Choppy FX Price Action at Start of Week

There have been three developments to note to start the week.  First, the removal of Yanukovych in Ukraine has seen a continued relief rally with 10-year yields dropping a little more than 100 bp to around 8.9%.  

The 5-year CDS has also fallen 185 bp to about 940.  Both are now back to late-January levels.  The equity market extended the gains seen at the end of last week. 

Ukraine has an estimated $17 bln of debt coming due by the end of next year, excluding interest costs.  As of the end of January the foreign reserves were estimated at almost $18 bln and may have fallen by as much as a third this month.   There are some reports that the interim government, led by Turchynov, is seeking as much as $35 bln in foreign assistance.

There is not much of a positive to knock-on effect to other emerging markets from the political developments in Ukraine.    The MSCI Emerging market equity index is off about a 0.3%, though remaining well within the pre-weekend range, and most of the freely accessible emerging market currencies are under water today.   

Perhaps this is, in part, a reaction to the second important development today:  China's yuan has extended last week's losses as the PBOC set the reference rate (fix) lower for the fifth consecutive session, hitting a two-month low.     

The Shanghai Composite fell 1.8%, its biggest loss in seven weeks amid reported in the Shanghai Securities News that some state-owned banks are restricting lending to the property sector.  This saw property developers lead the decline. A sub-index of property fell the most in 8 months )5.4%) .     A report out earlier shows that increase in new home prices is slowing.  

The third development bring us back to the high income economies.  Specifically, the Germany IFO shows European engine is strong, but similar to the ZEW, the expectations component was softer.  This warns that this may be the best it gets.  The business climate and current assessment picked up more than expected to stand at 111.3 and 114.4 respectively, from 110.6 and 112.4.  The expectations component slipped to 108.3 from 108.9.  The consensus expected a larger decline in expectations. 

The preliminary euro area January CPI was revised up to 0.8%, the same as the core.  This is seen as largely a rounding up adjustment and does not change the overall disinflation environment.  The more important inflation data will come at the end of the week, with the preliminary February reading.  This seems far more important for the ECB's March 6 meeting that the January figures.  The consensus expects a preliminary 0.7% increase in the headline rate and unchanged core reading.  An unexpected drop in the preliminary CPI, however, will excite those who look for the ECB to take new initiative, under the shield of new staff forecasts. 

The euro built on the pre-weekend gains, but stalled out in front of last week's seven week high (~$1.3773).  The $1.3800 area has kept the euro's advance in check since last October.    While intra-day penetration has taken place over the past five months, it has rarely managed to close above it.   Sterling, on the other hand, fell in early Europe to an 8-day low just below $1.66, but it quickly rebounded to test to the $1.6680 area, where it again seemed to stall. 

The Australian dollar's function as a China-proxy of sorts was evident today.  The Aussie tumbled on the Chinese news and it approached last week's lows just below $0.8940.  However, it rebound in Europe to new highs, just shy of $0.9000.  It will the fifth consecutive session of lower highs, unless it can push through $0.9015 today. 

The dollar has traded a bit heavier against the yen, though held above the JPY102 level.  We suspect that provided the greenback holds above the uptrend line of the Feb 4, Feb 17 and Feb 20 lows, comes in near JPY101.80.  

The North American session sees the Jan Chicago National Fed Activity Index and the February Dallas Fed Manufacturing  Index.  The risk is that both disappoint to the downside as has more often than not been the base in the recent weeks.  The weather is an important factor, though we acknowledge it is not the only one.  We see the impact of the inventory cycle, the failure to extended emergency unemployment benefits and the expiration of a tax break on capital expenditures as also playing a role.  

In the US morning, European afternoon, Italy's new Prime Minister, Renzi will faced a confidence vote in the Senate.  There is little doubt that he will be supported by a majority.  However, a telling point will be whether he secures more votes that Letta (173).    Tomorrow he will face a confidence vote in the Chamber of Deputies.  Over the weekend, a closer Renzi advisor and the head of the cabinet office suggested that some funds to finance the Renzi's reforms, could be raised by increasing the tax on government bonds.