 13 bp.   

We note that the euro area banks are will repay 468 mln euros of LTROs next week.  This week they repaid 3.7 bln euros.  This is a five month low. 

The euro extended this week's losses on the back of that soft CPI report, but bids emerged near $1.3520, in front the month's low (~$1.3508).   A break of this area would be significant from a technical perspective and open the door to 1-2 cent losses initially.  

The other highlight of today's session is a slew of Japanese data.  This includes the first month-over-month decline in core CPI (which excludes only fresh food) in nine months.  The year-over-year rate, however, ticked  up to 1.3% from 1.2%.  For the record the headline rate stands at 1.6% from 1.5% in November.  Europe (leaving aside the UK)  has replaced Japan with the lowest regional inflation.  The so-called core-core rate, which excludes food and energy) stands at 0.7%, up from 0.6%.  

Japan also reported a unexpectedly sharp drop in the unemployment rate to 3.7% from 4.0%.  The labor force fell by 240k, the first decline since July and the number of employed fell by 40k.  Industrial production rose 1.1% in December, a little softer than expected (1.3%). 

Since late last week, the dollar has flirted with the JPY102 area, but has not closed the North American session (the end of the 24-hour session) below there.   A convincing break signals a test on the more important JPY101.50-60 area.   It appears to us that the yen's gains are primarily the reduction of short yen positions as opposed to new "safe haven" related purchases.  

The North American session features Q4 US Employment Cost Index, which is expected to remain low with a 0.4% rise expected.  This coupled with the December personal income and consumption data has been rendered moot by yesterday's Q4 GDP report.  The PCE and PI data was already incorporated into the estimate.  That leaves the January Chicago PMI and the University of Michigan's measure of consumer confidence as the new news.    Canada reports Nov GDP figures, which also have been superseded by events and will unlikely have much market impact.