Oil Continues to Slide, Blowing Deflationary Winds

Brent oil is off another 3% today, taking its decline since the end of last year to 20%.  This is overshadowing other macro-economic forces.  With the Federal Reserve among the least likely central banks to respond, the dollar is firm, even if within recent ranges.   

The deflationary forces are depressing bond yields, arguably more than central bank buying could, and encouraging investors to move into equities.  Core European bonds yields, as well as Spanish and Italian benchmark 10-year yields are off 3 bp.  US 10-year Treasury yields are also off 3 bp and are just above the mid-Oct flash crash low of 1.86%.  A break here could spur another 20-30 bp move from a technical perspective.  

Asian equities struggled after US equity losses yesterday and with Japan re-opening after yesterday's holiday.  Chinese equities snapped their small losing streak.  On the other hand, European shares are moving higher with the Dow Jones Stoxx 600 up 0.75%, though the energy sector is a drag.   The decline in energy prices is expected to boost disposable income, and this is helping the consumer staples and discretionary sectors. 

The US corporate earnings season formally began with Alcoa yesterday.  Both its top and bottom lines beat expectations.   Foreign exchange developments actually worked to its benefit, contrary to media reports that made it seem as if they would only work against US earnings.   Yesterday the S&P 500 closed the downside gap created from the higher opening on January 8, easing some of the technical downside pressure.  US shares are trading higher in Europe, pointing to a higher open today.  

Two inflation reports and two trade reports dominate today's macro-economic developments.  The UK reported a 0.5% year-over-year increase in CPI.  This was below the 0.7% consensus and is half the pace seen in November.   BOE Governor Carney has to write a letter to Chancellor of the Exchequer Osborne to explain the undershoot.  Energy and food prices are the key drivers.  We note that the core rate actually ticked up from 1.2% to 1.3%.   The December short-sterling futures firmed to test the contract high set last April at 99.32 (implied yield 68 bp) as the market all but give up on the idea of a rate hike this year. 

Sweden also reported December CPI figures.  It was surprisingly firm at 0.2% on the month.  The market had expected a 0.1% decline.  The year-over-year rate did slip into more negative territory (-0.3% from -0.2%) but was not as low as had been feared/expected (-0.5%).  The underlying  rate did tick up to 0.2% from 0, but caution is advised here.  The underlying rate is calculating using a fixed mortgage interest rate rather than excluding food and energy. 

The Swedish krona rallied on the news and is the strongest of the major currencies today, gaining 1% against the US dollar.  The Riksbank meets on February 12, and an adoption of aggressive action seems somewhat less likely now.   It may still adjust its forward guidance; pushing out the timing of the first rate hike and perhaps lengthening the some repo operations, but negative rates or bond purchases seems unlikely.  

Japan and China reported trade figures.  Japan's November current account surplus was larger than expected at JPY433 bln, but was a little more than half of the October surplus, due largely to seasonal factors.  The drop in oil price appears to be doing what the decline in the yen has largely failed to do, and that is improve the trade balance.   This is likely to continue in the months ahead.  

China's December trade surplus was largely in line with expectations at $49.6 bln.    However, the mix was surprising.  Exports on a year-over-year basis doubled to 9.7% from 4.7% in November.  The consensus expected a 6.0% increase.  Imports surprised too.  They fell 2.4% after November's 6.7% decline.  The consensus expected a 6.2% fall.    There are some suspicions that there may still be an invoicing problem as a way to disguise capital flows.  However, in the past such invoicing irregularities were a way to conceal capital inflows while the yuan was appreciating.   The yuan depreciated by 1% in December after slipping 0.5% in November. 

Separately, and receiving less attention, Greece reported the pace of deflation intensified in December.  Under the harmonized calculus, Greece CPI fell -2.5% year-over-year from -1.2% in November.  With yields rising ahead of the January 25 election, the real interest rate is crushing.  Separately, Italy offered a rare upside surprise.  Industrial output rose 0.3% in November, and the October series was revised to flat from -0.1%.    Italy remains among the weakest of the largest EMU members, and political tensions are likely to increase.