Dollar Marks Time, Yen Softens as Equities Recover

The US dollar's strength is a product of both the expected trajectory of Fed policy and the fact that ECB and BOJ are still in aggressive easing modes.  Both sides of the equation of being driven home.  Wall Street's Journal's Hilsenrath recognized to be well sourced at the Federal Reserve reaffirms that it is on track to raise rates later this year.   Next week, the FOMC will likely continue to recognize that it can be "patient".  However, to sustain expectations of a mid-year hike, it seems likely to change its guidance at the March meeting, which is followed by a press conference. 

At the same time, there are expectations for the BOJ to cut its growth and inflation forecasts at the conclusion of its two day meeting tomorrow.  There is also speculation that it may cut its deposit rate, which has stood at 30 bp since late 2008.    While the Japanese 2-year bond yield has been negative, today is the first day that the 5-year yield has slipped below zero.  

The main focus this week is on the ECB and the likelihood that it announces a more aggressive asset purchase plan that will include sovereign bonds.  Even though the German representatives at the ECB are still expected to balk at the decision, the German government appears to have indicated that it will not publicly oppose, despite its private misgivings.  The compromises on risk-sharing (sovereign bonds to stay on national central bank balance sheets), the size of the program (seen around 500-700 bln euros), and maturities (shorter) are anticipated.  Many observers share our concern that the  program has largely been discounted, and more importantly, may not fix what ails the eurozone. 

The BOJ is expanding its balance sheet by an incredible 1.4% of GDP per month and is fighting an uphill battle to lift inflation.  The ECB's program will be considerably smaller.    Six eurozone members already have negative 2-year yields, two have negative 5-year yields (Germany and Finland), and another four have 5-year yields below 10 bp.   As we have seen with the ABS that the ECB is trying to buy, there are less willing sellers.  

While the modalities of the ECB's asset purchases are dominating the discussions, the ECB may also take its deposit rate more into negative territory.  Also, recall that this week's ECB meeting is the first under the new rotating voting regime.  Spain, Estonia, Ireland and Greece will not vote.  Given the importance of consensus decision making, it is not yet clear the significance of the rotation.  Lastly, the ECB is expected to respond to the Greek central bank's request to extend ELA funding to local banks. 

There are three sets of economic reports that are noteworthy today.  First, China's economic data was mixed, but not far from expectations.  The Q4 GDP was reported at 7.3% year-over-year, the same as Q3 and a tick better than expected.  December industrial output (7.9% year-over-year) and retail sales (11.9% year-over-year) were also slight better than expected.  Fixed asset investment (15.7% year-over-year) was in line with expectations.  The main take-away is that the Chinese economy is slowing gradually.  On its face, the data does not warrant a large scale stimulus effort.  Instead, a continued targeted approached, bringing forward some public investment and fine tuning monetary support is the most likely scenario. 

Second, and not completely unrelated, the IMF cuts its global growth forecasts for this year and next.  Last October the IMF projected world growth at 3.8% this year.  This has been cut to 3.5%.  Next year's growth forecast has been cut to 3.7% from 4.0%.   It sees the decline in oil prices to be net positive, but not sufficient to offset other headwinds.  Chinese growth was cut to 6.8% this year and 6.3% in 2016.    The IMF sees India surpassing China's growth in FY2017 (6.3% through March 2016 and 6.5% in the year to March 2017).  Emerging markets more generally bear the burden.  The IMF cut Russia, Brazil, Middle East and African growth forecasts.    

Even assuming further easing by the ECB, the IMF shaved 0.2% and 0.3% off eurozone growth this year and next to 1.2% and 1.4% for 2015 and 2016 respectively.   The US and Spain's growth forecasts were revised higher.  US is expected to grow 3.6% this year (up from 3.1%) and 3.3% in 2016.  This is more optimistic than the Fed's views.   The IMF reckons Japan will grow 0.6% this year, down from 0.8% of its previous forecast. 

Third, the German ZEW investor survey was better than expected.  The assessment of the current situation rose to 22.4 from 10.0.  The consensus was a for a small increase to 13.0.  It is the third consecutive improvement after the sharp fall at the start of Q4.  The expectations component rose to 48.4 form 34.9, handily beating expectations for a 40.0 reading.  It now stands at its highest level since February 2014.  We find the survey often tracks the equity market performance.  The DAX is extending last week's advance that lifted it to record highs. 

There are no market moving data in North America today.  Due to yesterday's holiday in the US, the weekly API and EIA reports have been delayed a day.  They will be reported Wednesday and Thursday.    Brazil's central bank is widely expected to lift the Selic rate by 50 bp after the markets close today.