Major Currencies Stuck in Range, while Antipodeans become Unstuck

The euro, sterling and yen remain confined to their recent ranges, while the Australian and New Zealand dollars succumbed to selling pressure.  

The Reserve Bank of New Zealand shifted to a more neutral tone, as had been widely anticipated.  What seemed to have surprised the market was the more aggressive efforts to talk the currency down.  It was already an offered market and participants were happy to comply.  Consider on Tuesday the New Zealand dollar traded just below $0.7900.  Today it recorded a low near $0.7280 in Europe, and the selling pressure remains acute.   The $0.7000 area is the next main objective.  

The Australian dollar posted a outside down day yesterday, trading on both sides of Tuesday's range, and closing below Tuesday's low.  The slightly firmer than expected Q4 CPI figures was shrugged off; encouraged by the local RBA-watcher playing up the risk that the RBA delivers a rate cut next week.  The Aussie had briefly traded up to $0.8025 yesterday.  Today it was pushed below $0.7800, for the first time since 2009.  

The lack of much price action from the majors should not be confused with the lack of news.  Indeed, the session has been eventful.  In addition to the antipodean developments, there were two other developments in the Asia-Pacific region.  First, Japan reported disappointing retail sales.  Instead of rising 0.3% as the consensus expected, retail sales in December fell by 0.3%.  It was the third consecutive monthly decline.  Tomorrow Japan reports a full slate of economic data, including employment and CPI.  Despite the unprecedented pace of balance sheet expansion by the BOJ, the market generally is anticipating more measures toward the middle of the new fiscal year that begins April 1.  

Second, once again Chinese officials are reportedly cracking down on brokerage lending and margin use.  This led to a 1.3% decline in the Shanghai Composite,led by the financials. Separately, the PBOC continued to provide liquidity (CNY45 bln) via reverse repos.    The PBOC fixed the yuan-dollar higher today.  The dollar surrendered initial gains to return to little changed levels.  

There are a number of developments in Europe that are demanding continued attention by investors. Greek bonds remain under strong downside pressure, while the stock market is bucking the weakening trend and posting modest gains.  The new government is but a few days old, but investors and observers see in the early appointments, no willingness to compromise with its official creditors. Talk of Grexit has risen, and of course, the euro-skeptics are making much hay.  Nevertheless, we continue to see room for compromise, even though it is premature to expect it now.  Both sides are hardening their negotiating position.  At the end of last year, the Troika extended the current assistance program two months until the end of February.  Given Europe's track record, it would not be surprising to see the prolonged brinkmanship tactics lead to another month extension.

Italy's presidential election begins today.  Prime Minister Renzi's overtures to Berlusconi risk alienating the left-wing of the PD and making for much drama.  Recall that 1) there is a maximum of two rounds per day and 2) the first three rounds require super-majority, while beginning with the fourth round, a simply majority suffices.   The first three rounds then are about posturing and positioning to gain chits and alliances for the subsequent rounds.    

Turning to economics, one of our thesis is that there has been some improvement in the financial conditions in the eurozone prior to the sovereign bond buying program, which does not begin until March.  Today's data bears this out.  First, M3 rose 3.6% year-over-year in December.  This was a touch faster than expected, and marks improved over the 3.1% pace seen in November.  Money supply growth has been improving since mid-2014.  It is understood to be a precondition for arresting deflation. 

Second, with the money supply data, bank lending figures were released.  These also continue to improve.  In fact, lending to the private sector posted its first positive reading in two years, albeit a small 0.1% increase.  Lending to households continued to improve.  It rose 0.8% (0.7% in November).  Lending to business continued to contract but at a slower rate (-1.0% from -1.4%).  This is important in its own right, but also for the implications for March TLTRO, which is tied to future lending.  Recall that earlier this month, the ECB cut the 10 bp premium over the repo rate for the TLTRO borrowings.  

Deflationary forces are still strengthening in the euro area.  The flash January CPI will be reported tomorrow.   It is expected to be -0.5% year-over-year.  The risk may be on the downside after the German figures.  German states reporting have shown some sizable drops.  The nationwide figure will be released shortly and is expected to be at least -0.2% year-over-year.  The German contingent at the ECB objected to the sovereign bond buying program,but it is not clear how the BBK itself would address the loss of price stability (i.e., outright deflation) in Germany. 

One reason why officials fear deflation is that it could prompt consumer to hold back purchases in anticipation of lower prices.  While the theory may be solid, the practice suggests otherwise.  The theory clearly does not work for some goods, like electronics.  More importantly, look at Spain. Tomorrow it will report is preliminary CPI figures, and deflation pressures are likely to have strengthened.   The harmonized measure is expected to slump to -1.5% from -1.1% year-over-year. Yet, today Spain reported retail sales in December jumped 6.5% year-over-year on a seasonally adjusted basis, well above the 2.5% expected and the 1.9% pace in November.  

The US weekly initial jobless claims and pending home sales are overshadowed by yesterday's FOMC statement and tomorrow's Q4 GDP and Employment Cost Index.  The brief FOMC statement contained no surprises.  The modest upgrade in the growth assessment is consistent with continued above trend growth seen since last April.  The reference to international developments is prudent; new but not surprising.  With Japan and Europe taking measures to provide more economic support, falling interests rates and the drop in energy prices, the international headwinds may not prevent the Fed from responding to the improving US labor market and economic strength.  

We would be surprised if any one's view on the likely trajectory of Fed policy changed due to yesterday's statement, our views included.  We still think that a mid-year hike is the most likely scenario.  We recognize that just as the tapering began a little later than most expected, a September lift-off is also possible.