Dollar Bid

The US dollar is posting across the board gains as the global capital markets continue to be unsettled. The yen is holding its own against the dollar, but is firmer on the crosses. Emerging market assets and currencies remain under pressure.

The Fed's decision to continue to taper made no reference to the market turmoil. The key take away is that the bar for Yellen to change the course Bernanke has put the Fed on is higher than such turmoil and a disappointing jobs report. Many observes still insist that the Fed's tapering in behind the emerging market turmoil. We do accept the idea that the Fed reducing its asset purchases begins a change in the overall investment climate, but it is really a transition phase. 

The Fed is not removing any stimulus whatsoever. It is injecting it at a slightly slower pace. And even that pace--$65 bln in the month of February is still 50% larger than the initial amount for QE3+ before the purchases of Operation Twist were rolled into it. It may not be until some time in Q2 that its purchases are back to the initial size. US 10-year government bond yields fell 20-25 before the recent market turmoil began and therefore, the proximate cause cannot be simply attributed to higher US interest rates.  

Following the FOMC statement, a news wire poll of primary dealers found unanimous agreement that tapering will continue at the next meeting (March 18-19).  Note that due to weather factors, there is risk that the January employment report (due at the end of next week) will also be soft.  Meanwhile, the survey found that 14 of 16 primary dealers do next expect a hike before Q3 2015.  

The timing of the market pressure coincides better with the disappointing preliminary HSBC manufacturing PMI for China. The sub-50 reading was confirmed today at 49.5, down from last week's 49.6 and December's 50.5 reading.  The official measure is to be released Saturday.  The wealth management issue has also been resolved, but at a price.  The moral hazard implicit in acting as if 10% returns can be guaranteed, when one year government bonds (risk free investment) yield less than 5% will continue.  We noted this previously and it has become a larger talking point today. 

Yet the other horn of the dilemma seems to be under-appreciated.  This year and next year billions of dollars worth of wealth management products are set to mature.  There is also greater concerned about the explosion of debt in China over the past few years.  This is coinciding with the diminishing returns of capital.  Each new unit of capital (debt) is generating a smaller incremental increase in GDP.  Chinese officials want to navigate this problem on its own terms and not let the market force its hand by triggering a crisis over a maturing trust.  

There have not been sufficient developments to stabilize sentiment yet.   Japanese December retail sales were considerably weaker than expected, posting a 1.1% fall on the month after a 2.0% rise in November.  The consensus had called for a 0.3% increase anticipating a continued front-running of the retail sales tax hike on April 1.  The tax is scheduled to go up in 2015 again (from 8% to 10%), but it appears that the government has yet to commit to it and it may still be rescinded (at a future date). 

Separately we note that latest MOF weekly portfolio data was released and the foreign appetite for Japanese stocks is understandably waning.  The 2.45% decline in the Nikkei today brings the year-over-year decline to 7.9%. .  Foreign investors sold Japanese stocks last week and appears set to have been net sellers for the month, the first such month since last August.  Japanese investors have been consistent  sellers of foreign bonds for four weeks and five of the past six weeks. 

German issued a strong employment report.  Unemployment fell by 28k people, more than five times more than the Bloomberg consensus expected.  The unemployment rate stands at 6.8%, unchanged from the revised December figures (was 6.9%).   The US unemployment rate is likely to fall below the German rate in the coming months, especially if the Congress does not extend the emergency unemployment benefits. 

German states have reported January inflation readings and it looks as if for the country as a while a small increase to 1.5% is possible.  This means that deflation for the euro zone as a whole continues to be kept at bay.  The deflationary pressures in the periphery are seen as largely desirable as an "internal devaluation" and the only way to boost competitiveness under the terms of a monetary union (and ordo-liberalism that is enshrined to varying extents in European institutions).  

In Europe, there are two other developments to note today.  First, there is a low level Danish political crisis caused by one of the three parties in the minority government leaving in protest over the purchase of a 19% stake in the state-owned energy company by a US investment bank. A larger crisis appears to have been averted as the party said it will still support the government but not be a member of it.  There has not been much of a market reaction.  

Second, developments in the Ukraine illustrate the key nexus of external events and policy response.  Ukraine is in a difficult position and its difficulties have been exacerbated by the policy response.  It is proving too much for President Yanukovich, who reports say is taking some sick time, what ever that really means for a  President.  That he has a headache and under stress is surely understandable.  After seeing Putin's carrots, he felt the stick yesterday.  

Russia apparently has frozen assistance and clamped down on border checks to apparently protest the resignation of the pro-Russian Prime Minister Asarov and the softening of the stance against anti-Russian protesters.    Ukraine bonds are being crushed.  The 10-year yield is up 45 bp today to 9.78% and the 5-year CDS is also sharply higher.  No doubt, some clever wag will show how Ukraine's problems are somehow tied to the Fed's tapering. 

The US reports weekly initial jobless claims and the first estimate of Q4 GDP.  Weekly jobless claims may tick up a little, but the four week moving average, which is at its lows since early December is likely to fall further.  The economy is expected to have grown around 3.0% at an annualized pace, following 4.1% in Q3.  Final sales (GDP minus inventories) should be even stronger than in Q3.  On the other hand, the core PCE deflator is likely to have fallen closer to 1% from 1.4% in Q3.